Mark Poerio specializes in executive compensation,
employee benefits, and fiduciary matters, especially from a business,
governance, tax, securities, and litigation perspective. He currently
serves as President of the prestigious American College of Employee
Benefits Counsel, and on the executive board of the American Benefits
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Wagner Law Group is a nationally recognized practice in the areas of
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in 1996, The Wagner Law Group is dedicated to the highest standards
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April 24, 2018
2018 Update for Internal
Revenue Code Section 162(m) Changes
Cuts and Jobs Act of 2017 made fundamental changes to Section 162(m)
of the Internal Revenue Code. The general nature of those changes is
noted below, along with thoughts about their impact on public
companies - and next steps that compensation committees should
consider. Forward-minded action is warranted in order to preserve
corporate deductions, especially for severance and other
post-employment compensation that were previously safe from 162(m).
- 2017 Tax Law
Change: An exemption from 162(m) remains broadly available for
taxable income that is paid pursuant to a written binding
contract that was in effect on 11/02/2017 and is not thereafter
materially modified.* Compensation Committees - In order to
preserve grandfathering, be careful to preserve grandfathering
not only through caution before amending any compensatory plans
or agreements in effect before 11/02/2017, but also by assuring
that material modifications do not occur for performance-based
awards (such as, arguably, by failing to maintain committee
independence or to provide proper certifications of performance
results, when needed).
Renewals - These are deemed material modifications, so consider
162(m) implications before renewing employment agreements for senior
discretion" - It is unclear, though reasonably arguable,
that a material modification does not occur if a company
exercises negative discretion after 11/02/17 provided that right
existed beforehand. Companies should seek updated information
from legal counsel before exercising such discretion.
No Future Exemption for Performance-based
- 2017 Tax Law
Change: gone is the 162(m) exemption for income from for stock
options, SARs, or other performance-based compensation (unless
attributable to a grandfathered contract).
- For new or
amended equity award and incentive plans: consider eliminating 162(m)
provisions, such as those that require --award timing in first
90 days of the year;
by "non-employee directors";
objective formulae and metrics (because subjective measures and
increased discretion are allowable now that 162(m) does not
of results by non-employee directors before payouts; and
approval of the plan or awards.
careful to examine shareholder-approval issues before amending
a plan that previously received such approval.
- To preserve
corporate deductions, consider increased use of deferred
compensation and restricted stock (with longer vesting
schedules), and less use of stock options.
draft new severance plans and employment agreements to provide
for installment payouts, as well as to allow severance bonus
payouts at target - 162(m) formerly did not allow.
- Beware of
Code 409A implications before changing the time of payment for
the severance due under existing employment agreements.
- Be aware of
8-K and proxy statement disclosure requirements for any actions
- See "New
Year, New Stock Plan"
for further alternatives to consider.
Expanded "Covered Employee" Definition
- 2017 Law
Changes: (1) CFOs join CEOs and the top three highest paid
employees listed in proxy statements, and (2) once a covered
employee after 2016, always a covered employee, in contrast to
prior law which applied only to those employed at year-end.
deferred compensation, installment payouts, and other changes
that preserve the company's ability to deduct compensation, and
severance, paid after a covered employee's termination of
- Be careful
to make changes for corporate purposes, and in accordance with
material modifications to compensatory plans and awards that
were in place on 11/02/2017 and that provide post-employment
compensation (e.g. SERPs).
New Companies Brought within 162(m)'s Scope
- 2017 Law
Change: expands 162(m) to cover companies with publicly-traded
debt, and foreign companies with publicly-traded ADRs.
Anticipated Reaction from Shareholder
- Take into
account the likely reaction of investors and shareholder
advisory groups before updating executive compensation plans and
practices in response to the foregoing 162(m) changes.
Reproduced in the Appendix below are comments that ISS published
early in 2018, in order to provide its perspective.
- It has long
been generally accepted that, although 162(m)'s $1 million
deduction limit is a factor to consider in executive
compensation planning, it is more important to structure
executive compensation in a manner that achieves corporate
goals. Interestingly, the tax law changes that occurred in 2017
should make it easier to align these considerations, mainly
because public companies are now freed from jumping through the
162(m) hoops that were required before 2018 in order to secure
ISS Warnings (from David Kokell, head of ISS U.S. Compensation
Research, posted 1/25/2018 on Harvard Governance Blog):
- GENERAL ADVICE: "For
companies, think carefully about significant departures from
your existing compensation framework and, to the extent
possible, test those changes with your shareholder base to get
early feedback whether they view the changes as beneficial."
- FORMULA AWARDS: "As in
previous years, changes that generally reduce the transparent
and objective pay-and-performance alignment between shareholders
and executives will be viewed negatively when we evaluate
compensation pay-for-performance. Negative changes could include
material shifts away from performance-based compensation, less
transparent disclosure of performance metrics and goals,
selecting metrics and setting performance goals later in the
performance cycle, and issuing in-the-money stock options."
- SHIFT TO SALARY? "We've seen
at least one high profile company, citing the new tax regime,
replace variable bonus opportunities with large guaranteed base
salaries. Such a decision effectively eliminates the at-risk
nature of pay and severs the linkage between pay and
performance. I have no doubt that any board that eliminates or
reduces performance-conditioned incentives in favor of
guaranteed or highly discretionary pay is going to face investor
backlash. ISS will continue to closely scrutinize any decision
that diminishes performance pay, and wholesale shifts to fixed
pay components will likely result in adverse vote
- PLAN CHANGES: "I would caution
companies that may be considering removing these
shareholder-friendly features (such as limits on discretion or
award caps) from their incentive programs simply because they
are no longer required under 162(m). ISS, and many investors,
will view such actions as detrimental to shareholders' interests."
- DISCRETION AND AWARD LIMITS: "The
requirement that awards be contingent on the attainment of
pre-established performance goals remains paramount. Investors
also tend to prefer an objective payout formula with performance
goals established early in the performance measurement period. I
would also stress that setting individual award caps and
limiting the ability for upwards discretion on payouts will also
be viewed as important safeguards. That said, we've heard from
some investors that they have comfort with some level of
discretion embedded in programs, as long as that discretion is
applied judiciously and is well-explained."