[Federal Register Volume 84, Number 245 (Friday, December 20, 2019)]
[Proposed Rules]
[Pages 70356-70391]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-26116]



[[Page 70355]]

Vol. 84

Friday,

No. 245

December 20, 2019

Part IV





Department of the Treasury





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Internal Revenue Service





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26 CFR Part 1





 Certain Employee Remuneration in Excess of $1,000,000 Under Internal 
Revenue Code Section 162(m); Proposed Rule

  Federal Register / Vol. 84, No. 245 / Friday, December 20, 2019 / 
Proposed Rules  

[[Page 70356]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-122180-18]
RIN 1545-BO95


Certain Employee Remuneration in Excess of $1,000,000 Under 
Internal Revenue Code Section 162(m)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document sets forth proposed regulations under section 
162(m) of the Internal Revenue Code (Code), which limits the deduction 
for certain employee remuneration in excess of $1,000,000 for federal 
income tax purposes. These proposed regulations implement the 
amendments made to section 162(m) by the Tax Cuts and Jobs Act. These 
proposed regulations would affect publicly held corporations. This 
document also provides a notice of a public hearing on these proposed 
regulations.

DATES: Written or electronic comments must be received by February 18, 
2020. Outlines of topics to be discussed at the public hearing 
scheduled for March 9, 2020, at 10 a.m. must be received by February 
18, 2020.

ADDRESSES: Submit electronic submissions via the Federal eRulemaking 
Portal at www.regulations.gov (indicate IRS and REG-122180-18) by 
following the online instructions for submitting comments. Once 
submitted to the Federal eRulemaking Portal, comments cannot be edited 
or withdrawn. The Department of the Treasury (Treasury Department) and 
the IRS will publish for public availability any comment received to 
its public docket, whether submitted electronically or in hard copy. 
Send hard copy submissions to: CC:PA:LPD:PR (REG-122180-18), Room 5203, 
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
122180-18), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW, Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning these proposed regulations, 
Ilya Enkishev at (202) 317-5600; concerning submissions of comments, 
the hearing, and/or being placed on the building access list to attend 
the hearing, Regina Johnson at (202) 317-6901 (not toll-free numbers) 
or [email protected].

SUPPLEMENTARY INFORMATION: 

Background

    This document sets forth proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under section 162(m). Section 162(m)(1) 
disallows the deduction by any publicly held corporation for applicable 
employee remuneration paid with respect to any covered employee to the 
extent that such remuneration for the taxable year exceeds $1,000,000. 
Section 162(m) was added to the Code by section 3211(a) of the Omnibus 
Budget Reconciliation Act of 1993, Public Law 103-66. Proposed 
regulations under section 162(m) were published in the Federal Register 
on December 20, 1993 (58 FR 66310) (1993 proposed regulations). On 
December 2, 1994, the Treasury Department and the IRS issued amendments 
to the proposed regulations (59 FR 61884) (1994 proposed regulations). 
On December 20, 1995, the Treasury Department and the IRS issued final 
regulations under section 162(m) (TD 8650) (60 FR 65534) (final 
regulations).
    Section 162(m) was amended by section 13601 of the Tax Cuts and 
Jobs Act (TCJA) (Pub. L. 115-97, 131 Stat. 2054, 2155 (2017)). Section 
13601 of TCJA amended the definitions of covered employee, publicly 
held corporation, and applicable employee remuneration in section 
162(m). Section 13601 also provided a transition rule applicable to 
certain outstanding compensatory arrangements (commonly referred to as 
the grandfather rule).
    On August 21, 2018, the Treasury Department and the IRS released 
Notice 2018-68 (2018-36 I.R.B. 418), which provides guidance on certain 
issues under section 162(m). Specifically, the notice provides guidance 
on the amended rules for identifying covered employees. Furthermore, 
the notice provides guidance on the operation of the grandfather rule, 
including when a contract will be considered materially modified so 
that it is no longer grandfathered. Notice 2018-68 requested comments 
on the following issues:
     The application of the definition of publicly held 
corporation to foreign private issuers, including the reference to 
issuers that are required to file reports under section 15(d) of the 
Securities Exchange Act of 1934,
     the application of the definition of covered employee to 
an employee who was a covered employee of a predecessor of the publicly 
held corporation,
     the application of section 162(m) to corporations 
immediately after they become publicly held either, through an initial 
public offering or a similar business transaction, and
     the application of the Securities and Exchange Commission 
(SEC) executive compensation disclosure rules for determining the three 
most highly compensated executive officers for a taxable year that does 
not end on the same date as the last completed fiscal year.
    In drafting these proposed regulations, the Treasury Department and 
the IRS have considered all comments received on the notice. See Sec.  
601.601(d)(2)(ii)(b). Commenters noted that the many examples in Notice 
2018-68 were helpful in illustrating the guidance in the notice. In 
light of these comments, the Treasury Department and the IRS have 
included numerous examples in these proposed regulations to illustrate 
the proposed rules.

Explanation of Provisions

I. Overview

    Section 13601 of TCJA significantly amended section 162(m). This 
document adds a section to the Income Tax Regulations (26 CFR part 1) 
to reflect these amendments. The amended section 162(m) applies to 
taxable years beginning after December 31, 2017, except to the extent 
the grandfather rule applies. Because the final regulations continue to 
apply to deductions related to amounts of remuneration that are 
grandfathered, the final regulations are retained as a separate section 
in the Income Tax Regulations under section 162(m).

II. Publicly Held Corporation

A. In General
    Section 162(m)(2) defines the term ``publicly held corporation.'' 
Before the amendments made by section 13601(c) of TCJA, section 
162(m)(2) defined publicly held corporation as any corporation issuing 
any class of common equity securities required to be registered under 
section 12 of the Securities Exchange Act of 1934 (Exchange Act). In 
defining a publicly held corporation, Sec.  1.162-27(c)(1) adds that 
whether a corporation is publicly held is determined based solely on 
whether, as of the last day of its taxable year, the corporation is 
subject to the reporting obligations of section 12 of the Exchange Act.
    Section 13601(c) of TCJA amended the definition of publicly held 
corporation in section 162(m)(2) to

[[Page 70357]]

provide that the term means any corporation which is an issuer (as 
defined in section 3 of the Exchange Act) the securities of which are 
required to be registered under section 12 of the Exchange Act, or that 
is required to file reports under section 15(d) of the Exchange Act. 
Thus, section 13601(c) of TCJA expanded the definition of publicly held 
corporation in two ways to include: (1) A corporation with any class of 
securities (rather than only a class of common equity securities) that 
is required to be registered under section 12 of the Exchange Act, and 
(2) a corporation that is required to file reports under section 15(d) 
of the Exchange Act.
    The proposed regulations similarly define a publicly held 
corporation as any corporation that issues securities required to be 
registered under section 12 of the Exchange Act or that is required to 
file reports under section 15(d) of the Exchange Act. Unlike the final 
regulations, the proposed regulations do not focus on whether the 
corporation is subject to the reporting obligations of section 12 of 
the Exchange Act. Rather, tracking the statutory text as amended, the 
proposed regulations focus on whether a corporation's securities are 
required to be registered under section 12, or whether a corporation is 
required to file reports under section 15(d).
    Consistent with the statutory expansion of section 162(m), Congress 
provided in the legislative history to TCJA that the definition of a 
publicly held corporation ``may include certain additional corporations 
that are not publicly traded, such as large private C or S 
corporations.'' H. Rep. 115-466, at 490 (2017) (Conf. Rep.). See also 
Staff of the Joint Committee on Taxation, General Explanation of Public 
Law 115-97 (Blue Book), at 261 (December 20, 2018). As a result, these 
proposed regulations make clear that an S corporation (as defined in 
section 1361(a)(1)) would qualify as a publicly held corporation if it 
(1) issues securities required to be registered under section 12(b) of 
the Exchange Act, or (2) is required to file reports under section 
15(d) of the Exchange Act (for example, because the S corporation has 
issued publicly traded debt). See Proposed Sec.  1.162-33(c)(1)(i). 
Accordingly, the proposed regulations also provide that an S 
corporation parent of a qualified subchapter S subsidiary (as defined 
in section 1361(b)(3)(B)) (QSub) that issues securities required to be 
so registered, or is required to file such reports, likewise would 
qualify as a publicly held corporation. See part II.G of this 
Explanation of Provisions section. See also Proposed Sec.  1.162-
33(c)(1)(iv).
    For ease of administration, the proposed regulations follow the 
approach in the final regulations and use the last day of a 
corporation's taxable year to determine whether it is publicly held. 
Accordingly, the proposed regulations provide that a corporation is 
publicly held if, as of the last day of its taxable year, its 
securities are required to be registered under section 12 of the 
Exchange Act or it is required to file reports under section 15(d) of 
the Exchange Act.
    A corporation is required to register its securities under section 
12 of the Exchange Act in two circumstances. First, section 12(b) of 
the Exchange Act requires a corporation to register its securities in 
order to list them for trading on a national securities exchange (15 
U.S.C. 78l(b)). Second, section 12(g) of the Exchange Act requires an 
issuer with total assets exceeding $10 million to register a class of 
equity securities that is held of record by either 2,000 or more 
persons, or 500 or more persons who are not accredited investors (as 
that term is defined by the SEC) (15 U.S.C. 78l(g)).\1\
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    \1\ In the case of an issuer that is a bank, savings and loan 
holding company, or bank holding company, section 12(g) of the 
Exchange Act requires registration if the issuer has assets 
exceeding $10 million and a class of equity securities held of 
record by 2,000 or more persons. See Exchange Act Rule 12g-1 (17 CFR 
240.12g-1) regarding the requirements of section 12(g) generally, 
and Exchange Act Rule 12g5-1 (17 CFR 240.12g5-1) for determining 
record ownership of securities for purposes of Exchange Act sections 
12(g) and 15(d).
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    A corporation is required to file reports under section 15(d) of 
the Exchange Act when it offers securities for sale in a transaction 
subject to the registration requirements of the Securities Act of 1933 
(Securities Act) and its registration statement is declared effective 
by the SEC. A corporation's section 15(d) filing obligation is 
automatically suspended when certain statutory requirements are met, 
and a corporation that meets other requirements established by rule may 
file a form with the SEC to suspend its section 15(d) filing 
obligation.\2\ A commenter suggested that a corporation should not be 
considered publicly held if its obligation to file reports under 
section 15(d) of the Exchange Act is suspended. The proposed 
regulations adopt this suggestion.
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    \2\ See Exchange Act Section 15(d) (15 U.S.C. 78o(d)), and 
Exchange Act Rules 15d-6 (17 CFR 240.15d-6) and 12h-3 (17 CFR 
240.12h-3).
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    In defining the term publicly held corporation under pre-amended 
section 162(m)(2), the final regulations included examples illustrating 
whether a corporation, as of the last day of its taxable year, is 
subject to the reporting obligations of section 12 of the Exchange Act. 
Similarly, these proposed regulations include examples illustrating 
when a corporation, as of the last day of its taxable year, is either 
required to file reports under section 15(d) of the Exchange Act or 
required to register its securities under section 12 of the Exchange 
Act. Even though the examples in these proposed regulations illustrate 
the application of the Securities Act and the Exchange Act and the 
rules thereunder (17 CFR part 240) for purposes of section 162(m), the 
examples are not intended to provide any guidance on how an issuer 
should apply the requirements of the Securities Act, the Exchange Act, 
and the rules thereunder (17 CFR part 240). Questions regarding those 
requirements should be directed to the SEC.
B. Subsidiaries That File Reports Under Section 15(d) of the Exchange 
Act
    Pursuant to the definition of publicly held corporation in the 
proposed regulations, a corporation is publicly held if, as of the last 
day of its taxable year, it is required to file reports under section 
15(d) of the Exchange Act. A commenter suggested that if a wholly-owned 
subsidiary corporation of a publicly held corporation subject to 
section 162(m) is required to file reports under section 15(d) of the 
Exchange Act, then it should not be considered a publicly held 
corporation separately subject to section 162(m) because its parent 
corporation is already subject to section 162(m). According to the 
commenter, to consider the subsidiary a publicly held corporation would 
result in two sets of covered employees--one for the parent corporation 
and one for the subsidiary corporation. The commenter was concerned 
that there would be too many covered employees for the group of 
corporations. The proposed regulations do not adopt this suggestion 
because not treating the subsidiary corporation as a separate publicly 
held corporation is inconsistent with the text of amended section 
162(m)(2), which defines a publicly held corporation as a corporation 
that is required to file reports under section 15(d) of the Exchange 
Act. This conclusion is consistent with the affiliated group rule in 
the final regulations (which is retained in these proposed regulations 
and discussed in section II.E of this preamble) providing that a 
publicly held subsidiary is separately subject to section 162(m) and, 
therefore, has its own set of covered employees.

