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January 22, 2025 | Legal Advisory

On January 14, 2025, the Internal Revenue Service (the “IRS”) issued new proposed regulations under section 162(m) of the Internal Revenue Code (the “Code”), supplementing regulations already in effect. Under section 162(m), publicly held companies are subject to an annual deduction limitation of $1 million for certain compensation of “covered employees.” The proposed regulations address an amendment made to section 162(m) by the American Rescue Plan of 2021 (the “ARP”). Prior to the ARP amendment, “covered employees” included only:

1. the principal executive officer (the “PEO”) or principal financial officer (the “PFO”) at any time during the taxable year;
2. employees, excluding the PEO and PFO, whose compensation must be reported to shareholders under the Securities Exchange Act of 1934 (the “Exchange Act”) by reason of being among the three highest compensated officers for the taxable year; and
3. anyone who was covered under (1) or (2) for any taxable year beginning after December 31, 2016 (i.e., the “once a covered employee, always a covered employee” rule).

The ARP amendment expanded the list of “covered employees” for taxable years beginning after December 31, 2026 by adding new section 162(m)(3)(C) to include also the next five highest compensated employees for the taxable year, regardless of whether they are officers, excluding individuals already captured in categories (1) or (2), above. The proposed regulations clarify the methods by which the IRS will determine “employees” for these purposes.

Determining Eligible Employees

The proposed regulations clarify that any common law employee or officer may be considered an employee under section 162(m). This includes any individual that was an employee at any time during the taxable year at issue, regardless of whether such individual was employed at the end of the taxable year. Because the text of section 162(m)(3) does not exclude individuals captured by category (3), above, an individual who falls within both category (3) and the new five highest compensated employee category will count as one of those next five highest compensated employees as well. The PEO, PFO, and the three highest compensated officers under the Exchange Act would not count as one of those next five highest compensated employees. The proposed regulations also clarify that employees engaged through a professional employer organization will be treated as employees for these purposes, so long as they are providing services to the company.

Determining the Next Five Highest Compensated Employees

The proposed regulations use the definition of “compensation” in the current section 162(m) regulations, which includes compensation that would (but for section 162(m)) be deductible. It is noteworthy that this is not the same approach for determining compensation required to be disclosed under the Exchange Act.

Application to Affiliated Groups

The proposed regulations continue to define the term “publicly held corporation” to include an affiliated group of corporations (as defined in section 1504 of the Code) that includes at least one corporation that is publicly held. The proposed regulations provide further clarity for affiliated groups, for example:

• To address the concern that a company could move its highest compensated employees to a non-publicly held corporation that is an affiliate of a publicly held corporation, the proposed regulations provide that any employee of any corporation in the affiliated group may be one of the five highest compensated employees for these purposes, regardless of whether the employee performs services for the publicly held corporation.
• With respect to an affiliated group with multiple publicly held corporations, each publicly held corporation will have its own five highest compensated employees. In these cases, the affiliated group is split into smaller affiliated groups, each consisting of a publicly held corporation and its affiliates.
• For employees who are compensated by more than one member of an affiliated group, their compensation is aggregated for purposes of determining the five highest compensated employees.
• Compensation paid by foreign members of an affiliated group may be taken into account, but only if it is incurred in connection with a trade or business carried on in the U.S.

What’s Next?

We are continuing to monitor updates and will keep you apprised of future developments. If you have any questions, please do not hesitate to contact your Nutter attorney.

This advisory was prepared by Erin Whitney Cicchetti in Nutter’s Tax Department. For more information, please contact the author or your Nutter attorney at 617.439.2000.

This advisory is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.