More Employees Will Be 162(m) Covered Employees under the American Rescue Plan Act

The American Rescue Plan Act (ARPA), passed by Congress and signed into law on March 11, 2021, expands the definition of “covered employee” under Internal Revenue Code Section 162(m), requiring the inclusion of an additional top five highest paid employees (beyond those officers already counted).

Section 162(m) imposes a $1 million deduction limit on remuneration paid to a covered employee. Currently, covered employees for a particular tax year include the principal executive officer, the principal financial officer, and the next three most highly compensated officers (the Five Officers). The 2017 Tax Cuts and Jobs Act (TCJA) changed the Section 162(m) rules for tax years after December 31, 2016, so that an individual’s status as a covered employee will continue even if he or she is no longer among the five highest paid officers (e.g., for purposes of compensation paid after he or she terminates from employment with the public company). Therefore, today the list of covered employees includes the Five Officers and anyone who was one of the Five Officers for tax years beginning after December 31, 2016.

Effective for tax years beginning after December 31, 2026, the ARPA expands the definition of covered employee to include any employee who is among the highest paid five employees of the public company (the High Five) in addition to the Five Officers. Thus, a public company will have at least ten covered employees for each tax year – the Five Officers, the High Five, and any of the individuals who were among the Five Officers whose status as a covered employee has continued from a prior tax year pursuant to the TCJA revisions.

Unlike the Five Officers, the High Five will not have their covered employee status continue in subsequent tax years, unless they continue to be among the High Five for the relevant year, and most likely (based on prior interpretations and understandings of Section 162(m)) will not be considered a covered employee after termination of employment as a result of being in the High Five.

Public companies have a significant amount of time to consider the impact of this change to Section 162(m) prior to its effective date, but they should consider beginning the planning process now. It will now be necessary to track and address the tax and accounting implications for three distinct groups: (1) CEO/CFO (once on the list/always on the list); (2) the next three highest paid officers (once on/always on); and (3) the next five highest paid employees (counted only in the year among the High Five). Although this change could change again before it becomes effective for tax years beginning after December 31, 2026, the Biden administration seems inclined to pursue legislation that will impose higher taxes on corporations rather than remove limitations on tax deductions. In addition, public companies that sponsor nonqualified deferred compensation plans with grandfathered benefits should also keep in mind helpful payment guidance in the 162(m) final regulations.

Contact your Faegre Drinker benefits attorney to discuss the impact of these changes on your company’s compensation structure.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

About Author: Sarah Bassler Millar

Sarah Bassler Millar counsels employer plan sponsors and service providers on the design, implementation, and administration of health and welfare benefits, retirement plans and nonqualified plans. She routinely advises on fiduciary governance matters, including current best practices and the implications of the prohibited transaction rules. When counseling clients, she focuses on identifying solutions that effectively mitigate risks and manage identified compliance issues, while taking into account the client’s employee recruitment and retention goals. Sarah formerly led the firm’s benefits and executive compensation group. View all posts by and

About Author: Mark Rosenfeld

An employee benefits lawyer, Mark Rosenfeld counsels employers, plan sponsors and administrators on the design, administration and governance of retirement plans (such as 401(k) plans) and welfare plans (such as health plans). He also drafts executive compensation arrangements, equity incentive plans and severance plans. Mark provides detailed analysis and advice on IRS Code § 280G golden parachute provisions in M&A transactions. View all posts by and

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