As I posted yesterday, the IRS has published Notice 2018-68 with essential guidance on the 162(m) transition/grandfathering rules. The guidance answers nearly all of our questions, but it is not nearly as favorable as we hoped and not even as favorable as we expected. It contains more than 14 detailed examples, which are more helpful than the text itself. However, the guidance (and the examples) is full of twists and turns and exceptions to the exceptions.
One thing the guidance does make absolutely clear is that the first step in determining whether any payment to any person in any year after 2017 is subject to the draconian limits of Section 162(m) is to determine whether there was a written binding contract in effect on November 2, 2017, which created a legal obligation on the company under any applicable law (e.g., state contract law) to pay the compensation under such contract if the employee performs services or satisfies the applicable vesting conditions. Every one of the many examples provided in the guidance begins with a determination of whether the plan or agreement created a legal obligation on the company. In the examples, some do and some do not.
The existence of discretion to reduce any promised payment does not always make the full payment subject to the deduction limit of 162(m), but it usually reduces the amount of the payment that is grandfathered. However, the failure, in whole or in part, to exercise negative discretion under a contract does not result in the material modification of that contract.
As we predicted in a few blogs from earlier in the year, the accrued benefits and accounts under non-qualified deferred compensation plans are most likely to qualify for grandfathering protection. In many cases, future payments to the company’s CFO will be grandfathered and remain deductible. However, as we feared, benefits and accounts under plans that reserve to the company the right to amend or terminate the plan prospectively (which includes all well-drafted plans) will only be grandfathered to the extent they are legal obligations as of November 2, 2017.