[[Page 70358]]

C. Foreign Private Issuers
    Foreign issuers \3\ may access the U.S. capital markets to raise 
capital or establish a trading presence for their securities. There are 
specific rules under the Federal securities laws that apply if a 
foreign issuer meets the regulatory definition of ``foreign private 
issuer'' (FPI). ``Foreign private issuer'' is defined in 21 CFR 240.3b-
4(c). A foreign private issuer is any foreign issuer other than a 
foreign government, except for an issuer that has (1) more than 50% of 
its outstanding voting securities held of record by U.S. residents and 
(2) any of the following: (i) A majority of its officers and directors 
are citizens or residents of the United States, (ii) more than 50% of 
its assets are located in the United States, or (iii) its business is 
principally administered in the United States.
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    \3\ The term ``foreign issuer'' means any issuer which is a 
foreign government, a national of any foreign country or a 
corporation or other organization incorporated or organized under 
the laws of any foreign country. 21 CFR 240.3b-4(b).
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    A FPI may access the U.S. capital markets or establish a trading 
presence in the U.S. by offering or listing its securities, often in 
the form of American Depositary Receipts (ADRs). An ADR is a negotiable 
certificate that evidences ownership of a specified number (or 
fraction) of the FPI's securities held by a depositary (typically, a 
U.S. bank). Depending on the FPI's level of participation in the U.S. 
capital market or trading presence, the FPI may be required to register 
its deposited securities (underlying the ADRs) under section 12 of the 
Exchange Act.
    Commenters recommended that the proposed regulations provide that 
section 162(m) does not apply to FPIs. Before TCJA, the IRS ruled in 
several private letter rulings that section 162(m) does not apply to 
FPIs because FPIs are not required to file a summary compensation table 
pursuant to the reporting obligations under the Exchange Act.\4\ The 
rationale of the rulings is that section 162(m) does not apply to FPIs 
because they do not have covered employees as a result of not being 
required to file a summary compensation table with the SEC. Commenters 
suggested that section 162(m) should continue to be inapplicable to 
FPIs because they are not required to disclose compensation of their 
officers on an individual basis under the Exchange Act, unless that 
disclosure is required by their home country. The commenters asserted 
that determining compensation on an individual basis (in order to 
determine the three most highly compensated executive officers) would 
require the FPIs to expend significant time and money in adopting the 
necessary internal legal and compliance procedures to comply with the 
Exchange Act requirements that are otherwise inapplicable to them.
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    \4\ A private letter ruling may be relied upon only by the 
taxpayer to whom the ruling was issued, and does not constitute 
generally applicable guidance. See section 11.02 of Revenue 
Procedure 2019-1, 2019-01 I.R.B. 157.
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    The proposed regulations do not adopt the recommendation to exclude 
FPIs from the application of section 162(m). Pursuant to the definition 
of publicly held corporation in amended section 162(m)(2), a FPI is a 
publicly held corporation if it is required either to register its 
securities under section 12 of the Exchange Act or to file reports 
under section 15(d) of the Exchange Act. The legislative history to 
TCJA indicates that Congress intended for section 162(m) to apply to 
FPIs.\5\ Furthermore, the rationale of the private letter rulings, 
which conclude that section 162(m) does not apply to FPIs because they 
are not required to file a summary compensation table, is inconsistent 
with the definition of covered employee in amended section 162(m)(3). 
As discussed in section III of this preamble, under the definition of 
covered employee as amended by TCJA, a publicly held corporation has 
covered employees regardless of whether it is required to file a 
summary compensation table, and regardless of whether the employees 
appear on a summary compensation table that is filed. Accordingly, the 
proposed regulations do not adopt the suggestion to exclude FPIs from 
the application of section 162(m). The proposed regulations include 
examples illustrating when a FPI is a publicly held corporation. 
Because the calculation of compensation to determine the three highest 
compensated executive officers for a taxable year is made in accordance 
with the SEC executive compensation disclosure rules under the Exchange 
Act, the Treasury Department and the IRS request comments on whether a 
safe harbor for that determination is appropriate for FPIs that are not 
required to disclose compensation of their officers on an individual 
basis in their home countries and, if so, how that safe harbor should 
be designed.
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    \5\ The legislative history to TCJA provides that the amendment 
to the definition of publicly held corporation under section 162(m) 
``extends the applicability of section 162(m) to include . . . all 
foreign companies publicly traded through ADRs.'' House Conf. Rpt. 
115-466, 489 (2017). The Blue Book similarly states that ``the 
provision extends the applicability of section 162(m) to include all 
foreign companies publicly traded through ADRs.'' Blue Book at page 
261.
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D. Publicly Traded Partnerships
    Partnerships may issue equity interests that are required to be 
registered under section 12 of the Exchange Act because they are traded 
on an established securities market. These partnerships are known as 
publicly traded partnerships (PTPs). Under section 7704(a), a PTP 
generally is treated as a corporation for purposes of the Code, unless 
its gross income meets the requirement of section 7704(c)(2). 
Stakeholders have asked whether a PTP that is treated as a corporation 
under that provision would be considered a publicly held corporation. 
As described in the preamble to the 1993 proposed regulations, 
stakeholders previously raised this issue:

    Questions have arisen as to the application of section 162(m) to 
certain master limited partnerships whose equity interests are 
required to be registered under the Exchange Act and that, beginning 
in 1997, may be treated as corporations for Federal income tax 
purposes. Whether these partnerships would be publicly held 
corporations within the meaning of section 162(m) and, if so, the 
manner in which they would satisfy the exception for performance-
based compensation is currently under study and is not addressed in 
these proposed regulations. If necessary, guidance as to the 
application of section 162(m) to these entities will be provided in 
the future.

(58 FR 66310, 66311). The Treasury Department and the IRS have 
concluded that, for purposes of section 162(m), a PTP that is treated 
as a corporation under section 7704 (or otherwise) is a publicly held 
corporation if, as of the last day of its taxable year, its securities 
are required to be registered under section 12 of the Exchange Act or 
it is required to file reports under section 15(d) of the Exchange Act. 
A PTP that is not treated as a corporation for Federal tax purposes 
(for example, because it satisfies the gross income requirement under 
section 7704(c)(2) and is not otherwise treated as a corporation for 
Federal tax purposes) is not a publicly held corporation for purposes 
of section 162(m).
E. Affiliated Groups
    In defining the term ``publicly held corporation,'' Sec.  1.162-
27(c)(1)(ii) provides that a publicly held corporation includes an 
affiliated group of corporations, as defined in section 1504 
(determined without regard to section 1504(b)). The proposed 
regulations retain this rule with a modification described below. 
Because an affiliated group may include more

[[Page 70359]]

than one publicly held corporation, Sec.  1.162-27(c)(1)(ii) provides 
that an affiliated group of corporations does not include any 
subsidiary that is itself a publicly held corporation. In that case, 
pursuant to the final regulations, the publicly held subsidiary and its 
subsidiaries (if any) are separately subject to section 162(m). 
Therefore, the parent corporation that is a publicly held corporation 
and the publicly held subsidiary each has its own set of covered 
employees. However, the final regulations do not specifically address 
the situation in which a parent corporation is privately held and the 
subsidiary is publicly held. Because the amended definition of publicly 
held corporation includes a corporation that is required to file 
reports under section 15(d) of the Exchange Act, this type of 
affiliated group may be more common post-TCJA. Accordingly, unlike the 
final regulations, which provide that a publicly held subsidiary is 
excluded from an affiliated group, with the result that a privately 
held parent is not part of an affiliated group with its publicly held 
subsidiary, these proposed regulations provide that an affiliated group 
includes a parent corporation that is privately held and its subsidiary 
that is publicly held. Furthermore, because an affiliated group of 
corporations is determined without regard to section 1504(b), an 
affiliated group may also include a domestic parent corporation that is 
publicly held and its foreign subsidiary that is not publicly held.
    A covered employee of a publicly held corporation may also perform 
services for another member of the affiliated group. In these 
situations, Sec.  1.162-27(c)(1)(ii) provides that

    [i]f a covered employee is paid compensation in a taxable year 
by more than one member of an affiliated group, compensation paid by 
each member of the affiliated group is aggregated with compensation 
paid to the covered employee by all other members of the group. Any 
amount disallowed as a deduction by this section must be prorated 
among the payor corporations in proportion to the amount of 
compensation paid to the covered employee by each such corporation 
in the taxable year.

    The proposed regulations retain this rule and include additional 
rules addressing the proration of the deduction disallowance in 
situations in which a covered employee is paid compensation in a 
taxable year by more than one publicly held corporation in an 
affiliated group. Under these rules, the amount disallowed as a 
deduction is determined separately with respect to each publicly held 
payor corporation of which the individual is a covered employee. 
Accordingly, in determining the deduction disallowance with respect to 
compensation paid to a covered employee by one publicly held payor 
corporation of an affiliated group, compensation paid to the covered 
employee by another publicly held payor corporation of the affiliated 
group (of which the individual is also a covered employee) is not 
aggregated for purposes of the deduction disallowance proration.
F. Disregarded Entities
    Generally under Sec.  301.7701-2(c)(2)(i), a business entity that 
has a single owner and is not a corporation under Sec.  301.7701-2(b) 
is disregarded as an entity separate from its owner for Federal tax 
purposes (disregarded entity). All of the activities of a disregarded 
entity are therefore treated in the same manner as a sole 
proprietorship or as a branch or division of its owner under Sec.  
301.7701-2. Section 301.7701-2(c)(2)(iv) provides that Sec.  301.7701-
2(c)(2)(i) does not apply to taxes imposed under Subtitle C--Employment 
Taxes and Collection of Income Tax (Chapters 21, 22, 23, 23A, 24, and 
25 of the Code). Because section 162(m) is in Subtitle A, the general 
rule in Sec.  301.7701-2(c)(2)(i) applies for purposes of section 
162(m).
    Nonetheless, a disregarded entity that is owned by a privately held 
corporation may be an issuer of securities that are required to be 
registered under section 12(b) of the Exchange Act or may be required 
to file reports under section 15(d) of the Exchange Act. The Treasury 
Department and the IRS have concluded that, for purposes of section 
162(m), a corporation that is the owner of a disregarded entity is 
treated as issuing any securities issued by its disregarded entity. 
Accordingly, if a disregarded entity that is owned by a privately held 
corporation is an issuer of securities that are required to be 
registered under section 12(b) of the Exchange Act or is required to 
file reports under section 15(d) of the Exchange Act, these proposed 
regulations treat the privately held corporation as a publicly held 
corporation for purposes of section 162(m).
    The Treasury Department and the IRS are aware that a corporation 
could form a partnership with a minority partner in an attempt to 
circumvent the proposed rules treating a corporation that wholly-owns a 
disregarded entity that issues certain securities as a publicly held 
corporation for purposes of section 162(m). In these circumstances, the 
corporation may be treated as a publicly held corporation by reason of 
the application of Sec.  1.701-2 or other federal income tax 
principles. The Treasury Department and the IRS also note that, in 
addition to the above-described fact pattern involving disregarded 
entities, Sec.  1.701-2 and other federal income tax principles may 
apply to any transaction in which a corporation forms a partnership in 
an attempt to circumvent the proposed rules.
G. Qualified Subchapter S Subsidiaries
    Section 1361(b)(3)(B) defines a QSub as any domestic corporation 
that is not an ineligible corporation (as defined in section 
1361(b)(2)) if an S corporation owns 100 percent of the stock of such 
corporation and the S corporation elects to treat the corporation as a 
QSub. Under section 1361(b)(3)(A), unless otherwise provided by 
regulations, a QSub is not treated as a separate corporation, and 
therefore all of its assets, liabilities, and items of income, 
deduction, and credit are treated as assets, liabilities, and such 
items (as the case may be) of its parent S corporation.
    Like a disregarded entity, a QSub may issue securities required to 
be registered under section 12(b) of the Exchange Act, or be required 
to file reports under section 15(d) of the Exchange Act. The Treasury 
Department and the IRS have concluded that, for purposes of section 
162(m), an S corporation that is the owner of a QSub is treated as 
issuing any securities that are issued by its QSub. Accordingly, if a 
QSub is an issuer of securities that are required to be registered 
under section 12(b) of the Exchange Act, or is required to file reports 
under section 15(d) of the Exchange Act, these proposed regulations 
treat the QSub's S corporation parent as a publicly held corporation 
for purposes of section 162(m). See Proposed Sec.  1.162-33(c)(1)(iv).

III. Covered Employee

A. In General
    Section 162(m)(3) defines the term ``covered employee.'' Before 
TCJA, section 162(m)(3) defined a covered employee as any employee of 
the taxpayer if (a) as of the close of the taxable year, such employee 
is the chief executive officer of the taxpayer or is an individual 
acting in such capacity, or (b) the total compensation of such employee 
for the taxable year is required to be reported to shareholders under 
the Exchange Act by reason of such employee being among the four 
highest compensated officers for the taxable year (other than the chief 
executive officer).
    Section 13601(b) of TCJA amended the definition of covered employee 
in section 162(m)(3) to provide that a

[[Page 70360]]

covered employee means any employee of the taxpayer if (a) the employee 
is the principal executive officer (PEO) or principal financial officer 
(PFO) of the taxpayer at any time during the taxable year, or was an 
individual acting in such a capacity, (b) the total compensation of the 
employee for the taxable year is required to be reported to 
shareholders under the Exchange Act by reason of such employee being 
among the three highest compensated officers for the taxable year 
(other than the PEO and PFO), or (c) the individual was a covered 
employee of the taxpayer (or any predecessor) for any preceding taxable 
year beginning after December 31, 2016. Section 13601(c) of TCJA also 
added flush language to provide that a covered employee includes any 
employee whose total compensation for the taxable year places the 
individual among the three highest compensated officers for the taxable 
year (other than any individual who is the PEO or PFO of the taxpayer 
at any time during the taxable year, or was an individual acting in 
such a capacity) even if the compensation of the officer is not 
required to be reported to shareholders under the Exchange Act.
    The SEC executive compensation disclosure rules generally require 
disclosure of compensation of the three most highly compensated 
executive officers if they were employed at the end of the taxable year 
and up to two executive officers whose compensation would have been 
disclosed but for the fact that they were not employed at the end of 
the taxable year. See Item 402 of Regulation S-K, 17 CFR 229.402(a)(3). 
After TCJA amended the definition of covered employee, stakeholders 
submitted comments indicating that they would benefit from initial 
guidance on whether amended section 162(m)(3)(B) and the flush language 
to section 162(m)(3) require an employee to be employed at the end of 
the taxable year to qualify as a covered employee. Notice 2018-68 
provided that a covered employee for any taxable year means any 
employee who is among the three highest compensated executive officers 
for the taxable year, regardless of whether the executive officer is 
serving at the end of the publicly held corporation's taxable year, and 
regardless of whether the executive officer's compensation is subject 
to disclosure for the last completed fiscal year under the applicable 
SEC rules. To reach this conclusion, consistent with Notice 2018-68, 
the proposed regulations rely on the flush language to section 
162(m)(3), the legislative history,\6\ and the SEC executive 
compensation disclosure rules that do not necessarily require an 
executive officer to be employed at the end of the fiscal year for his 
or her compensation to be disclosed for the year. Based on these 
considerations, the proposed regulations adopt the position set forth 
in Notice 2018-68.\7\
---------------------------------------------------------------------------

    \6\ See House Conf. Rpt. 115-466, 489 (2017).
    \7\ Furthermore, in explaining the amended definition of covered 
employee, the Blue Book concurred with the guidance provided in 
Notice 2018-68. Blue Book at page 260.
---------------------------------------------------------------------------

