We have discussed previously the anomalous exemption of public company chief financial officers from the $1 million deductibility limitations of Code Sec. 162(m) created by a mismatch of SEC reporting rules and the regulations under Code. However, a recent Chief Counsel Memorandum 201543003 adds yet another twist to the situation.

Treatment of CFOs Under 162(m)

Code Section 162(m)(3) defines a “covered employee” (whose compensation over $1 million the company cannot deduct) as an employee of the company if (a) as of the close of the taxable year, such employee is the CEO of the taxpayer or is an individual acting in such capacity, or (b) the total compensation of such employee for the taxable year is required to be reported to shareholders in the proxy statement because such employee is among the four highest compensated officers for the taxable year (other than the CEO). The SEC rules refer to these executives as “named executive officers” or “NEOs” [Item 402 of Regulation S-K].

Under the SEC’s 2006 disclosure rules, NEOs consist of (i) all individuals serving as the company’s principal executive officer or acting in a similar capacity during the last completed fiscal year, regardless of compensation level; (ii) all individuals serving as the company’s principal financial officer or acting in a similar capacity during the last completed fiscal year, regardless of compensation level; and (iii) the company’s three most highly compensated executive officers other than the CEO and the CFO who were serving as executive officers at the end of the last completed fiscal year.

However, in Notice 2007-49, the IRS indicated that it would interpret the term “covered employee” for purposes of section 162(m) to mean any employee of the company if, as of the close of the taxable year, such employee is the CEO of the company or if the total compensation of such employee for that taxable year is required to be reported to shareholders under the Exchange Act by reason of such employee being among the three highest compensated officers for the taxable year (other than the CEO or CFO). The Notice also provided that the term “covered employee” for purposes of 162(m) does not include those individuals for whom disclosure is required under the Exchange Act on account of the individual being the company’s CFO.

This Notice and a private letter ruling [PLR 200945009] from 2009 made it clear that the IRS really intended to exclude CFOs from 162(m).

Chief Counsel Memorandum 201543003

The CCM involved the CFO of a public company, which was generally subject to the executive compensation disclosure requirements under the Securities Exchange Act of 1934. However, the company also was a smaller reporting company under Item 402(m) of Regulation S-K. The SEC applies more lenient disclosure requirements to smaller reporting companies. 

SEC rules define a “smaller reporting company” generally as a public company that had a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter, computed by multiplying the aggregate worldwide number of shares of its voting and non-voting common equity held by non-affiliates by the price at which the common equity was last sold, or the average of the bid and asked prices of common equity, in the principal market for the common equity. Whether or not an issuer is a smaller reporting company is determined on an annual basis.

The CFO was the second highest compensated executive officer of the company for 2014, other than the CEO. The CCM observed that, for smaller reporting companies, the disclosure rules require disclosure of compensation for the CEO (based on his or her service as the CEO) and the two most highly compensated executive officers other than the CEO who were serving as executive officers at the end of the year. The disclosure rules for smaller reporting companies do not require disclosure of compensation of an officer because of the individual serving as CFO. Instead, the disclosure rules require disclosure of compensation for the CFO of a smaller reporting company only if the CFO is one of the two most highly compensated executive officers other than the CEO who were serving as executive officers at the end of the year.

Therefore, the CCM concluded that the CFO of a smaller reporting company is a covered employee if the CFO is one of the two most highly compensated executive officers other than the CEO who were serving as executive officers at the end of the year.

Smaller reporting companies should take note of this clarification and review their current approach to 162(m).