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ARPA Expands Section 162(m) Limits on Deductibility of Pubic Company Executive Compensation in Excess of $1 Million to Include Additional Employees

November 16, 2021

The American Rescue Plan Act (“ARPA”) has expanded the list of “covered employees” of a publicly traded corporation whose annual compensation in excess of $1 million dollars is not deductible by the publicly traded corporation under Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”). ARPA was enacted on March 11, 2021, but these provisions under Section 162(m) are not effective until tax years beginning after 2026.

Under current law, the “covered employees” of a publicly traded corporation whose compensation in excess of $1 million for the year is not deductible are (1) any individual who serves as the principal executive officer at any time during the year (the “CEO”), (2) any individual who serves as the principal financial officer at any time during the year (the “CFO”), (3) the three most highly-compensated officers for the year other than the CEO or the CFO (the “Other NEOs”), and (4) any other individuals who were covered employees during any prior year beginning after 2016 on account of being the CEO, CFO or an Other NEO for such prior year.   

With ARPA’s changes, beginning in 2027, a publicly traded corporation’s “covered employees” for a year will be expanded to also include the five highest compensated employees of the corporation for the year other than the current or former CEO, the current or former CFO and the current or former Other NEOs (“Additional HCEs”). Accordingly, a publicly traded corporation will have at least ten covered employees during any year beginning after 2026.

Under current law and continuing under ARPA, individuals who are the CEO, CFO and the Other NEOs for a year permanently retain their status as covered employees for all future years. By contrast, those Additional HCEs included in the ARPA-expanded list of covered employees for a year are not covered employees for any future year unless they are the CEO, the CFO, an Other NEO or among the next highest paid five employees for the year.

ARPA made various other changes to Code Section 162(m), including treating as an Other NEO a service provider who is not an officer but who is among the three highest paid service providers for a year other than the CEO or the CFO.

The ARPA-expanded list of covered employees, coupled with other recent changes such as the 2017 Tax Cuts and Jobs Act repeal of the performance-based compensation exception to the Code Section 162(m) $1 million annual deduction limitation, will likely significantly expand the scope and impact of the provision.

If you have any questions regarding how to appropriately assess the deductibility limits for compensation paid to employees of public companies, please contact one of the Attorneys in Honigman’s Tax or Employee Benefits practices. 

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