B. Taxable Years Not Ending on Same Date as Fiscal Years
    The SEC executive compensation disclosure rules are based on a 
corporation's fiscal year. Usually, a corporation's fiscal and taxable 
years end on the same date; however, this is not always the case (for 
example, due to a short taxable year as a result of a corporate 
transaction that does not result in a short fiscal year). In these 
cases, the publicly held corporation will have three most highly 
compensated executive officers under section 162(m)(3)(B) for the short 
taxable year (instead of the fiscal year). In Notice 2018-68, the 
Treasury Department and IRS requested comments on the application of 
the SEC executive compensation disclosure rules to determine the three 
most highly compensated executive officers for a taxable year that does 
not end on the same date as the fiscal year for purposes of section 
162(m)(3)(B). The notice provided that until additional guidance is 
issued, taxpayers should base their determination of the three most 
highly compensated executive officers for purposes of section 
162(m)(3)(B) upon a reasonable good faith interpretation of the 
statute.
    A commenter suggested that the determination of the three highest 
compensated executive officers should be based on the total amount of 
otherwise deductible remuneration. The proposed regulations do not 
adopt this approach. In defining covered employee, section 162(m)(3)(B) 
provides that the three most highly compensated executive officers are 
officers whose compensation is required to be (or would be required to 
be) reported to shareholders under the Exchange Act. Therefore, under 
the statutory text, the determination of the three most highly 
compensated executive officers is made pursuant to the rules under the 
Exchange Act. Accordingly, the proposed regulations provide that the 
amount of compensation used to identify the three most highly 
compensated executive officers is determined pursuant to the executive 
compensation disclosure rules under the Exchange Act using the taxable 
year as the fiscal year for purposes of making the determination. Thus, 
for example, if a publicly held corporation uses a calendar year fiscal 
year for SEC reporting purposes, but has a taxable year beginning July 
1, 2019, and ending June 30, 2020, then the three most highly 
compensated executive officers are determined for the taxable year 
ending June 30, 2020, by applying the executive compensation disclosure 
rules under the Exchange Act as if the fiscal year ran from July 1, 
2019 to June 30, 2020. The same rule applies to short taxable years. 
Assume in the previous example that, due to a corporate transaction, 
the corporation's taxable year ran from July 1, 2019, to March 31, 
2020. In that situation, the three most highly compensated executive 
officers would be determined for the taxable year ending March 31, 2020 
by applying the disclosure rules as if the fiscal year began July 1, 
2019, and ended March 31, 2020. For a discussion of the proposed 
special applicability dates related to the determination of the three 
most highly compensated executive officers for a corporation whose 
fiscal year and taxable year do not end on the same date, see section 
VIII.B of this preamble.
C. Covered Employees Limited to Executive Officers
    The SEC executive compensation disclosure rules require disclosure 
of compensation for certain executive officers. The term executive 
officer is defined in 17 CFR 240.3b-7 as follows:

    The term executive officer, when used with reference to a 
registrant, means its president, any vice president of the 
registrant in charge of a principal business unit, division or 
function (such as sales, administration or finance), any other 
officer who performs a policy making function or any other person 
who performs similar policy making functions for the registrant. 
Executive officers of subsidiaries may be deemed executive officers 
of the registrant if they perform such policy making functions for 
the registrant.

    Under the amended definition of covered employee, a PEO and PFO are 
covered employees by virtue of having those positions or acting in 
those capacities. The three highest compensated officers (other than 
the PEO or PFO) are covered employees by reason of their compensation. 
With respect to the three highest compensated officers for a taxable 
year, a commenter asked whether only an executive officer (as defined 
in 17 CFR 240.3b-7) may qualify as a covered employee. Because the SEC 
executive compensation disclosure rules that

[[Page 70361]]

require disclosure of the three highest compensated executive officers 
apply only to executive officers, only an executive officer may qualify 
as a covered employee under section 162(m)(3)(B).
    A publicly held corporation may own an interest in a partnership as 
discussed in section IV.B. of this preamble. Consistent with the 
definition of the term executive officer in 17 CFR 240.3b-7, an officer 
of a partnership is deemed to be an executive officer of a publicly 
held corporation that owns an interest in such partnership if the 
officer performs a policy making function for the publicly held 
corporation. As a deemed executive officer of the publicly held 
corporation, the officer of the partnership may be a covered employee 
under section 162(m)(3)(B) if the officer is one of the three highest 
compensated executive officers of the publicly held corporation.
D. Covered Employees After Separation From Service
    Consistent with section 162(m)(3)(C), as amended by TCJA, Notice 
2018-68 provides that a covered employee identified for taxable years 
beginning after December 31, 2016, will continue to be a covered 
employee for all subsequent taxable years. Accordingly, if an 
individual is a covered employee for a taxable year, the individual 
remains a covered employee for all subsequent taxable years, even after 
the individual has separated from service. For example, if a publicly 
held corporation makes nonqualified deferred compensation (NQDC) 
payments to a former PEO after separation from service, then the 
deduction for the payments generally would be subject to section 
162(m). Notice 2018-68 based this conclusion on the statutory text in 
section 162(m)(3)(C) and the legislative history, which provides that

    if an individual is a covered employee with respect to a 
corporation for a taxable year beginning after December 31, 2016, 
the individual remains a covered employee for all future years. 
Thus, an individual remains a covered employee with respect to 
compensation otherwise deductible for subsequent years, including 
for years during which the individual is no longer employed by the 
corporation and years after the individual has died.

(House Conf. Rpt. 115-466, 489 (2017)). The Blue Book reiterated the 
legislative history in explaining the amended definition of covered 
employee.\8\
---------------------------------------------------------------------------

    \8\ The Blue Book states that, ``[i]n addition, if an individual 
is a covered employee with respect to a corporation for a taxable 
year beginning after December 31, 2016, the individual remains a 
covered employee for all future years. Thus, an individual remains a 
covered employee with respect to compensation otherwise deductible 
for subsequent years, including for years during which the 
individual is no longer employed by the corporation and years after 
the individual has died.'' Blue Book at page 260.
---------------------------------------------------------------------------

    One commenter suggested that a covered employee ceases to be a 
covered employee for taxable years following the taxable year in which 
the individual separates from service because the statutory text uses 
the term ``employee'' instead of ``individual'' in defining covered 
employee. In other words, the commenter asserted that the term 
``employee'' in the statute should be interpreted as referring to a 
``current employee'' instead of a ``current or former employee.'' The 
commenter suggested that because this is the plain reading of the 
statute, the legislative history should be ignored. The proposed 
regulations do not adopt this suggestion. The statute gives no 
indication that the term ``employee'' is limited to a current employee, 
and a reference in the Code to an ``employee'' has frequently been 
interpreted in regulations as a reference to a current or a former 
employee.\9\ Given the ambiguity in the meaning of ``employee'' and the 
legislative intent in this context to include a former employee, as 
evidenced by the legislative history and the Blue Book explanation of 
the term covered employee, the proposed regulations define employee to 
include a former employee.
---------------------------------------------------------------------------

    \9\ For example, under Sec.  1.105-11(c)(3)(iii), the 
nondiscrimination rules of section 105(h)(3) apply to former 
employees even though the Code uses only the term ``employees.''
---------------------------------------------------------------------------

E. Predecessor Corporation
    Section 162(m)(3)(C) provides that the term ``covered employee'' 
means any employee who was a covered employee of the taxpayer for any 
preceding taxable year beginning after December 31, 2016. The term 
``covered employee'' also means any employee who was a covered employee 
of any predecessor of the taxpayer for any preceding taxable year 
beginning after December 31, 2016. For clarity, these proposed 
regulations use the term ``predecessor of a publicly held corporation'' 
instead of ``predecessor.'' An individual who is a covered employee for 
one taxable year (including a taxable year of a predecessor of a 
publicly held corporation) remains a covered employee for subsequent 
taxable years.
    In certain circumstances, the term ``predecessor of a publicly held 
corporation'' includes the publicly held corporation itself if it was a 
publicly held corporation for a prior taxable year. Specifically, the 
proposed regulations provide that a predecessor of a publicly held 
corporation includes a publicly held corporation that, after becoming 
privately held, again becomes a publicly held corporation for a taxable 
year ending before the 36-month anniversary of the due date for the 
corporation's U.S. Federal income tax return (excluding any extensions) 
for the last taxable year for which the corporation was previously 
publicly held. For a discussion of the proposed special applicability 
date related to the definition of predecessor of a publicly held 
corporation as applied to a privately held corporation that was 
previously a publicly held corporation and again becomes a publicly 
held corporation, see section VIII.B of this preamble.
    The proposed regulations also provide that the term ``predecessor 
of a publicly held corporation'' includes a publicly held corporation 
that is acquired (target corporation), or the assets of which are 
acquired, by another publicly held corporation (acquiror corporation) 
in certain transactions. Accordingly, the covered employees of the 
target corporation in those transactions are also covered employees of 
the acquiror corporation.
    The proposed regulations define the term ``predecessor of a 
publicly held corporation'' by reference to the type of corporate 
acquisition in which a publicly held corporation is acquired. The 
proposed regulations describe corporate acquisitions in four 
categories: (1) Corporate reorganizations, (2) corporate divisions, (3) 
stock acquisitions, and (4) asset acquisitions. Certain transactions 
may fall within more than one category, but this redundancy is intended 
to provide certainty as to the application of these rules if a taxpayer 
is unsure which category covers the acquisition in question.
    With respect to corporate reorganizations, the proposed regulations 
provide that a predecessor of a publicly held corporation includes a 
publicly held corporation that is acquired or that is the transferor 
corporation in a corporate reorganization described in section 
368(a)(1). For example, if a publicly held target corporation merges 
into a publicly held acquiror corporation, then any covered employee of 
the target corporation would become a covered employee of the acquiror 
corporation.
    With respect to corporate divisions, the proposed regulations 
provide that a predecessor of a publicly held corporation includes a 
publicly held distributing corporation that distributes or exchanges 
the stock of one or more

[[Page 70362]]

controlled corporations in a transaction described in section 355(a)(1) 
(a 355(a)(1) transaction) if the controlled corporation is a publicly 
held corporation. This rule applies to the distributing corporation 
only with respect to covered employees of the distributing corporation 
who are hired by the controlled corporation (or by a corporation 
affiliated with the controlled corporation that received stock of the 
controlled corporation as a shareholder of the distributing corporation 
in the 355(a)(1) transaction) within the period beginning 12 months 
before and ending 12 months after the distribution. For example, if a 
publicly held distributing corporation exchanges with its shareholders 
the stock of a controlled corporation for stock of the distributing 
corporation in a 355(a)(1) transaction, and the controlled corporation 
is a publicly held corporation after the exchange, then any covered 
employee of the distributing corporation would become a covered 
employee of the controlled corporation if hired by the controlled 
corporation within the period beginning 12 months before and ending 12 
months after the exchange. Furthermore, a covered employee of the 
distributing corporation who becomes a covered employee of the 
controlled corporation will remain a covered employee of the 
distributing corporation for all subsequent taxable years because, as 
discussed in section III.D of this preamble, if an individual is a 
covered employee for a taxable year, the individual remains a covered 
employee for all subsequent taxable years.
    With respect to stock acquisitions, a predecessor of a publicly 
held corporation includes a publicly held corporation that becomes a 
member of an affiliated group (as defined in proposed Sec.  1.162-
33(c)(1)(ii)). For example, if an affiliated group that is considered a 
publicly held corporation pursuant to proposed Sec.  1.162-33(c)(1)(ii) 
in the proposed regulations acquires a publicly held target corporation 
that becomes a member of the affiliated group, then the target 
corporation would be considered a predecessor of the affiliated group. 
Therefore, any covered employee of the target corporation would become 
a covered employee of the affiliated group.
    With respect to asset acquisitions, if an acquiror corporation or 
one or more members of an affiliated group (acquiror group) acquires at 
least 80% of the operating assets (determined by fair market value on 
the date of acquisition) of a publicly held target corporation, then 
the target corporation is a predecessor of the acquiror corporation or 
group. For example, if an acquiror corporation acquires 80% or more of 
the operating assets of a publicly held target corporation, then any 
covered employees of the target corporation that become employees of 
the acquiror corporation would become covered employees of the acquiror 
corporation. For acquisitions of assets that occur over time, the 
proposed regulations provide that generally only acquisitions that 
occur within a 12-month period are taken into account to determine 
whether at least 80% of the target corporation's operating assets were 
acquired.
    Similarly, this asset acquisition rule provides that the target is 
a predecessor of a publicly held corporation only with respect to a 
covered employee of the target corporation who is hired by the acquiror 
(or a corporation affiliated with the acquiror) within the period 
beginning 12 months before and ending 12 months after the date on which 
all events necessary for the acquisition have occurred.
    These proposed regulations provide that the rules for determining 
predecessors are applied cumulatively, with the result that a 
predecessor of a corporation includes each predecessor of the 
corporation and the predecessor or predecessors of any prior 
predecessor or predecessors.
    Also, in a similar manner to the rule for a publicly held 
corporation that becomes privately held, and subsequently becomes 
publicly held, these proposed regulations provide that a target 
corporation may be a predecessor corporation in certain circumstances. 
For example, the proposed regulations provide that if a target 
corporation was a publicly held corporation, subsequently becomes 
privately held, is then acquired by an acquiror that is not a publicly 
held corporation, and the acquiror becomes a publicly held corporation 
for a taxable year ending before the 36-month anniversary of the due 
date for the target corporation's U.S. Federal income tax return 
(excluding any extensions) for the last taxable year for which the 
target corporation was publicly held, then the target corporation is a 
predecessor of the publicly held corporation. The proposed regulations 
also provide a similar rule for asset acquisitions.
    These proposed regulations further clarify that, in the case of an 
election to treat as an asset purchase either the sale, exchange, or 
distribution of stock pursuant to regulations under section 336(e) or 
the purchase of stock pursuant to regulations under section 338, the 
corporation is treated as the same corporation before and after the 
transaction for which the election is made. Similar exceptions are made 
to the general treatment of an election under section 336(e) and 
section 338 that would treat the post-election corporation as a new 
corporation for purposes of other rules regarding various compensation 
tax provisions (see Sec.  1.338-1(b)(2)(i)). These exceptions align 
with the other predecessor rules in these proposed regulations by 
treating a substantial continuation of the earlier business in the 
post-election corporation as continuing the pre-election corporation, 
so that the covered employees continue to be covered employees.
F. Disregarded Entities
    Under section 162(m)(3), only employees of the taxpayer may be 
covered employees. When a corporation owns an entity that is 
disregarded as an entity separate from its owner under Sec.  301.7701-
2(c)(2)(i), the corporation that is a publicly held corporation (and 
not its wholly-owned entity) is the taxpayer for purposes of section 
162(m)(3). In that case, the covered employees of the publicly held 
corporation are identified pursuant to the rules discussed in sections 
III.A through III.E of this preamble. Accordingly, a PEO, PFO, or 
executive officer of a disregarded entity wholly-owned by a corporation 
is generally not treated as a PEO, PFO, or executive officer of the 
corporate owner (the publicly held corporation). However, consistent 
with the definition of the term executive officer in 17 CFR 240.3b-7 
that treats executive officers of subsidiaries as executive officers of 
the registrant if the executive officers perform policy making 
functions for the registrant, an executive officer of a disregarded 
entity is treated as an executive officer of its corporate owner for 
the taxable year if the executive officer performs policy making 
functions for the corporate owner during the taxable year. These 
proposed regulations include examples illustrating how to determine 
whether employees of a disregarded entity are treated as covered 
employees of its publicly held corporate owner for purposes of section 
162(m).
    The Treasury Department and the IRS are aware that, in an attempt 
to circumvent the proposed rules treating a corporation that wholly-
owns a disregarded entity that issues certain securities as a publicly 
held corporation for purposes of section 162(m), a corporation could 
form a partnership with a minority partner and the partnership could 
then employ an individual who otherwise would have

[[Page 70363]]

been a covered employee of the corporation. In these circumstances, 
Sec.  1.701-2 and other federal income tax principles may apply to a 
transaction in which a corporation forms a partnership in an attempt to 
circumvent the proposed rules.
G. Qualified Subchapter S Subsidiaries
    Like the case when a corporation owns a disregarded entity, when an 
S corporation that is a publicly held corporation owns a QSub, the S 
corporation, and not its QSub, is the taxpayer for purposes of section 
162(m)(3). Therefore, pursuant to the rules discussed in sections III.A 
through III.E of this preamble, a PEO, PFO, or executive officer of 
such QSub generally is not treated as a PEO, PFO, or executive officer 
of the S corporation owner (that is, the publicly held corporation). 
Under these proposed regulations, an executive officer of a QSub is 
treated as an executive officer of its S corporation owner for the 
taxable year if the executive officer performs policy making functions 
for the S corporation owner during the taxable year. See Proposed Sec.  
1.162-33(c)(2)(iv). This treatment is consistent with the definition of 
the term executive officer in 17 CFR 240.3b-7, which treats executive 
officers of subsidiaries as executive officers of the registrant if the 
executive officers perform policy making functions for the registrant.

