As you all know by now, a company that pays more than $1 million in total compensation (cash, equity, etc.) to a “covered employee” in 2018 or later generally will not be able to deduct the amount over $1 million, subject to the transition rule for plans and agreements in place on November 2, 2017.

Beginning in 2018, the definition of “covered employee” is broader, including the CEO, the CFO, one of the next three highest paid executive officers, or anyone who fits into one of these categories in 2017 or after (including former employees). Once an employee becomes a “covered employee” under Section 162(m), payments made to him or her will remain subject to the $1 million limit on deductibility forever, even on the individual’s death!

What planning strategies are left to us to reduce the impact of this limit? We have come up with two, so far. Deferring compensation until retirement or termination of employment is one of them. Keeping in mind the “once a covered employee, always a covered employee” rule, deferred compensation, supplemental executive retirement plans (SERPs), and other forms of non-qualified plan benefits offer two possible benefits.

First, with respect to former covered employees to whom a company will be obligated to pay more than $1 million in deferred compensation or SERP benefits per year after retirement or termination, even though the amount in excess of $1 million will not be deductible, at least the company will be able to postpone the outflow of cash (with no corresponding deduction) for several years. Cash flow is important to most companies.

Second, after a covered employee’s retirement or other termination of employment, the company still will be able to pay and deduct up to $1 million in benefits each year. For active executive employees at many companies, $1 million per year may be only a fraction of salary, bonus, and long-term incentive. However, the payments made by many, if not most, companies to former covered employees after retirement or termination will be less than $1 million and, therefore, fully deductible. (And, of course, the company will not have to expend the cash until then.)

Finally, the Conference Committee report on the Tax Cuts and Jobs Act suggested that accounts and accrued benefits as of November 2, 2017 would be exempt from the $1 million limit under the transition/grandfathering rule applicable to written, binding contracts. We will need to wait for guidance from the IRS as to the breadth of this grandfathering protection, but it seems certain to be of help.

Happy New Year.