Tax deductions

How Good Planning Can Reduce Lost Tax Deductions For Senior Executives


Unlike all previous definitions of a covered employee subject to the $ 1 million deduction limit, the expansion of ARPA includes non-commissioned officers in the definition of covered employees. (Photo: Shutterstock)

On December 16, 2019, the Internal Revenue Service (IRS) issued a draft regulation (REG-122180-18) under section 162 (m) of the Internal Revenue Code (IRC), which is the provision tax which generally imposes an annual limit of $ 1 million on deductions by a public company for compensation paid to certain senior executives.


John schultz is Managing Director of the Compensation and Benefits Group of Alvarez and Marsal. He specializes in compensation and benefits planning and consulting.

A few years earlier, in 2017, the Tax Cuts and Jobs Act (TCJA) amended section 162 (m) by broadening the definition of public company and covered employees, and eliminating the performance-based compensation exception. almost universally used. Under the TCJA, the definition of a covered employee has been revised to include the CEO, CFO and the three highest paid executives (previously the CFO was excluded from the definition of covered employee). In addition, once designated as a covered employee, an officer will always be a covered employee for the purposes of the TCJA (including with subsequent employers).

Related: Top Executive Compensation Issues To Consider In An Economic Downturn

The American Rescue Plan Act of 2021 (ARPA) was signed by President Joe Biden on March 11, 2021. In addition to many other provisions, the ARPA also included an amendment to section 162 (m), which expands the definition of a covered employee. . As of December 31, 2026, the definition of a covered employee will be revised to include five other highest paid employees (whether executives or not), significantly expanding the group of employees subject to the deduction limit of 1. million bucks. These five highest paid employees are in addition to the broader definition of employees covered by the TCJA.



Jeff Swerdlow is Senior Director of the Compensation and Benefits group of Alvarez & Marsal. He brings his experience in assisting public, private, private equity and non-profit organizations.

Unlike all previous definitions of a covered employee subject to the $ 1 million deduction limit, the expansion of ARPA includes non-commissioned officers in the definition of covered employees. This change brings the base number of covered employees to ten (it could be greater than ten if the business is required to include certain legacy covered employees).

However, these five new employees will not be subject to the TCJA “once an employee is covered, always a covered employee”. This means that even though the CEO, CFO and the next three highest paid executives will still be considered a covered employee (since subject to the “once an employee is covered…” rule), the additional group of five employees is more. subject to change. from year to year. Therefore, the five additional covered employees added by the ARPA reviews will need to be assessed each year and may change with each tax year.

Due to this potential year-over-year change in the next five highest paid covered employees, companies can plan ahead for payments to this larger group of highest paid employees and bypass the payroll deduction limit. of $ 1 million. For example, companies may seek to defer compensation payments to a later year after the beneficiary is no longer in the next five highest paid groups (for example, after separation from service) or to provide additional compensation over the course of of the current year (for example, by increasing bonus payments) to manage which employees are included in the extended group.


Sarah rumsey is a senior partner in the Compensation and Benefits group of Alvarez & Marsal. She focuses on executive compensation, design of stock-based incentive plans, human resources due diligence, review of executive employment contracts and benchmarking compensation.

However, keeping track of this larger group of the top five paid employees could be tricky and likely require some administrative work. In addition, questions remain as to whether or not the IRS will continue to use the Securities and Exchange Commission definition of compensation for purposes of determining the highest paid groups of officers and employees, or will choose to adopt a. different approach.

While the effects of ARPA will not be felt until 2027, the delayed implementation should not lull companies into a false sense of security. Deferred tax planning and review of compensation arrangements should take place as early as possible, as the impact of ARPA could negatively impact future compensation deductions if sufficient planning is not carried out.

Deferred compensation may become more useful than ever in ensuring that companies can continue to deduct compensation from highly paid employees who might otherwise be subject to the extended covered employee rule. Finally, companies will want to develop administrative follow-ups for both groups of covered employees as they will have one group of permanent covered employees and another group of current covered employees that are subject to annual changes.


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