IV. Applicable Employee Remuneration

A. In General
    Section 162(m)(4) defines the term ``applicable employee 
remuneration'' with respect to any covered employee for any taxable 
year as the aggregate amount allowable as a deduction for such taxable 
year (determined without regard to section 162(m)) for remuneration for 
services performed by such employee (whether or not during the taxable 
year). Before TCJA, applicable employee remuneration did not include 
remuneration payable on a commission basis (as defined in section 
162(m)(4)(B)) or performance-based compensation (as defined in section 
162(m)(4)(C)). Section 13601(a) of TCJA amended the definition of 
applicable employee remuneration to eliminate these exclusions, while 
section 13601(d) of TCJA added a special rule for remuneration paid to 
beneficiaries. This special rule, set forth in section 162(m)(4)(F), 
provides that remuneration shall not fail to be applicable employee 
remuneration merely because it is includible in the income of, or paid 
to, a person other than the covered employee, including after the death 
of the covered employee.
    For simplicity, when incorporating the amendments TCJA made to the 
definition of applicable employee remuneration, these proposed 
regulations use the term ``compensation'' instead of ``applicable 
employee remuneration.'' Consistent with the amendments made by TCJA, 
these proposed regulations provide that compensation means the 
aggregate amount allowable as a deduction under chapter 1 of the Code 
for the taxable year (determined without regard to section 162(m)) for 
remuneration for services performed by a covered employee, whether or 
not the services were performed during the taxable year. The proposed 
regulations also clarify that compensation includes an amount that is 
includible in the income of, or paid to, a person other than the 
covered employee, including after the death of the covered employee.
B. Compensation Paid by a Partnership to a Covered Employee
    These proposed regulations address the issue of compensation paid 
by a partnership (as defined for Federal tax purposes) to a covered 
employee of a publicly held corporation; this issue has been subject to 
a no-rule position for private letter rulings since 2010. Between 2006 
and 2008, the IRS issued four private letter rulings addressing 
specific situations in which a publicly held corporation was a partner 
in a partnership. As part of the analysis, the private letter rulings 
stated that if a publicly held corporation is a partner in a 
partnership, then section 162(m) does not apply to the corporation's 
distributive share of the partnership's deduction for compensation paid 
by the partnership for services performed for it by a covered employee 
of the corporation. Therefore, the private letter rulings ruled on the 
facts presented that section 162(m) did not limit the otherwise 
deductible compensation expense of the publicly held corporation for 
compensation the partnership paid the covered employee. Upon further 
consideration, and recognizing the potential for abuse, the IRS stopped 
issuing private letter rulings involving section 162(m) and 
partnerships.\10\ Stakeholders have asked the Treasury Department and 
the IRS to address this issue in these proposed regulations.
---------------------------------------------------------------------------

    \10\ Initially, the IRS announced the no-rule position in 2010 
in section 5.06 of Revenue Procedure 2010-3, 2010-1 I.R.B. 110, 
which provided that ``[w]hether the deduction limit under Sec.  
162(m) applies to compensation attributable to services performed 
for a related partnership'' was an area under study in which rulings 
or determination letters will not be issued until the IRS resolves 
the issue through publication of a revenue ruling, revenue 
procedure, regulations, or otherwise. Most recently, section 
4.01(13) of Revenue Procedure 2019-3, 2019-01 I.R.B. 130, provides 
that this issue is an area in which rulings or determination letters 
will not ordinarily be issued.
---------------------------------------------------------------------------

    In relevant part, section 162(m)(1) provides that ``[i]n the case 
of any publicly held corporation, no deduction shall be allowed under 
this chapter for applicable employee remuneration with respect to any 
covered employee.'' This language does not limit the application of 
section 162(m) to deductions for compensation paid by the publicly held 
corporation; it also covers the deduction for compensation paid to the 
corporation's covered employees by another party to the extent the 
corporation is allocated a share of the otherwise deductible item. For 
instance, if a publicly held corporate partner is allocated a 
distributive share of the partnership's deduction for compensation paid 
by the partnership, the allocated distributive share of the deduction 
is subject to section 162(m) even though the corporation did not 
directly pay the compensation to the covered employee. Thus, the 
publicly held corporation must take into account its distributive share 
of the partnership's deduction for compensation expense paid to the 
publicly held corporation's covered employee and aggregate that 
distributive share and the corporation's otherwise allowable deduction 
for compensation paid directly to that employee in determining the 
amount allowable to the corporation as a deduction for compensation 
under section 162(m). See Sec.  1.702-1(a)(8)(ii) and (iii).
    The Treasury Department and the IRS are aware that this issue has 
not been addressed in generally applicable guidance and understand 
taxpayers may have taken positions contrary to those set forth in these 
proposed regulations. Accordingly, the proposed regulations provide 
transition relief for current compensation arrangements, but also 
prohibit the formation or expansion of these types of structures for 
the purpose of avoiding the application of section 162(m) prior to the 
issuance of final regulations. Specifically, in order to ensure that 
compensation agreements are not formed or otherwise structured to 
circumvent this rule after publication of these proposed regulations 
and prior to the publication of the final regulations, the proposed 
regulations propose that the rule with respect to compensation paid by 
a partnership will apply to any deduction for compensation that is 
otherwise

[[Page 70364]]

allowable for a taxable year ending on or after December 20, 2019 but 
will not apply to compensation paid pursuant to a written binding 
contract in effect on December 20, 2019 that is not materially modified 
after that date. The Treasury Department and the IRS request comments 
on whether similar rules should apply to trusts.
C. Compensation for Services in a Capacity Other Than an Executive 
Officer
    A commenter suggested that, if a covered employee separates from 
service as an executive officer and subsequently performs services as a 
director of the publicly held corporation, then the compensation paid 
to the individual as a director should not be considered applicable 
employee remuneration for purposes of section 162(m)(4). These proposed 
regulations do not adopt this suggestion.
    Since the enactment of section 162(m) in 1993, director fees were 
considered applicable employee remuneration for purposes of section 
162(m)(4). In describing compensation for which the deduction is 
limited by section 162(m), the legislative history to the enactment of 
section 162(m) states:

    Unless specifically excluded, the deduction limitation applies 
to all remuneration for services, including cash and the cash value 
of all remuneration (including benefits) paid in a medium other than 
cash. If an individual is a covered employee for a taxable year, the 
deduction limitation applies to all compensation not explicitly 
excluded from the deduction limitation, regardless of whether the 
compensation is for services as a covered employee and regardless of 
when the compensation was earned.

House Conf. Rpt. 103-213, 585 (1993). Thus, in enacting section 162(m), 
Congress did not exclude compensation for services not performed as a 
covered employee from the deduction limitation. As stated in the 
preamble to the 1993 proposed regulations, ``[t]he deduction limit of 
section 162(m) applies to any compensation that could otherwise be 
deducted in a taxable year, except for enumerated types of payments set 
forth in section 162(m)(4)'' (58 FR 66310, 66310). Compensation earned 
by a covered employee through a non-employee position, such as director 
fees, was never one of the ``enumerated types of payments set forth in 
section 162(m)(4)'' and so this compensation does not fall within the 
exception and has always been considered applicable employee 
remuneration for which the deduction is limited by section 162(m).\11\ 
The amendments to section 162(m)(4) made by TCJA did not change this 
aspect of the definition of applicable employee remuneration; 
accordingly, the proposed regulations do not adopt the commenter's 
suggestion.
---------------------------------------------------------------------------

    \11\ Furthermore, as explained in section II.E of this preamble, 
the final regulations provide that all compensation paid to a 
covered employee by more than one member of an affiliated group is 
aggregated for purposes of prorating the amount disallowed as a 
deduction by section 162(m). For purposes of aggregating the total 
compensation paid by the affiliated group, the final regulations do 
not exclude compensation paid for services performed by a covered 
employee in a capacity other than an employee (for example, as an 
independent contractor).
---------------------------------------------------------------------------

    Pursuant to the amended definition of covered employee in section 
162(m)(3)(C), a covered employee includes any individual who was a 
covered employee of the publicly held corporation (or any predecessor) 
for any taxable year beginning after December 31, 2016. Therefore, a 
covered employee remains a covered employee after separation from 
service. If, after separation from service as an employee, a covered 
employee returns to provide services to the publicly held corporation 
in any capacity, including as a common law employee, a director, or an 
independent contractor, then any deduction for compensation paid to the 
covered employee is subject to section 162(m).

V. Privately Held Corporations That Become Publicly Held

    Section 162(m) applies to the deduction for compensation paid to a 
covered employee that is otherwise deductible for a taxable year of a 
publicly held corporation. These proposed regulations provide that, in 
the case of a corporation that is a privately held corporation that 
becomes a publicly held corporation, section 162(m) applies to the 
deduction for any compensation that is otherwise deductible for the 
taxable year ending on or after the date that the corporation becomes a 
publicly held corporation. Furthermore, the proposed regulations 
provide that a corporation is considered to become publicly held on the 
date that its registration statement becomes effective either under the 
Securities Act or the Exchange Act.
    Commenters suggested that these proposed regulations retain the 
transition relief provided in the final regulations for privately held 
corporations that become publicly held. Commenters reasoned that 
corporations that become publicly held corporations need time to adjust 
compensation arrangements to take into account section 162(m). The 
proposed regulations do not adopt this suggestion.
    As background, in enacting section 162(m) in 1993, Congress 
excepted performance-based compensation from the definition of 
applicable employee remuneration and, thus, the section 162(m) 
deduction limitation. Before TCJA, section 162(m)(4)(C) defined 
performance-based compensation as ``any remuneration payable solely on 
account of the attainment of one or more performance goals, but only 
if--
    (i) the performance goals are determined by a compensation 
committee of the board of directors of the taxpayer which is comprised 
solely of 2 or more outside directors,
    (ii) the material terms under which the remuneration is to be paid, 
including the performance goals, are disclosed to shareholders and 
approved by a majority of the vote in a separate shareholder vote 
before the payment of such compensation, and
    (iii) before any payment of such remuneration, the compensation 
committee referred to in clause (i) certifies that the performance 
goals and any other material terms were in fact satisfied.
    These requirements are also set forth in Sec. Sec.  1.162-27(e)(2) 
through (e)(5). In enacting section 162(m), Congress recognized that 
privately held corporations may have difficulty adopting compensation 
arrangements that satisfy the requirements for performance-based 
compensation. Specifically, Congress was concerned about the 
shareholder approval requirement. Congress also recognized that, when a 
corporation becomes a publicly held corporation in connection with an 
initial public offering (IPO), prospective shareholders who read the 
corporation's prospectus are aware of the compensation arrangements 
adopted prior to the IPO. Accordingly, Congress thought that 
shareholders who read the prospectus and purchase the corporation's 
shares are, in effect, approving the corporation's compensation 
arrangements. The 1993 legislative history provides as follows:

    [I]n the case of a privately held company that becomes publicly 
held, the prospectus is subject to the rules similar to those 
applicable to publicly held companies. Thus, if there has been 
disclosure that would satisfy the rules described above, persons who 
buy stock in the publicly held company will be aware of existing 
compensation arrangements. No further shareholder approval is 
required of compensation arrangements existing prior to the time the 
company became public unless there is a material modification of 
such arrangements.


[[Page 70365]]


House Conf. Rpt. 103-213, 588 (1993). Based on the legislative history, 
the final regulations provided transition relief for corporations that 
become publicly held. Section 1.162-27(f)(1) provides that in the case 
of a corporation that was not a publicly held corporation and then 
becomes a publicly held corporation, section 162(m) ``does not apply to 
any remuneration paid pursuant to a compensation plan or agreement that 
existed during the period in which the corporation was not publicly 
held.'' If a corporation becomes publicly held in connection with an 
IPO, then the relief provided in Sec.  1.162-27(f)(1) applies only to 
the extent that the prospectus accompanying the IPO disclosed 
information concerning the existing compensation plans or agreements 
and satisfied all applicable securities laws.
    Section 13601(a) of TCJA amended the definition of applicable 
employee remuneration in section 162(m)(4) to eliminate the exception 
for performance-based compensation, which among other things, made 
shareholder approval of compensation arrangements irrelevant with 
respect to entitlement to the deduction. Accordingly, these proposed 
regulations do not retain the transition relief provided in the final 
regulations.
    For a discussion of rules applicable to privately held corporations 
that previously were publicly held corporations, see section III.E. of 
this preamble.

