IRS Issues Guidance on 162(m) Grandfathering Rules

August 28, 2018

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Following up on the release, last week, (August 21, 2018) of Guidance on Section 162(m) of the Federal Tax Code, we are sharing the initial reactions of Attorney Mike Melbinger, Partner in the Chicago offices of Winston & Strawn, LLP.

Below are excerpts from two of Mike’s posts about this timely topic, previously published in the Executive Compensation Blog, and republished here with permission.

Additionally, you’ll want to review:

Stop the Presses! IRS Issues Critical 162(m) Grandfathering Rules

Publishing date: Aug 21, 2018

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 (named executive officer, added for clarity), 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.


More Details on the IRS Guidance on the 162(m) Grandfathering Rules

Publishing date: Aug 22, 2018

As I posted yesterday, the IRS has published Notice 2018-68 with essential guidance on the 162(m) transition/grandfathering rules. The guidance answers nearly all of our questions, but it is not nearly as favorable as we hoped and not even as favorable as we expected. It contains more than 14 detailed examples, which are more helpful than the text itself. However, the guidance (and the examples) is full of twists and turns and exceptions to the exceptions.

One thing the guidance does make absolutely clear is that the first step in determining whether any payment to any person in any year after 2017 is subject to the draconian limits of Section 162(m) is to determine whether there was a written binding contract in effect on November 2, 2017, which created a legal obligation on the company under any applicable law (e.g., state contract law) to pay the compensation under such contract if the employee performs services or satisfies the applicable vesting conditions. Every one of the many examples provided in the guidance begins with a determination of whether the plan or agreement created a legal obligation on the company. In the examples, some do and some do not.

The existence of discretion to reduce any promised payment does not always make the full payment subject to the deduction limit of 162(m), but it usually reduces the amount of the payment that is grandfathered. However, the failure, in whole or in part, to exercise negative discretion under a contract does not result in the material modification of that contract.

As we predicted in a few blogs from earlier in the year, the accrued benefits and accounts under non-qualified deferred compensation plans are most likely to qualify for grandfathering protection. In many cases, future payments to the company’s CFO will be grandfathered and remain deductible. However, as we feared, benefits and accounts under plans that reserve to the company the right to amend or terminate the plan prospectively (which includes all well-drafted plans) will only be grandfathered to the extent they are legal obligations as of November 2, 2017.

Continue to read Fulcrum Partners News for further insights on Guidance on the Application of Section 162(m). Most importantly, contact any member of the nationwide Fulcrum Partners team of executive benefits professionals for customized, creative solutions to help your organization attract, retain, and reward key employees and top talent.

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