March 29, 2021

Congress Expands Covered Employee Limits in Section 162(m) Through American Rescue Plan Act

Holland & Knight Alert
Kerry L. Halpern | Victoria H. Zerjav | Michael Romeo


  • The American Rescue Plan Act added a new subsection to Section 162(m) of the Internal Revenue Code to expand the application of Section 162(m) to an additional five most highly compensated individuals.
  • The expansion of Section 162(m) coverage is effective for tax years beginning after Dec. 31, 2026.
  • Unlike the employees subject to Section 162(m) by virtue of being the chief executive officer (CEO), chief financial officer (CFO) or three most highly compensated employees, an employee who is identified as one of the "additional" five employees is not considered to be a covered employee indefinitely.

President Joe Biden on March 11, 2021, signed the American Rescue Plan Act of 2021 (ARPA), a $1.9 trillion conglomerate of COVID-19 relief, funding and tax legislation. While numerous other provisions of ARPA have received public attention – mainly focused in national news sources on the inclusion of $1,400 stimulus payments to citizens – ARPA expands the reach of the Internal Revenue Code's Section 162(m), $1 million compensation deduction limitations to include an additional five of the highest-paid employees, other than the chief executive officer (CEO), chief financial officer (CFO) and three highest-paid employees currently covered by Section 162(m).

Overview of Section 162(m)

Section 162(m) precludes publicly held corporations from deducting more than $1 million per year in compensation paid to certain covered employees. For taxable years beginning on or before Dec. 31, 2017, the term "covered employees" applied to the individual serving as the CEO as of the last day of the taxable year, in addition to the three most highly compensated officers whose compensation was required to be reported to shareholders pursuant to the U.S. Securities and Exchange Commission's disclosure rules. Beginning in 2018, the definition of "covered employees" was expanded through the Tax Cuts and Jobs Act of 2017 (TCJA) to include any individual who served as the CEO or CFO during the taxable year, in addition to the three most highly compensated individuals aside from the CEO and CFO. Additionally, the TCJA expanded the definition of covered employees to include any individual who was a covered employee for any taxable year beginning after Dec. 31, 2016. In other words, any individual that was a covered employee for a tax year beginning on or after Jan. 1, 2017, and beyond would remain a covered employee for all future taxable years.

The American Rescue Plan Act's Revisions to Section 162(m)

Through the American Rescue Plan Act, Congress included a new subsection to Section 162(m), which expands the number of covered employees whose compensation exceeds $1 million in one fiscal year may not be deducted by a publicly held company. Although the expanded definition goes into effect beginning with tax years that begin after Dec. 31, 2026, the ARPA revision to Section 162(m) will include an additional "five highest compensated employees" beyond the CEO, CFO and the three highest-paid executive officers already covered by Section 162(m). In other words, for purposes of Section 162(m) covered employees will eventually include the CEO, CFO and the eight highest-paid employees of a public company (as well as any employees who were previously identified in an applicable year as the CEO, CFO or three most highly compensated employees).

Although the ARPA revision to Section 162(m) is an expansion of covered employees, the additional covered employees identified pursuant to ARPA will only be treated as covered employees for the relevant year in which they are reported and the "once a covered employee, always a covered employee" provision does not apply to them. Thus, based on the changes from ARPA, there are now three "tiers" of employees for Section 162(m) purposes for a taxable year: 1) anyone who served as a CEO or CFO for the taxable year; 2) the next three highest-compensated employees; and 3) the next five highest-compensated employees. Under the current iteration of the law, the covered employees in tiers 1 and 2 would remain a covered employee indefinitely, but the covered employees included in tier 3 could change depending on the compensation arrangement for a taxable year.

Conclusion and Takeaways

As noted above, the expansion of covered employees under Section 162(m) does not go into effect until the 2027 tax year. While the delayed effective date provides some time for deferred tax planning and revising of compensation arrangements, the expansion of deduction limits in Section 162(m) will undoubtedly impact compensation arrangements in the future.

If you have any questions about how the addition to Section 162(m) may affect your company, please contact the authors or another member of Holland & Knight's Employee Benefits and Executive Compensation Team, including Partners Bob Friedman, Ari Alvarez, Howard Clemons, Kelly Bley, John Martini, Ryan Meadows, David Pardys and Rachel Shim.

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