VI. Grandfather Rules

A. In General
    Section 13601(e) of TCJA generally provides that TCJA amendments to 
section 162(m) apply to taxable years beginning after December 31, 
2017. However, it further provides that those amendments do not apply 
to remuneration that is provided pursuant to a written binding contract 
that was in effect on November 2, 2017, and that was not modified in 
any material respect on or after such date.
    As discussed in Notice 2018-68, the text of section 13601(e) of the 
TJCA is almost identical to the text of pre-TCJA section 162(m)(4)(D), 
which provided a grandfather rule in connection with the enactment of 
section 162(m) in 1993. Under that grandfather rule, section 162(m) did 
not apply to remuneration payable under a written binding contract that 
was in effect on February 17, 1993, and that was not modified 
thereafter in any material respect before such remuneration was paid. 
Section 1.162-27(h) provides guidance on the definitions of written 
binding contract and material modification for purposes of applying the 
original grandfather rule, and Notice 2018-68 adopted those definitions 
for purposes of the grandfather rule in connection with section 
13601(e) of TCJA. The proposed regulations likewise adopt those 
definitions. Notice 2018-68 also provided examples illustrating the use 
of these definitions, and many of those examples are incorporated in 
these proposed regulations. However, to increase clarity, the proposed 
regulations replace some examples from Notice 2018-68 with other 
examples. This replacement with new examples does not reflect a 
substantive change from the definitions of written binding contract and 
material modification provided in Notice 2018-68.
    Notice 2018-68 clarified that remuneration is payable under a 
written binding contract that was in effect on November 2, 2017, only 
to the extent that the corporation is obligated under applicable law 
(for example, state contract law) to pay the remuneration under the 
contract if the employee performs services or satisfies the applicable 
vesting conditions. Accordingly, the TJCA amendments to section 162(m) 
apply to any amount of remuneration that exceeds the amount of 
remuneration that applicable law obligates the corporation to pay under 
a written binding contract that was in effect on November 2, 2017, if 
the employee performs services or satisfies the applicable vesting 
conditions.
    As an alternative to the grandfather rules in Notice 2018-68, some 
commenters suggested that these proposed regulations adopt a safe 
harbor regarding the determination of whether a contract qualifies as a 
written binding contract so that compensation paid pursuant to the 
contract would be grandfathered. Under the suggested safe harbor, any 
arrangement in effect on or before November 2, 2017, would be treated 
as a written binding contract if an amount related to the compensation 
payable under the contract was accrued (or could have been accrued) as 
a cost under Generally Accepted Accounting Principles (GAAP), 
regardless of whether the corporation is obligated to pay the 
remuneration under applicable law.
    Although the Treasury Department and the IRS understand that the 
application of the written binding contract standard may be burdensome 
in certain cases and welcome the potential for simplification, the 
suggested safe harbor raises several issues. First, as expressed in the 
comment, the accrual of a cost is often based on predictions of whether 
the amount will be paid, which may not necessarily reflect whether the 
amount must be paid in all cases. This raises issues of whether costs 
identified correlate with the statutory standard of being paid under a 
legally binding contract if, in fact, the employer was not necessarily 
bound to pay the amounts of compensation but rather was likely to pay 
them. Second, the suggested safe harbor is an accounting standard based 
on financial statements audited by accountants. This raises issues of 
tax administration, including the potential for the IRS to audit for 
section 162(m) purposes a corporation's ``audited'' financial 
statements, and challenges IRS examiners would have in applying GAAP 
principles. For these reasons, the proposed regulations do not adopt 
this suggested safe harbor. However, the Treasury Department and the 
IRS welcome further comments on whether the suggested safe harbor 
standard would be administrable, including how it would be implemented 
with respect to differing positions on corporate tax returns (such as 
use of the standard in Notice 2018-68 and these proposed regulations) 
that have already been filed.
B. Compensation Subject to Discretion
    Under the definition of written binding contract in Notice 2018-68 
and these proposed regulations, applicable law (such as state contract 
law) determines the amount of compensation that a corporation is 
obligated to pay pursuant to a written binding contract in effect on 
November 2, 2017. Some commenters suggested that negative discretion be 
completely disregarded in determining the amount of compensation that a 
corporation is obligated to pay pursuant to a written binding contract. 
The proposed regulations do not adopt this approach, because it is 
contrary to the statutory text and the legislative history. See House 
Conf. Rpt. 115-466, 490 (2017). The Treasury Department and the IRS are 
aware, however, that compensation arrangements may purport to provide 
the corporation with a wider scope of negative discretion than 
applicable law permits the corporation to exercise. In that case, the 
negative discretion is taken into account only to the extent the 
corporation may exercise the negative discretion under applicable law.
    One commenter asked whether an amount of compensation is 
grandfathered if it is paid pursuant to a written binding contract 
under which the corporation is obligated to recover an amount of 
compensation from the employee if a vesting condition is later 
determined not to have been satisfied.

[[Page 70366]]

For example, a vesting condition may be based on the achievement of 
results reported in the financial statements. In this example, if a 
corporation pays a bonus based on the financial statements but the 
financial statements are subsequently restated and demonstrate that the 
vesting condition was not, in fact, satisfied, then the corporation is 
required to recover a portion of the bonus from the employee. If, under 
applicable law, the employee retains the remaining portion of the bonus 
then, pursuant to the grandfather rules in Notice 2018-68 and these 
proposed regulations, that remaining portion of the bonus is 
grandfathered compensation that is not subject to TCJA amendments. 
Similarly, if the corporation has discretion to recover compensation 
(in whole or in part), only the amount of compensation that the 
corporation is obligated to pay under applicable law that is not 
subject to potential recovery is grandfathered. The proposed 
regulations include examples illustrating these principles.
    Applicable law may provide a corporation with contingent discretion 
to recover compensation. This issue was not addressed in Notice 2018-
68. Under these proposed regulations, a corporation is not treated as 
currently having discretion merely because it will have discretion to 
recover an amount if a condition occurs subsequent to the vesting and 
payment of the compensation and the occurrence of the condition is 
objectively outside of the corporation's control. For example, pursuant 
to a written binding contract in effect on November 2, 2017, a 
corporation may be obligated under applicable law to pay $500,000 of 
compensation if the employee satisfies a vesting condition, but the 
corporation may be permitted to recover $300,000 from the employee if 
the employee is convicted of a felony within three calendar years from 
the date of payment. If the employee is not convicted of a felony 
within three calendar years from the date of payment, then the $500,000 
is grandfathered. If, however, the employee is convicted of a felony 
within three years after the payment of the $500,000, then the 
corporation has discretion whether to recover the $300,000 from the 
employee. Accordingly, if the employee is convicted of a felony within 
three calendar years after the payment, $300,000 of the $500,000 is not 
grandfathered. This is true regardless of whether the corporation 
exercises its discretion to recover the $300,000. Because the 
corporation may not recover $200,000 of the $500,000 payment in any 
event, the $200,000 remains grandfathered regardless of whether the 
employee is convicted of a felony.
C. Account and Nonaccount Balance Plans
    Notice 2018-68 includes examples illustrating the application of 
the grandfather rule to account balance plans, and those examples are 
incorporated into these proposed regulations. Commenters requested 
guidance on the application of the grandfather rule to nonaccount 
balance plans, and some of these commenters suggested that benefits 
accruing under a nonaccount balance plan after November 2, 2017, should 
be automatically grandfathered. The proposed regulations do not adopt 
this approach. Consistent with the text of section 13601(e) of TCJA 
providing the grandfather rule, the amount of compensation that is 
grandfathered under a nonaccount balance plan is the amount that the 
corporation is obligated to pay under applicable law on November 2, 
2017. The proposed regulations include examples illustrating these 
rules.
    Commenters also requested guidance on determining the amount of 
compensation that a corporation is obligated to pay under applicable 
law with respect to linked plan arrangements. In these arrangements, 
the amount payable to an employee under a NQDC plan is linked to a 
qualified employer plan. For example, a typical arrangement may provide 
that the amount of NQDC to be paid to an employee is the account 
balance (or an accumulated benefit) in a NQDC plan reduced by the 
account balance in a section 401(k) plan. These proposed regulations 
include an example involving this type of arrangement.
D. Earnings on Grandfathered Amounts in Account and Nonaccount Balance 
Plans
    Notice 2018-68 includes an example illustrating the circumstances 
in which earnings credited to account balance plans after November 2, 
2017, are grandfathered, as well as an example illustrating that those 
earnings are not grandfathered when the corporation retains the right 
under applicable law to amend the plan at any time either to stop or to 
reduce future credits (including earnings) to the account balance. 
Commenters suggested that earnings credited after November 2, 2017, on 
grandfathered amounts in nonaccount balance plans should also be 
grandfathered. The proposed regulations do not adopt the commenters' 
suggestion. Instead, consistent with TCJA and the guidance in Notice 
2018-68, the proposed regulations provide that earnings credited after 
November 2, 2017, on grandfathered amounts are grandfathered only if 
the corporation is obligated to pay the earnings under applicable law 
pursuant to a written binding contract in effect on November 2, 2017.
    Stakeholders asked how Sec.  1.409A-3(j)(4)(ix)(C)(3) affects the 
determination of whether earnings credited on a grandfathered amount 
after November 2, 2017, are grandfathered if the corporation retains 
the right under applicable law to terminate the plan at any time in 
compliance with section 409A. Section 1.409A-3(j)(4)(ix)(C)(3) provides 
that, if a service recipient terminates a NQDC plan, then the time and 
form of payments may be accelerated, but payment may not be made within 
12 months of the date of termination of the plan. The definition of 
written binding contract in Notice 2018-68 and these proposed 
regulations provides that earnings credited after November 2, 2017, on 
grandfathered amounts are grandfathered only if the corporation is 
obligated to pay the earnings under applicable law pursuant to a 
written binding contract in effect on November 2, 2017. Accordingly, 
if, under applicable law, the corporation is obligated to continue to 
credit earnings for amounts under the NQDC plan during the 12 months 
after terminating the plan, then the earnings would be 
grandfathered.\12\ In that case, the grandfathered amount would be the 
amount that the corporation is obligated to pay under applicable law as 
of November 2, 2017, plus the 12 months of earnings that the 
corporation is obligated to credit under applicable law. However, any 
additional amounts that become payable under the plan after November 2, 
2017, and earnings on those amounts would not be grandfathered.
---------------------------------------------------------------------------

    \12\ Section 1.409A-3(j)(4)(ix)(C) provides that if a service 
recipient terminates a NQDC plan (as defined in Sec.  1.409A-1(c)) 
for one participant, then it must terminate the NQDC plan for all 
participants. Given this requirement, a corporation might refrain 
from terminating a NQDC plan and continue to credit earnings on a 
grandfathered amount after November 2, 2017. If a corporation is 
permitted under applicable law to terminate the NQDC plan, then only 
the amount it would be obligated to pay under applicable law if it 
did terminate the NQDC plan is grandfathered.
---------------------------------------------------------------------------

    Applicable law and the terms of the plan determine the amount of 
earnings that the corporation is obligated to credit for amounts under 
the plan during the 12 months after plan

[[Page 70367]]

termination. Thus, for example, with respect to a nonaccount balance 
plan, under applicable law, the amount of earnings that the corporation 
is obligated to credit might be limited to the difference between the 
present value of the benefit under the plan as of November 2, 2017, and 
any increase in present value due solely to passage of time (12 
months). Furthermore, with respect to a nonaccount balance plan that 
provides for a formula amount (for example, the amount payable under 
the plan is based on the participant's final salary and years of 
service), the amount of earnings that the corporation is obligated to 
credit under applicable law might be limited to a reasonable rate of 
interest to reflect the time value of money during the passage of time 
(12 months) applied to the benefit under the plan as of November 2, 
2017 (and not reflecting any additional salary increase or years of 
service accumulated after November 2, 2017).
E. Severance Agreements
    Commenters asked about the application of the grandfather rule in 
Notice 2018-68 to compensation payable pursuant to a severance 
agreement that is a written binding contract and is in effect on 
November 2, 2017. Severance payable under such a contract is 
grandfathered only if the amount of severance is based on compensation 
elements the employer is obligated to pay under the contract. For 
example, if the amount of severance is based on final base salary, the 
severance is grandfathered only if the corporation is obligated to pay 
both the base salary and the severance under applicable law pursuant to 
a written binding contract in effect on November 2, 2017. For this 
purpose, a corporation may be obligated to pay severance under a 
written binding contract as of November 2, 2017, even if the employee 
remains employed as of November 2, 2017, but only with respect to the 
amount the corporation would have been required to pay if the employee 
had been terminated as of November 2, 2017.
    Commenters also asked whether all or a portion of severance is 
grandfathered if a portion of the amount is based on a variable 
component, such as a discretionary or performance bonus. The examples 
in these proposed regulations illustrate that each component of the 
severance formula is analyzed separately to determine the amount of 
severance that is grandfathered. For example, the amount of severance 
may be equal to two times the sum of: (1) Final base salary and (2) any 
bonus paid within 12 months prior to separation from service. In this 
example, the amount of severance is based on two components, base 
salary and bonus. Therefore, the entire amount of severance (based on 
both components) is grandfathered only if, under applicable law, the 
corporation is obligated to pay both portions, the base salary and the 
bonus pursuant to a written binding contract in effect on November 2, 
2017.
F. Material Modification
1. In General
    These proposed regulations adopt the definition of material 
modification in Notice 2018-68. Under that definition, a material 
modification occurs when the contract is amended to increase the amount 
of compensation payable to the employee. Furthermore, if a written 
binding contract is materially modified, it is treated as a new 
contract entered into as of the date of the material modification. 
Accordingly, amounts received by an employee under the contract before 
a material modification are not affected, but amounts received 
subsequent to the material modification are treated as paid pursuant to 
a new contract, rather than as paid pursuant to a written binding 
contract in effect on November 2, 2017. The adoption of a supplemental 
contract or agreement that provides for increased compensation, or the 
payment of additional compensation, is a material modification of a 
written binding contract if the facts and circumstances demonstrate 
that the additional compensation is paid on the basis of substantially 
the same elements or conditions as the compensation that is otherwise 
paid pursuant to the written binding contract in effect on November 2, 
2017. However, a material modification of a written binding contract 
does not include a supplemental payment that is equal to or less than a 
reasonable cost-of-living increase over the payment made in the 
preceding year under that written binding contract. In that case, only 
the deduction for the reasonable cost-of-living increase is subject to 
section 162(m) as amended by TCJA. In addition, the failure, in whole 
or in part, to exercise negative discretion under a contract does not 
result in the material modification of that contract. Finally, if 
amounts are paid to an employee from more than one written binding 
contract (or if a single written document consists of several written 
binding contracts), then a material modification of one written binding 
contract does not automatically result in a material modification of 
the other contracts unless the material modification affects the 
amounts payable under those contracts.
2. Earnings on Grandfathered Amounts That are Subsequently Deferred
    Notice 2018-68 provides rules for determining whether a material 
modification occurs if a written binding contract in effect on November 
2, 2017, is subsequently modified to defer the payment of compensation. 
Under those rules, which are adopted in these proposed regulations, if 
the contract is modified to defer the payment of compensation, any 
compensation paid or to be paid that is in excess of the amount that 
was originally payable to the employee under the contract will not be 
treated as resulting in a material modification if the additional 
amount is based on either a reasonable rate of interest or a 
predetermined actual investment (whether or not assets associated with 
the amount originally owed are actually invested therein) such that the 
amount payable by the employer at the later date will be based on the 
actual rate of return on the predetermined actual investment (including 
any decrease, as well as any increase, in the value of the investment). 
The proposed regulations provide that a predetermined actual investment 
means a predetermined actual investment as defined in Sec.  
31.3121(v)(2)-1(d)(2)(i)(B), and also include examples illustrating 
these rules relating to the treatment of earnings.
    However, even though the payment of earnings will not result in the 
contract being materially modified, this generally does not mean that 
the earnings are treated as grandfathered. For situations in which an 
employee defers an amount of grandfathered compensation after November 
2, 2017, the earnings on the deferred amount are not grandfathered if, 
as of November 2, 2017, the corporation was not obligated under the 
terms of the contract to provide the deferral election and to pay the 
earnings on the deferred amount under applicable law. Pursuant to the 
definition of written binding contract in Notice 2018-68 and these 
proposed regulations, these earnings are not grandfathered because, as 
of November 2, 2017, the corporation was not obligated to pay them 
under applicable law.
3. Material Modification Prior to Payment of a Grandfathered Amount
    Commenters asked whether a grandfathered amount of compensation is 
no longer considered grandfathered if the underlying compensation 
arrangement is materially modified after November 2, 2017, but before 
the

