As mentioned in a previous blog, the IRS has issued its initial guidance on Code Section 162(m), as modified by the Tax Cuts and Jobs Act. One important aspect of the guidance is its discussion of preserving deductibility under the transition rule, also known as the 162(m) “grandfather” rule. Under the grandfather rule, compensation paid pursuant to a written binding contract that is in effect on November 2, 2017 and has not been materially modified is deductible to the extent it would have been under the old Section 162(m) rules.
Significant focus has been placed on how the grandfather rule applies to performance-based compensation. However, employers should also review non-performance-based compensation arrangements that have historically relied on the deferred amounts being paid after the covered employee’s termination of employment for exemption from Section 162(m)’s deduction limit. Except for amounts qualifying under the grandfather rule, this exemption for amounts deferred until after termination of employment is no longer available under the new “once a covered employee, always a covered employee” rule of new Section 162(m).
Exactly how the grandfather rule will apply to deferred compensation is not entirely clear. For example, a provision in a deferred compensation arrangement that allows an employer to change or freeze earnings or investment credits on a deferred compensation account may mean that earnings after November 2, 2017, will not be grandfathered, depending on whether there are legal limitations on how that right could be exercised. However, it is clear that knowing an employee’s nonqualified deferred compensation account balance or accrued benefit on November 2, 2017, is critical, as may be the ability to track earnings on that account balance through the date of payment.
All employers, whether or not currently subject to Section 162(m), should consider gathering, and making arrangements to track and retain, this information for all employees participating in nonqualified deferred compensation plans, whether or not they are currently covered employees. Because of the potentially lengthy period of deferral (until termination of employment), it is possible that, at the time of payment, Section 162(m) will apply to the employer and the employee will be a covered employee.