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Article | Executive Pay Memo North America

COVID-19 relief act expands employees subject to $1 million pay cap 

Governance Advisory Services |Executive Compensation
COVID 19 Coronavirus

By Steve Seelig and Gary Chase | March 15, 2021

Revenue-raising provision effective in 2026 could portend expanded taxes on executive compensation

The Katie Couric rule lives, in a sense. Remember back in 2006 when the proposed Securities and Exchange Commission proxy disclosure rules would have required disclosure of the most highly paid employees, rather than those who were the highest-paid executive officers as of year-end? Back then, the concern was that America would get to see Katie Couric’s then eight-figure pay for anchoring the CBS Evening News in its proxy disclosure rather than the pay of the executive officers who managed the company. When that rule was changed in the final regulations, many companies breathed a sigh of relief.

To help raise revenue to offset the cost of the sweeping American Rescue Plan Act of 2021 (ARPA), Congress has updated Internal Revenue Code section 162(m), effective in 2026, to expand the number of “covered employees” subject to the $1 million deduction limit. Under current law, beginning in 2017, a corporation’s “covered employees” include any principal executive officer (PEO) or principal financial officer (PFO) at any time during the taxable year, plus any employee who is among the three highest compensated officers for that taxable year (other than the PEO or PFO). This means that companies must continue to track former employees in this category — because “once a covered employee, always a covered employee” — so that even payments made by a company post-termination and post-death must be viewed under the $1 million deduction limit.

Under ARPA, effective in 2026, this group is expanded to include employees who are among the five highest compensated employees for the year, in addition to the existing pool of officers who are “covered employees” under current 162(m), hence the analogy to the former Katie Couric rule. The law, however, does not apply the “once/always” rule under current 162(m) to this top five group of employees, so they will not automatically be treated as covered employees in a future year. This also means that, as companies often did under prior law section 162(m), there may be some planning opportunities to defer compensation until after separation from service, when that person is certain not to be in the top five. But because a company always will have a top five group of employees for every year, the question will be whether deferring compensation for that individual will yield any appreciable benefit for the company.

The reasons this tax-related provision made it to ARPA and why it has a delayed effective date are best characterized as arcane under the Budget Reconciliation rules that permitted ARPA to pass with a simple Senate majority. Suffice it to say that the expanded deduction limitations are forecast to cost corporate America just under $8 billion in lost deductions from 2026 to 2031. Note: Revenue impacts under these laws are only forecast over 10 years from the date they become law.

The potential good news is that a lot can change in Congress between this week’s effective date of the new law and 2026. The bad news is that Congress may very well need more revenue offsets as additional infrastructure and other spending bills are considered later this session.

Our experience over the years has been that once Congress has its eyes set on certain hot-button, tax-related issues, it often returns to those areas for more revenue raisers. For example, the repeal of the performance-based exception under 162(m) was forecast to generate significant revenue savings by denying deductions for compensation awarded after November 2, 2017, which includes the appreciated value of equity grants, but that provision sunsets in 2027. Congress could extend that rule’s impact for another four years to find more revenue, or it could turn to other areas that are now limited to its imagination.


Senior Director, Executive Compensation (Arlington)

Director, Retirement and Executive Compensation

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