[[Page 70368]]

payment of the grandfathered amount. Pursuant to the definition of 
material modification in Notice 2018-68 and these proposed regulations, 
if the contract is materially modified after November 2, 2017, but 
before the payment of a grandfathered amount of compensation, then the 
compensation is treated as paid pursuant to the new contract and is no 
longer grandfathered. For example, if, under applicable law, a 
corporation is obligated to pay $100,000 on December 31, 2020, under a 
written binding contract in effect on November 2, 2017, then the 
$100,000 is grandfathered. If, on January 1, 2019, the contract is 
materially modified, then the $100,000 is treated as paid pursuant to a 
new contract and is not grandfathered.
4. Acceleration of Payment or Vesting
    Under the definition of material modification in Notice 2018-68 and 
these proposed regulations, a modification of a written binding 
contract that accelerates the payment of compensation is a material 
modification unless the amount of compensation paid is discounted to 
reasonably reflect the time value of money. For example, if a 
corporation is obligated under applicable law to pay compensation on 
December 31, 2020, pursuant to a written binding contract in effect on 
November 2, 2017, then the compensation is grandfathered. If the 
corporation pays the entire amount of compensation on December 31, 2019 
without a discount to reasonably reflect the time of value of money, 
then the entire amount of compensation is treated as paid pursuant to a 
new contract and is no longer grandfathered. Furthermore, any 
subsequent payment made pursuant to the contract is not grandfathered 
because the contract itself was materially modified when the prior 
payment was accelerated without a discount to reasonably reflect the 
time value of money.
    Commenters asked whether accelerating the payment of compensation 
attributable to equity-based compensation is considered a material 
modification when the payment is subject to a substantial risk of 
forfeiture. For example, an option may be subject to a substantial risk 
of forfeiture if, on the date of grant, the terms of the option provide 
that an employee may exercise the option only after performing services 
for three years after the date of grant. In this example, if the terms 
of the option are subsequently modified to require performance of 
services for only two years, then the modification results in the lapse 
of a substantial risk of forfeiture. One might consider this a material 
modification because the employee may exercise the option and receive 
compensation attributable to the exercise earlier than provided in the 
terms of the option on the date of grant. However, commenters suggested 
that accelerating vesting of equity-based compensation should not be a 
material modification because the acceleration does not provide for an 
increase in the amount of compensation received. The commenters 
reasoned that the acceleration of vesting of an equity award for which 
the amount of compensation is always variable is unlike the 
acceleration of the payment of a fixed cash award in which the 
acceleration may always be considered an increase in compensation due 
to the time value of money. To support their recommendation, commenters 
pointed out that, with respect to incentive stock options, section 
424(h)(3)(C) and Sec.  1.424-1(e)(4)(ii) provide that acceleration of 
vesting of an incentive stock option is not a modification.
    These proposed regulations adopt the commenters' suggestion. 
Specifically, these proposed regulations provide that for compensation 
received pursuant to the substantial vesting of restricted property, or 
the exercise of a stock option or stock appreciation right that do not 
provide for a deferral of compensation (as defined in Sec.  1.409A-
1(b)(5)(i) and (ii)), a modification of a written binding contract in 
effect on November 2, 2017, that results in a lapse of the substantial 
risk of forfeiture (as defined Sec.  1.83-3(c)) is not considered a 
material modification. Likewise, with respect to other compensation 
arrangements, if an amount of compensation payable under a written 
binding contract in effect on November 2, 2017, is subject to a 
substantial risk of forfeiture (as defined in Sec.  1.409A-1(d)), then 
a modification of the contract that results in a lapse of the 
substantial risk of forfeiture is not considered a material 
modification. Thus, for all forms of compensation, a modification to a 
written binding contract that accelerates vesting will not be 
considered a material modification.
    The Treasury Department and the IRS considered alternatives to the 
commenters' suggestion. For example, the Treasury Department and the 
IRS considered an approach based on the rules under section 280G. Under 
those rules, an acceleration of vesting can give rise to an excess 
parachute payment under section 280G even if the timing of the payment 
is not accelerated. See Sec.  1.280G-1, Q&A-24. In other words, the 
rules under section 280G are based on the principle that there is 
independent value attributable to the acceleration of vesting, even if 
the timing of the payment is unchanged. Given the limited scope of the 
section 162(m) grandfathering rule and its diminishing applicability 
over time, the Treasury Department and the IRS have determined that it 
is not necessary to apply that principle in this context.
G. Ordering Rule for Payments Consisting of Grandfathered and Non-
Grandfathered Amounts
    Some NQDC arrangements provide for a series of payments instead of 
a lump sum. For a NQDC arrangement that is a written binding contract 
entered into prior to November 2, 2017, only a portion of the amounts 
payable under the arrangement might be grandfathered depending on the 
terms of the arrangement and applicable law. To identify the 
grandfathered amount when payment under the arrangement is made in a 
series of payments, the proposed regulations provide that the 
grandfathered amount is allocated to the first otherwise deductible 
payment paid under the arrangement. If the grandfathered amount exceeds 
the payment, then the excess is allocated to the next otherwise 
deductible payment paid under the arrangement. This process is repeated 
until the entire grandfathered amount has been paid. For example, 
assume that a NQDC arrangement provides for an annual payment of 
$100,000 for three years, and only $120,000 is grandfathered. Pursuant 
to the proposed regulations, the entire $100,000 paid in the first year 
is grandfathered. In the second year, only $20,000 of the $100,000 
payment is grandfathered; the remaining $80,000 paid in the second year 
is not grandfathered. In the third year, none of the $100,000 payment 
is grandfathered.

VII. Coordination With Section 409A

    Section 409A addresses NQDC arrangements and sets forth certain 
requirements that must be met to avoid current income inclusion and 
certain additional income tax. NQDC arrangements must designate a time 
and form of payment, among other requirements, to comply with section 
409A. Pursuant to Sec.  1.409A-2(b)(7)(i), a payment may be delayed 
past the designated payment date to the extent that the service 
recipient reasonably anticipates that, if the payment were made as 
scheduled, the service recipient's deduction with respect to such 
payment would not be permitted due to the application of section

[[Page 70369]]

162(m).\13\ Generally, a payment delayed in accordance with Sec.  
1.409A-2(b)(7)(i) must be paid no later than the service provider's 
first taxable year in which the deduction of such payment will not be 
barred by the application of section 162(m).
---------------------------------------------------------------------------

    \13\ In general, if a payment is delayed pursuant to Sec.  
1.409A-2(b)(7)(i), then the payment must be made either during the 
service provider's first taxable year in which the service recipient 
reasonably anticipates, or reasonably should anticipate, that the 
payment will not fail to be deductible because of section 162(m), if 
the payment is made during such year or, if later, during the period 
beginning on the day the service provider separates from service and 
ending on the later of the last day of the taxable year of the 
service recipient in which the separation from service occurs or the 
15th day of the third month following the separation from service.
---------------------------------------------------------------------------

    If any scheduled payment to a service provider in a service 
recipient's taxable year is delayed in accordance with Sec.  1.409A-
2(b)(7)(i), then the delay in payment is treated as a subsequent 
deferral election unless all scheduled payments to that service 
provider that could be delayed in accordance with Sec.  1.409A-
2(b)(7)(i) are also delayed.\14\ A subsequent deferral election will 
violate section 409A if the election fails to satisfy the requirements 
of section 409A(a)(4)(C).\15\ A similar rule under Sec.  1.409A-
1(b)(4)(ii) permits delayed payments of compensation that otherwise 
qualifies as a short-term deferral under Sec.  1.409A-1(b)(4)(i) 
(commonly referred to as the short-term deferral exception).
---------------------------------------------------------------------------

    \14\ See Sec.  1.409A-2(b)(7) for additional requirements for 
the service recipient to delay a payment so that the delay is not 
treated as a subsequent deferral election, such as treating all 
payments to similarly situated service providers on a reasonably 
consistent basis.
    \15\ Pursuant to section 409A(a)(4)(C), a subsequent deferral 
election (i) must be made at least 12 months before the prior 
scheduled payment date, (ii) cannot be effective for at least 12 
months after the date of the subsequent election, and (iii) must 
delay the payment at least 5 years from the original scheduled 
payment date.
---------------------------------------------------------------------------

    Before TCJA, an individual who was a covered employee for one 
taxable year would not necessarily remain a covered employee for 
subsequent taxable years, and would not be a covered employee after 
separation from service. Accordingly, parties to NQDC arrangements 
anticipated that in these cases, pursuant to Sec. Sec.  1.409A-
1(b)(4)(ii) and 1.409A-2(b)(7)(i), the corporation would be able to 
make the payment when the individual separated from service (if not 
earlier), when the individual would no longer be a covered employee and 
the deduction for the payment would no longer be restricted due to the 
application of section 162(m). Because TCJA amendments to the 
definition of covered employee fundamentally alter the premise of 
Sec. Sec.  1.409A-1(b)(4)(ii) and 1.409A-2(b)(7)(i), commenters asked 
whether a service recipient may delay the scheduled payment of 
grandfathered amounts in accordance with Sec. Sec.  1.409A-1(b)(4)(ii) 
and 1.409A-2(b)(7)(i), without delaying the payment of non-
grandfathered amounts, in circumstances in which the service recipient 
has discretion to delay the payment. Commenters stated that the service 
provider may not want the non-grandfathered payments delayed and that 
the corporation would be willing to pay those payments under the 
original schedule since a delay in many cases would not result in the 
corporation being able to deduct the payment.
    The Treasury Department and the IRS have concluded that the rules 
should be modified to accommodate this change. Consequently, in 
circumstances in which the service recipient has discretion to delay 
the payment, a service recipient may delay the scheduled payment of 
grandfathered amounts in accordance with Sec. Sec.  1.409A-1(b)(4)(ii) 
and 1.409A-2(b)(7)(i), without delaying the payment of non-
grandfathered amounts, and the delay of the grandfathered amounts will 
not be treated as a subsequent deferral election. As discussed in 
section VI of this preamble, the amendments made to section 162(m) by 
TCJA do not apply to grandfathered amounts. Therefore, the deduction 
for amounts grandfathered under the amended section 162(m) is not 
subject to section 162(m) when paid to a former covered employee who 
separated from service. Thus, the payment of these grandfathered 
amounts may be delayed consistent with Sec. Sec.  1.409A-1(b)(4)(ii) 
and 1.409A-2(b)(7)(i). The Treasury Department and the IRS intend to 
incorporate these modifications into the regulations under section 
409A, and taxpayers may rely on the guidance in this paragraph of the 
preamble for any taxable year beginning after December 31, 2017, until 
the issuance of proposed regulations under section 409A incorporating 
these modifications and permitting taxpayers to rely on such proposed 
regulations under section 409A.
    Even though Sec. Sec.  1.409A-1(b)(4)(ii) and 1.409A-2(b)(7)(i) 
provide that the service recipient has discretion to delay a payment, 
and that the discretion is not required to be set forth in the written 
plan, the Treasury Department and the IRS understand that compensation 
arrangements in effect on November 2, 2017, may explicitly require the 
service recipient to delay a payment if the service recipient 
reasonably believes the deduction with respect to the payment will not 
be permitted under section 162(m). Commenters pointed out that with 
respect to a service provider who is a covered employee, non-
grandfathered amounts may require the passage of a significant period 
of time before a payment of the entire amount would be deductible, and 
may possibly never become deductible if the service provider dies and 
the payment (or remaining amount due) is payable at death. Commenters 
requested that relief be provided so that compensation arrangements may 
be amended to no longer require the service recipient to delay a 
payment that the service recipient reasonably believes will not be 
deductible under section 162(m) without resulting in a failure to meet 
the requirements of section 409A. The Treasury Department and the IRS 
have determined that this type of relief is appropriate given the 
impact of TCJA amendments on application of the rules in Sec. Sec.  
1.409A-1(b)(4)(ii) and 1.409A-2(b)(7)(i). Accordingly, if a NQDC 
arrangement is amended to remove the provision requiring the 
corporation to delay a payment if the corporation reasonably 
anticipates at the time of the scheduled payment that the deduction 
would not be permitted under section 162(m), then the amendment will 
not result in an impermissible acceleration of payment under Sec.  
1.409A-3(j), and will not be considered a material modification for 
purposes of the grandfather rule under the amended section 162(m). The 
plan amendment must be made no later than December 31, 2020. If, 
pursuant to the amended plan, the corporation would have been required 
to make a payment (or payments) prior to December 31, 2020, then the 
payment (or payments) must be made no later than December 31, 2020. The 
Treasury Department and the IRS intend to incorporate these 
modifications into the regulations under section 409A, and taxpayers 
may rely on the guidance in this paragraph of the preamble for any 
taxable year beginning after December 31, 2017, until the issuance of 
proposed regulations under section 409A incorporating these 
modifications and permitting taxpayers to rely on such proposed 
regulations under section 409A.
    Amounts payable under NQDC arrangements may consist of both 
grandfathered amounts and non-grandfathered amounts. With respect to 
these arrangements, employers may apply the guidance provided in the 
previous two paragraphs of this preamble. Accordingly, the plan may be 
amended to remove the provision requiring the corporation to delay the 
payment of non-grandfathered amounts

[[Page 70370]]

if it is anticipated that the corporation's deduction with respect to 
the payments will not be permitted under section 162(m); 
notwithstanding such an amendment, the corporation may continue to 
delay payment of the grandfathered amounts in accordance with 
Sec. Sec.  1.409A-1(b)(4)(ii) and 1.409A-2(b)(7)(i).

