The IRS recently proposed an expansion of the definition of a “Covered Employee” under Section 162(m) to take effect for taxable years beginning after December 31, 2026. Please see below for details on the current rule and proposed regulations. Companies, investors, and interested parties have until March 17, 2025 to submit feedback on the proposed regulations.
Current Rule:
Currently, all compensation exceeding $1 million in a fiscal year to any Covered Employee is not tax-deductible to companies. Covered Employees are the following:
- Employees serving as Principal Executive Officer(s) during the fiscal year
- Employees serving as Principal Financial Officer(s) during the fiscal year
- The next three highest-paid Executive Officers in a fiscal year
Any employee designated as a Covered Employee in a taxable year beginning after December 31, 2016 is permanently considered a Covered Employee in each subsequent year going forward (i.e., “once covered, always covered”); in other words, any compensation paid over $1 million in all future fiscal years to these employees is not tax deductible in those respective fiscal years, even if the employee no longer meets one of the above criteria.
Proposed Regulations:
Under the proposed regulations, the definition of a Covered Employee will expand to include both the Covered Employees from the current rule and the next five highest-paid employees, which can include any of the following:
- Executive Officers
- Common law employees of the publicly held corporation and its affiliated group
- Individuals who are employed by a different employer but function as employees of the publicly-held corporation or its affiliated group
The “once covered, always covered” rule will not apply to the five additional employees that fall under this new definition (but will continue to apply to the PEO, PFO, and three next highest-paid executive officers under the current rule). Individuals already classified as Covered Employees from prior years by virtue of the “once covered, always covered” rule can be counted as one of the next five highest-paid employees (if they fall into this group in a given fiscal year).
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This report was authored by Ken Foulks and Jackson Haw. To discuss this topic and any additional issues, please visit our website or call us at 212-886-1022.
