Last month year, I blogged on the new Proposed Regulations issued by IRS and the Treasury Department on the changes to Code Section 162(m) made by the Tax Cuts and Jobs Act of 2017 (TCJA). This is a major development for executive compensation professionals, but I stopped blogging when we went into the Holiday Season (and I began to receive a 50% out-of-office bounce-back rate). But the party is over and I will continue by focusing on one aspect of the proposed regs at a time. Today’s topic is the exemption of a certain amount paid to the CFO under the transition/grandfathering rules of Section 162(m), as embellished by the proposed regs. Under the proposed regulations (and in our experience), CFOs are the most likely class of current executives to enjoy grandfathering protection for amounts paid pursuant to a written binding contract in effect on November 2, 2017.
Readers will recall that amounts paid pursuant to a written binding contract in effect on November 2, 2017, may be exempt from the $1 million deductibility limit of 162(m) under certain conditions. For example, certain incentive awards made before November 2, 2017, which satisfied the performance-based compensation requirements of pre-TCJA provision of 162(m) (e.g., stock options and performance shares) could be entitled to grandfathering status and be exempt from the deductibility limit when paid or exercise in subsequent years.
The grandfathering rules for CFOs are even more favorable. Prior to November 2, 2017, a company’s CFO was not a “covered person” under 162(m) and, therefore not subject to the $1 million deductibility limit. Thus, compensation paid or accrued to the CFO pursuant to a grandfathered employment agreement could be exempt, even if the amounts are not performance-based. The proposed regs. provide the following example, which I have edited for brevity:
On October 2, 2017, Corporation executed a 3-year employment agreement with its CFO for an annual salary of $2,000,000 beginning on January 1, 2018. The agreement provides for automatic extensions after the 3-year term for additional 1-year periods, unless the Corporation exercises its option to terminate the agreement within 30 days before the end of the 3-year term or, thereafter, within 30 days before each anniversary date. Termination of the employment agreement does not require the termination of the CFO’s employment with Corporation. Under applicable law, the agreement for annual salary constitutes a written binding contract in effect on November 2, 2017, to pay $2,000,000 of annual salary to the CFO for three years through December 31, 2020. Because the October 2, 2017, employment agreement:
1. is a written binding contract to pay the CFO an annual salary of $2,000,000, and
2. the CFO is not a covered employee for the Corporation’s 2018 through 2020 taxable years,
The deduction for the CFO’s annual salary for the 2018 through 2020 taxable years is not subject to section 162(m). However, the employment agreement is treated as renewed on January 1, 2021, unless it is previously terminated, and the $1 million limit will apply to the deduction for any payments made under the employment agreement on or after that date (not grandfathered).
The foregoing example also illustrates the complicated contract renewal and termination issues that apply to agreements that otherwise would be grandfather, but we will save those issues for another day.