VIII. Proposed Applicability Dates

A. General Applicability Date

    Generally, these regulations are proposed to apply to compensation 
that is otherwise deductible for taxable years beginning on or after 
[DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER]. 
Taxpayers may choose to rely on these proposed regulations until the 
applicability date of the final regulations, provided that taxpayers 
apply these proposed regulations consistently and in their entirety. 
Because these proposed regulations do not broaden the definition of 
``covered employee'' as provided in Notice 2018-68 and do not restrict 
the application of the definition of ``written binding contract'' as 
provided in Notice 2018-68, except as provided by the special 
applicability dates described in section VIII.B of this preamble, 
taxpayers may no longer rely on Notice 2018-68 for taxable years ending 
on or after December 20, 2019, but instead may rely on these proposed 
regulations for those taxable years.

B. Special Applicability Dates

    These regulations are proposed to include special applicability 
dates covering certain aspects of the following provisions of the 
proposed regulations:
    1. Definition of covered employee.
    2. Definition of predecessor of a publicly held corporation.
    3. Definition of compensation.
    4. Application of section 162(m) to a deduction for compensation 
otherwise deductible for a taxable year ending on or after a privately 
held corporation becomes a publicly held corporation.
    5. Definitions of written binding contract and material 
modification.
    First, the definition of covered employee is proposed to apply to 
taxable years ending on or after September 10, 2018, the publication 
date of Notice 2018-68, which provided guidance on the definition of 
covered employee. Notice 2018-68 also provided that the Treasury 
Department and the IRS anticipate that the guidance in the notice will 
be incorporated in future regulations that, with respect to the issues 
addressed in the notice, will apply to any taxable year ending on or 
after September 10, 2018. Because these proposed regulations adopt the 
definition of covered employee in Notice 2018-68, the guidance on the 
definition of covered employee in these proposed regulations is 
proposed to apply to taxable years ending on or after September 10, 
2018. The Treasury Department and the IRS recognize, however, that the 
rules related to a corporation whose fiscal year and taxable year do 
not end on the same date were not discussed in Notice 2018-68. 
Accordingly, the proposed regulations provide that, for a corporation 
whose fiscal and taxable years do not end on the same date, the rule 
requiring the determination of the three most highly compensated 
executive officers to be made pursuant to the rules under the Exchange 
Act applies to taxable years beginning on or after December 20, 2019.
    Second, the provisions defining a predecessor corporation of a 
publicly held corporation are proposed to apply to corporate 
transactions for which all events necessary for the transaction occur 
on or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL 
REGISTER]. With respect to the rules that apply to corporations that 
change from publicly held to privately held status or visa-versa, the 
definition of the term predecessor corporation of a publicly held 
corporation applies to a privately held corporation that again becomes 
a publicly held corporation on or after [DATE OF PUBLICATION OF THE 
FINAL RULE IN THE FEDERAL REGISTER]. Accordingly, depending on the 
timing of any earlier transition from a publicly held corporation to a 
privately held corporation, the publicly held corporation that existed 
before the issuance of final regulations may be treated as a 
predecessor of a privately held corporation that becomes a publicly 
held corporation after the date of issuance of final regulations. Until 
the applicability date of the final regulations, taxpayers may rely on 
the definition of predecessor of a publicly held corporation in these 
proposed regulations or a reasonable good faith interpretation of the 
term ``predecessor.'' The Treasury Department and the IRS have 
determined, however, that excluding the following target corporations 
from the definition of the term ``predecessor'' in the following 
situations is not a reasonable good faith interpretation of the 
statute: (1) A publicly held target corporation the stock or assets of 
which are acquired by another publicly held corporation in a 
transaction to which section 381(a) applies, and (2) a publicly held 
target corporation, at least 80% of the total voting power, and at 
least 80% of the total value, of the stock of which is acquired by a 
publicly held acquiring corporation (including an affiliated group). No 
inference is intended regarding whether the treatment of a target 
corporation as other than a ``predecessor'' in any other situation is a 
reasonable good faith interpretation of the statute.
    Third, as discussed in section IV.C. of this preamble, the rule 
that the definition of compensation in proposed Sec.  1.162-33(c)(3) 
includes an amount equal to the publicly held corporation's 
distributive share of a partnership's deduction for compensation 
expense attributable to the compensation paid by the partnership is 
proposed to apply to any deduction for compensation that is otherwise 
allowable for a taxable year ending on or after December 20, 2019. The 
Treasury Department and the IRS are aware that arrangements currently 
exist that reflect an understanding that the allocated deduction would 
not be limited by section 162(m). Accordingly, this aspect of the 
definition of compensation would not apply to compensation paid 
pursuant to a written binding contract in effect on December 20, 2019 
that is not materially modified after that date.
    Fourth, the guidance on the applicability of section 162(m)(1) to 
the deduction for any compensation otherwise deductible for a taxable 
year ending on or after the date when a corporation becomes a publicly 
held corporation is proposed to apply to corporations that become 
publicly held after December 20, 2019. A corporation that was not a 
publicly held corporation and then becomes a publicly held corporation 
on or before December 20, 2019 may rely on the transition relief as 
provided in Sec.  1.162-27(f)(1) until the earliest of the events 
provided in Sec.  1.162-27(f)(2).
    Fifth, the definitions of written binding contract and material 
modification are proposed to apply to taxable years ending on or after 
September 10, 2018, the publication date of Notice 2018-68, which 
provided guidance defining these terms. Notice 2018-68 also provided 
that the Treasury Department and IRS anticipated that the guidance in 
the notice would be incorporated in future regulations that, with 
respect to the issues addressed in the notice, would apply to any 
taxable year ending on or after September 10, 2018. Because these 
proposed regulations adopt the definitions of the terms ``written 
binding contract'' and ``material modification'' that were

[[Page 70371]]

included in Notice 2018-68, the guidance on these definitions in these 
proposed regulations is proposed to apply to taxable years ending on or 
after September 10, 2018.

Special Analyses

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Department of the Treasury and the Office of 
Management and Budget regarding review of tax regulations. Pursuant to 
the Regulatory Flexibility Act (RFA) (5 U.S.C. chapter 6), it is hereby 
certified that these proposed regulations would not have a significant 
economic impact on a substantial number of small entities. This 
certification is based on the fact that section 162(m)(1) applies only 
to publicly held corporations (for example, corporations that list 
securities on a national securities exchange and are rarely small 
entities) and only impacts those publicly held corporations that 
compensate certain executive officers in excess of $1 million in a 
taxable year. Notwithstanding this certification that the proposed 
regulations would not have a significant economic impact on a 
substantial number of small entities, the Treasury Department and the 
IRS invite comments on the impacts these proposed regulations may have 
on small entities. Pursuant to section 7805(f) of the Code, this 
proposed rule has been submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on its impact on small 
entities.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ADDRESSES heading. 
Treasury and the IRS request comments on all aspects of the proposed 
rules. All comments will be available at www.regulations.gov or upon 
request.
    A public hearing has been scheduled for March 9, 2020, beginning at 
10 a.m. in the Auditorium of the Internal Revenue Building, 1111 
Constitution Avenue NW, Washington, DC. Due to building security 
procedures, visitors must enter at the Constitution Avenue entrance. In 
addition, all visitors must present photo identification to enter the 
building. Because of access restrictions, visitors will not be admitted 
beyond the immediate entrance area more than 30 minutes before the 
hearing starts. For more information about having your name placed on 
the building access list to attend the hearing, see the FOR FURTHER 
INFORMATION CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit an outline of 
the topics to be discussed and the time to be devoted to each topic by 
February 18, 2020. Submit a signed paper or electronic copy of the 
outline as prescribed in this preamble under the ADDRESSES heading. A 
period of 10 minutes will be allotted to each person for making 
comments. An agenda showing the scheduling of the speakers will be 
prepared after the deadline for receiving outlines has passed. Copies 
of the agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is Ilya Enkishev, Office 
of Associate Chief Counsel (Employee Benefits, Exempt Organizations, 
and Employment Taxes). However, other personnel from the Treasury 
Department and the IRS participated in the development of these 
regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.162-27 is amended by revising paragraphs (a) and 
(j)(1) to read as follows:


Sec.  1.162-27  Certain employee remuneration in excess of $1,000,000 
not deductible for taxable years beginning on or after January 1, 1994, 
and for taxable years beginning prior to January 1, 2018

    (a) Scope. This section provides rules for the application of the 
$1 million deduction limitation under section 162(m)(1) for taxable 
years beginning on or after January 1, 1994, and beginning prior to 
January 1, 2018, and, as provided in paragraph (j) of this section, for 
taxable years beginning after December 31, 2017. For rules concerning 
the applicability of section 162(m)(1) to taxable years beginning after 
December 31, 2017, see Sec.  1.162-33. Paragraph (b) of this section 
provides the general rule limiting deductions under section 162(m)(1). 
Paragraph (c) of this section provides definitions of generally 
applicable terms. Paragraph (d) of this section provides an exception 
from the deduction limitation for compensation payable on a commission 
basis. Paragraph (e) of this section provides an exception for 
qualified performance-based compensation. Paragraphs (f) and (g) of 
this section provide special rules for corporations that become 
publicly held corporations and payments that are subject to section 
280G, respectively. Paragraph (h) of this section provides transition 
rules, including the rules for contracts that are grandfathered and not 
subject to section 162(m)(1). Paragraph (j) of this section contains 
the effective date provisions, which also specify when these rules 
apply to the deduction for compensation otherwise deductible in a 
taxable year beginning after December 31, 2017. For rules concerning 
the deductibility of compensation for services that are not covered by 
section 162(m)(1) and this section, see section 162(a)(1) and Sec.  
1.162-7. This section is not determinative as to whether compensation 
meets the requirements of section 162(a)(1). For rules concerning the 
deduction limitation under section 162(m)(6) applicable to certain 
health insurance providers, see Sec.  1.162-31.
* * * * *
    (j) Effective date--(1) In general. Section 162(m) and this section 
apply to the deduction for compensation that is otherwise deductible by 
the corporation in taxable years beginning on or after January 1, 1994, 
and beginning prior to January 1, 2018. Section 162(m) and this section 
also apply to compensation that is a grandfathered amount (as defined 
in Sec.  1.162-33(g)) at the time it is paid to the covered employee. 
For examples of the application of the rules of this section to 
grandfathered amounts paid during taxable years beginning after 
December 31, 2017, see Sec.  1.162-33(g).
* * * * *
0
Par. 3. Section 1.162-33 is added to read as follows:


Sec.  1.162-33  Certain employee remuneration in excess of $1,000,000 
not deductible for taxable years beginning after December 31, 2017

    (a) Scope. This section provides rules for the application of the 
$1 million deduction limitation under section 162(m)(1) for taxable 
years beginning after December 31, 2017. For rules concerning the 
applicability of section 162(m)(1) to taxable years beginning on or 
after January 1, 1994, and prior to January 1, 2018, see Sec.  1.162-
27. Paragraph (b) of this section provides the general rule limiting 
deductions under section 162(m)(1). Paragraph (c)

