Executives earning over $1,000,000 annually may permanently lose deferred compensation benefits if their employer does not take action by December 31, 2020, because of significant changes to Code Section 162(m) made by the Tax Cuts and Jobs Act (TCJA).
Background
Section 162(m) limits the amount publically traded companies can deduct for payments to a “covered employee” to $1,000,000. When Section 162(m) makes deferred compensation payments nondeductible, employers are allowed under Code Section 409A to delay those payments. These amounts are paid in a subsequent year when the employer is not prevented from taking the deduction under Section 162(m).
To take advantage of the ability to delay nondeductible amounts, some deferred compensation plans require the delay of payments until Section 162(m) no longer prevents the deduction. This provision worked well under prior Section 162(m) rules, because the delayed amount would eventually be deductible—the employee would at some point cease being a covered employee and, as a result, cease being subject to Section 162(m). Then the delayed payment would be made.
New Perpetual Delay in Payment
This all changed when the TCJA amended Section 162(m) to provide that once an employee becomes a covered employee, the employee is always a covered employee. The consequence can be severe for deferred compensation plans that require a delay in payment until Section 162(m) no longer prevents the deduction. Since a covered employee is always a covered employee, Section 162(m) could continually restrict the deductibility of amounts owed to that employee, even after termination of employment, leading to a perpetual delay in payment.
The IRS recognized this issue and gave employers until December 31, 2020, to remove mandatory delay provisions.
The new perpetual delay in payment issue does not affect plans that allow—but do not require—the delay in payment due to Section 162(m).
Action Steps
In light of the Section 162(m) changes, employers should:
- Determine whether they are subject to Section 162(m). The TCJA expanded the definition of “publicly traded” to include companies not traditionally considered publicly traded, so it’s important for an employer to reassess whether it’s now subject to Section 162(m).
- Review their deferred compensation plans to determine whether the documents include a mandatory delay provision. If a plan includes this provision, then the plan should be amended no later than December 31, 2020.
If you would like assistance determining whether you are subject to Section 162(m) or reviewing or amending your deferred compensation plans, please contact any member of Warner’s Employee Benefits/Executive Compensation Practice Group.
