The American Rescue Plan Act (ARPA), the new $1.9 trillion COVID-19 relief bill, includes provisions related to the treatment of executive compensation under Internal Revenue Code (IRC) Section 162(m).
The Tax Cuts and Jobs Act of 2017 (TCJA) previously made changes to the treatment of executive compensation and nonqualified deferred compensation (NQDC) plans. Under Section 162(m), employers can pay someone $1 million and receive a tax deduction, but there would be no deduction for earnings greater than that. The TCJA expanded the definition of compensation for purposes of the $1 million deduction limit to include all remuneration paid for services by eliminating the performance-based compensation and commission exceptions for compensation paid to top executives at publicly traded companies.
In addition, under the TCJA, the definition of “covered employee” expanded to include anyone who is the chief executive officer (CEO) or the chief financial officer (CFO) at any time during the tax year, as well as the three highest paid officers during the year.
Compensation includes amounts distributed from NQDC plans. The TCJA also updated 457(f) plans and applied a 21% excise tax to the top-five highest-paid employees (or former employees) of a tax-exempt or governmental entity each year on any compensation that exceeds $1 million per employee. 457(f) deferred compensation that is vested (i.e., that is no longer subject to a substantial risk of forfeiture) counts toward the $1 million threshold.
The ARPA expands the application of the $1 million deductibility cap to include the next five highest compensated employees, in addition to the CEO, CFO and the three other highest compensated officers.
Attorneys from Seyfarth Shaw point out in a legal update that unlike other covered employees, the ARPA does not require that these additional five employees be permanently treated as covered employees; the five additional covered employees would be re-determined based on compensation levels each year.
Changes will take effect for tax years beginning after December 31, 2026.
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