Stop the presses! IRS issues critical 162(m) Grandfathering Rules Blog Executive Compensation Blog

Apologies for my second blog post of the day, but this is BIG news. Today, the IRS published Notice 2018-68 with essential guidance on the 162(m) transition rules. Recall that the new, harsher version of Section 162(m), with no exception for performance-based compensation, “ shall not apply to remuneration which is provided pursuant to a written binding contract which was in effect on November 2, 2017, and which was not modified in any material respect on or after such date .” Until now, the biggest mystery of 2018 has been the extent to which the transition guidance will allow companies to continue to deduct awards, payments, and benefits under Code Section 162(m). The waiting is over and our real work can begin.

Because the new rules are (long and) complicated, I plan to address them in this blog in bite-sized pieces over the next week, rather than try to cram it all into this post. However, briefly, Notice 2018-68 provides guidance on:

• What constitutes a written binding contract in effect on November 2, 2017 ( hint , it may require a legal judgment)
• What constitutes a material modification of a written binding contract
• The types of remuneration that may remain deductible (protected from the new rules under the grandfather exception)
• The extent to which certain individuals employed in 2017 and the future will become and remain covered employees subject to the deductibility limit

And, the Tax Cuts and Jobs Act of 2017 didn’t just eliminate the performance-based compensation exception under 162(m), it expanded the deductibility cap to the company’s CFO and imposed the cap on all future compensation paid to any employee who ever became a “covered employee” in or after 2017. For example, if an employee who became an NEO, as reported in the proxy statement, in 2017 or 2018, was terminated from employment in some future year—whether it is 2019 or 2029—and received severance, benefits, and deferred compensation payouts of $3 million in that year, the company would not be able to deduct any amount over $1 million . Therefore, unless public companies all over America suddenly decide to cut dramatically the compensation of their executives and officers, a priority for executive compensation professionals will be to find a way to maximize the deductibility of current and future compensation. And the best way to maximize the deductibility of current and future compensation is to protect it under the grandfathering rules.