[[Page 70372]]

of this section provides definitions of generally applicable terms. 
Paragraph (d) of this section provides rules for determining when a 
corporation becomes a publicly held corporation. Paragraph (e) of this 
section provides rules for payments that are subject to section 280G. 
Paragraph (f) of this section provides a special rule for coordination 
with section 4985. Paragraph (g) of this section provides transition 
rules, including the rules for contracts that are grandfathered. 
Paragraph (h) of this section sets forth the effective date provisions. 
For rules concerning the deductibility of compensation for services 
that are not covered by section 162(m)(1) and this section, see section 
162(a)(1) and Sec.  1.162-7. This section is not determinative as to 
whether compensation meets the requirements of section 162(a)(1). For 
rules concerning the deduction limitation under section 162(m)(6) 
applicable to certain health insurance providers, see Sec.  1.162-31.
    (b) Limitation on deduction. Section 162(m)(1) precludes a 
deduction under chapter 1 of the Internal Revenue Code by any publicly 
held corporation for compensation paid to any covered employee to the 
extent that the compensation for the taxable year exceeds $1,000,000.
    (c) Definitions--(1) Publicly held corporation--(i) General rule. A 
publicly held corporation means any corporation that issues securities 
required to be registered under section 12 of the Exchange Act or that 
is required to file reports under section 15(d) of the Exchange Act. In 
addition, a publicly held corporation means any S corporation (as 
defined in section 1361(a)(1)) that issues securities that are required 
to be registered under section 12(b) of the Exchange Act, or that is 
required to file reports under section 15(d) of the Exchange Act. For 
purposes of this section, whether a corporation is publicly held is 
determined based solely on whether, as of the last day of its taxable 
year, the securities issued by the corporation are required to be 
registered under section 12 of the Exchange Act or the corporation is 
required to file reports under section 15(d) of the Exchange Act. 
Whether registration under the Exchange Act is required by rules other 
than those of the Exchange Act is irrelevant to this determination. A 
publicly traded partnership that is treated as a corporation under 
section 7704 (or otherwise) is a publicly held corporation if, as of 
the last day of its taxable year, its securities are required to be 
registered under section 12 of the Exchange Act or it is required to 
file reports under section 15(d) of the Exchange Act.
    (ii) Affiliated groups--(A) In general. A publicly held corporation 
includes an affiliated group of corporations, as defined in section 
1504 (determined without regard to section 1504(b)) that includes one 
or more publicly held corporations (as defined in paragraph (c)(1)(i) 
of this section). In the case of an affiliated group that includes two 
or more publicly held corporations as defined in paragraph (c)(1)(i) of 
this section, each member of the affiliated group that is a publicly 
held corporation as defined in paragraph (c)(1)(i) of this section is 
separately subject to this section, and the affiliated group as a whole 
is subject to this section. Thus, for example, assume that a publicly 
held corporation (as defined in paragraph (c)(1)(i) of this section) is 
a wholly-owned subsidiary of another publicly held corporation (as 
defined in paragraph (c)(1)(i) of this section), which is a wholly-
owned subsidiary of a privately held corporation. In this case, the two 
subsidiaries are separately subject to this section, and all three 
corporations are members of an affiliated group that is subject to this 
section. Furthermore, each subsidiary has its own set of covered 
employees as defined in paragraphs (c)(2)(i) through (iv) of this 
section (although it is possible that the same individual may be a 
covered employee of both subsidiaries).
    (B) Proration of amount disallowed as a deduction. If, in a taxable 
year, a covered employee (as defined in paragraphs (c)(2)(i) through 
(iv) of this section) of one member of an affiliated group is paid 
compensation by more than one member of the affiliated group, 
compensation paid by each member of the affiliated group is aggregated 
with compensation paid to the covered employee by all other members of 
the affiliated group (excluding compensation paid by any other publicly 
held corporation in the affiliated group, as defined in paragraph 
(c)(1)(i) of this section, of which the individual is also a covered 
employee as defined in paragraphs (c)(2)(i) through (iv) of this 
section). In the event that, in a taxable year, a covered employee (as 
defined in paragraphs (c)(2)(i) through (iv) of this section) is paid 
compensation by more than one publicly held corporation in an 
affiliated group and is also a covered employee of more than one 
publicly held payor corporation (as defined in paragraph (c)(1)(i) of 
this section) in the affiliated group, the amount disallowed as a 
deduction is determined separately with respect to each publicly held 
corporation of which the individual is a covered employee. Any amount 
disallowed as a deduction by this section must be prorated among the 
payor corporations (excluding any other publicly held payor corporation 
of which the individual is also a covered employee) in proportion to 
the amount of compensation paid to the covered employee (as defined in 
paragraphs (c)(2)(i) through (iv) of this section) by each such 
corporation in the taxable year. This process is repeated for each 
publicly held payor corporation of which the individual is a covered 
employee.
    (iii) Disregarded entities. For purposes of paragraph (c)(1) of 
this section, a publicly held corporation includes a corporation that 
owns an entity that is disregarded as an entity separate from its owner 
within the meaning of Sec.  301.7701-2(c)(2)(i) of this chapter if the 
disregarded entity issues securities required to be registered under 
section 12(b) of the Exchange Act, or is required to file reports under 
section 15(d) of the Exchange Act.
    (iv) Qualified subchapter S subsidiaries. For purposes of paragraph 
(c)(1) of this section, a publicly held corporation includes an S 
corporation that owns a qualified subchapter S subsidiary as defined in 
section 1361(b)(3)(B) (QSub) if the QSub issues securities required to 
be registered under section 12(b) of the Exchange Act, or is required 
to file reports under section 15(d) of the Exchange Act.
    (v) Examples. The following examples illustrate the provisions of 
this paragraph (c)(1). For each example, assume that no corporation is 
a predecessor of a publicly held corporation within the meaning of this 
paragraph (c)(2)(ii). Furthermore, for each example, unless provided 
otherwise, a reference to a publicly held corporation means a publicly 
held corporation as defined in paragraph (c)(1)(i) of this section. 
Additionally, for each example, assume that the corporation is a 
calendar year taxpayer and has a fiscal year ending December 31 for 
reporting purposes under the Exchange Act. These examples are not 
intended to provide guidance on the legal requirements of the 
Securities Act and Exchange Act and the rules thereunder (17 CFR part 
240).

    (A) Example 1 (Corporation required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. Corporation Z plans 
to issue debt securities in a public offering registered under the 
Securities Act. Corporation Z is not required to file reports under 
section 15(d) of the Exchange Act with respect to any other class of 
securities and does not have another class of securities required to 
be registered

[[Page 70373]]

under section 12 of the Exchange Act. On April 1, 2021, the 
Securities Act registration statement for Corporation Z's debt 
securities is declared effective by the SEC. As a result, 
Corporation Z is required to file reports under section 15(d) of the 
Exchange Act. Accordingly, as of December 31, 2021, the last day of 
its taxable year, Corporation Z is required to file reports under 
section 15(d) of the Exchange Act.
    (2) Conclusion. Corporation Z is a publicly held corporation for 
its 2021 taxable year because it is required to file reports under 
section 15(d) of the Exchange Act as of the last day of its taxable 
year.
    (B) Example 2 (Corporation not required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. The facts are the 
same as in paragraph (c)(1)(v)(A) of this section (Example 1), 
except that, on January 1, 2022, pursuant to section 15(d) of the 
Exchange Act, Corporation Z's obligation to file reports under 
section 15(d) is automatically suspended for the fiscal year ending 
December 31, 2022, because Corporation Z meets the statutory 
requirements for an automatic suspension to file reports under 
section 15(d). Accordingly, as of December 31, 2022, Corporation Z 
is not required to file reports under section 15(d) of the Exchange 
Act.
    (2) Conclusion. Corporation Z is not a publicly held corporation 
for its 2022 taxable year because it is not required to file reports 
under section 15(d) of the Exchange Act as of as of the last day of 
its taxable year.
    (C) Example 3 (Corporation not required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. The facts are the 
same as in paragraph (c)(1)(v)(B) of this section (Example 2), 
except that, on January 1, 2022, pursuant to section 15(d) of the 
Exchange Act, Corporation Z's obligation to file reports under 
section 15(d) is not automatically suspended for the fiscal year 
ending December 31, 2022 because Corporation Z does not meet the 
statutory requirements for automatic suspension. Instead, on May 2, 
2022, Corporation Z is eligible to suspend its section 15(d) 
reporting obligation under Rule 12h-3 of the Exchange Act (17 CFR 
240.12h-3) and files Form 15, Certification and Notice of 
Termination of Registration under Section 12(g) of the Securities 
Exchange Act of 1934 or Suspension of Duty to File Reports under 
Sections 13 and 15(d) of the Securities Exchange Act of 1934 (or its 
successor), to suspend its section 15(d) reporting obligation for 
its fiscal year ending December 31, 2022. Accordingly, as of 
December 31, 2022, Corporation Z is not required to file reports 
under section 15(d) of the Exchange Act.
    (2) Conclusion. Corporation Z is not a publicly held corporation 
for its 2022 taxable year because it is not required to file reports 
under section 15(d) of the Exchange Act as of the last day of its 
taxable year.
    (D) Example 4 (Corporation required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. The facts are the 
same as in paragraph (c)(1)(v)(C) of this section (Example 3), 
except that, Corporation Z does not utilize Rule 12h-3 under the 
Exchange Act (17 CFR 240.12h-3) to file a Form 15, Certification and 
Notice of Termination of Registration under Section 12(g) of the 
Securities Exchange Act of 1934 or Suspension of Duty to File 
Reports under Sections 13 and 15(d) of the Securities Exchange Act 
of 1934 (or its successor), to suspend its section 15(d) reporting 
obligation during its fiscal year ending December 31, 2022. 
Accordingly, Corporation Z's reporting obligation under section 
15(d) of the Exchange Act is not suspended for its fiscal year 
ending December 31, 2022.
    (2) Conclusion. Corporation Z is a publicly held corporation for 
its 2022 taxable year because it is required to file reports under 
section 15(d) of the Exchange Act as of the last day of its taxable 
year.
    (E) Example 5 (Corporation required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. Corporation Y is a 
wholly-owned subsidiary of Corporation X, which is required to file 
reports under the Exchange Act. Corporation Y issued a class of debt 
securities in a public offering registered under the Securities Act, 
and therefore is required to file reports under Exchange Act Section 
15(d), including for its fiscal year ending December 31, 2020. 
Corporation Y has no other class of securities registered under the 
Exchange Act. In its Form 10-K, Annual Report Pursuant to Section 13 
or 15(d) of the Securities Exchange Act of 1934 (or its successor), 
for the 2020 fiscal year, Corporation Y may omit Item 11 Executive 
Compensation (required by Part III of Form 10-K), which requires 
disclosure of compensation of certain executive officers because it 
is wholly-owned by Corporation X and the other conditions of General 
Instruction I to Form 10-K are satisfied.
    (2) Conclusion. Corporation Y is a publicly held corporation for 
its 2020 taxable year because it is required to file reports under 
section 15(d) of the Exchange Act as of the last day of its taxable 
year.
    (F) Example 6 (Corporation not required to file reports under 
section 15(d) of the Exchange Act and not required to register 
securities under section 12 of the Exchange Act)--(1) Facts. 
Corporation A has a class of securities registered under section 
12(g) of the Exchange Act. For its 2020 taxable year, Corporation A 
is a publicly held corporation. On September 30, 2021, Corporation A 
is eligible to terminate the registration of its securities under 
section 12(g) of the Exchange Act pursuant to Rule 12g-4(a)(2) of 
the Exchange Act (17 CFR 240.12g-4(a)(2)), but does not terminate 
the registration of its securities prior to December 31, 2021. 
Because Corporation A did not issue securities in a public offering 
registered under the Securities Act, Corporation A is not required 
to file reports under section 15(d) of the Exchange Act.
    (2) Conclusion. Corporation A is not a publicly held corporation 
for its 2021 taxable year because, as of the last day of its taxable 
year, the securities issued by Corporation A are not required to be 
registered under section 12 of the Exchange Act and Corporation A is 
not required to file reports under section 15(d) of the Exchange 
Act.
    (G) Example 7 (Corporation required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. The facts are the 
same as in paragraph (c)(1)(v)(F) of this section (Example 6), 
except that Corporation A previously issued a class of securities in 
a public offering registered under the Securities Act. Furthermore, 
on October 1, 2021, Corporation A terminates the registration of its 
securities under section 12(g) of the Exchange Act. Because 
Corporation A issued a class of securities in a public offering 
registered under the Securities Act and is not eligible to suspend 
its reporting obligation under section 15(d) of the Exchange Act, as 
of December 31, 2021, Corporation A is required to file reports 
under section 15(d) of the Exchange Act.
    (2) Conclusion. Corporation A is a publicly held corporation for 
its 2021 taxable year because it is required to file reports under 
section 15(d) of the Exchange Act as of the last day of its taxable 
year.
    (H) Example 8 (Corporation not required to file reports under 
section 15(d) of the Exchange Act and not required to register 
securities under section 12 of the Exchange Act)--(1) Facts. On 
November 1, 2021, Corporation B is an issuer with only one class of 
equity securities. On November 5, 2021, Corporation B files a 
registration statement for its equity securities under section 12(g) 
of the Exchange Act. Corporation B's filing of its registration 
statement is voluntary because the Exchange Act does not require 
Corporation B to register its class of securities under section 
12(g) of the Exchange Act based on the number and composition of its 
record holders. On December 1, 2021, the Exchange Act registration 
statement for Corporation B's securities is declared effective by 
the SEC. As of December 31, 2021, the last day of its taxable year, 
Corporation B continues to have its class of equity securities 
registered voluntarily under section 12 of the Exchange Act. 
Furthermore, Corporation B is not required to file reports under 
section 15(d) of the Exchange Act because it did not register any 
class of securities in a public offering under the Securities Act.
    (2) Conclusion. Corporation B is not a publicly held corporation 
for its 2021 taxable year because, as of the last day of that 
taxable year, the securities issued by Corporation B are not 
required to be registered under section 12 of the Exchange Act and 
Corporation B is not required to file reports under section 15(d) of 
the Exchange Act.
    (I) Example 9 (Corporation not required to file reports under 
section 15(d) of the Exchange Act and not required to register 
securities under section 12 of the Exchange Act)--(1) Facts. The 
facts are the same as in paragraph (c)(1)(v)(H) of this section 
(Example 8), except that, on December 31, 2022, because of a change 
in circumstances, under the Exchange Act, Corporation B must 
register its class of equity securities under section 12(g) of the 
Exchange Act within 120 days of December 31, 2022. On February 1, 
2023, the Exchange Act registration statement for Corporation B's 
securities is declared effective by the SEC.
    (2) Conclusion. Corporation B is not a publicly held corporation 
for its 2022 taxable year because, as of the last day of that 
taxable year, Corporation B is not required to file reports under 
section 15(d) of the Exchange Act, and the class of equity 
securities issued

[[Page 70374]]

by Corporation B is not yet required to be registered under section 
12 of the Exchange Act. Corporation B has 120 days following 
December 31, 2022, to file a registration statement to register its 
class of equity securities under section 12(g) of the Exchange Act.
    (J) Example 10 (Securities of foreign private issuer in the form 
of ADRs traded in the over-the-counter market)--(1) Facts. For its 
fiscal and taxable years ending December 31, 2021, Corporation W is 
a foreign private issuer. Because Corporation W has not registered 
an offer or sale of securities under the Securities Act, it is not 
required to file reports under section 15(d) of the Exchange Act. 
Corporation W qualifies for an exemption from registration of its 
securities under section 12(g) of the Exchange Act pursuant to Rule 
12g3-2(b) under the Exchange Act (17 CFR 240.12g3-2(b)). Corporation 
W wishes to have its securities traded in the U.S. in the over-the-
counter market in the form of ADRs. Because Corporation W qualifies 
for an exemption pursuant to Rule 12g3-2(b) under the Exchange Act 
(17 CFR 240.12g3-2(b)), Corporation W is not required to register 
its securities underlying the ADRs under section 12 of the Exchange 
Act. However, the depositary bank is required to register the ADRs 
under the Securities Act. Even though the depositary bank is 
required to register the ADRs under the Securities Act, such 
registration of the ADRs does not create a requirement for either 
the depositary bank or Corporation W to file reports under section 
15(d) of the Exchange Act. On February 3, 2021, the Securities Act 
registration statement for the ADRs is declared effective by the 
SEC. On February 4, 2021, Corporation W's ADRs begin trading in the 
over-the-counter market. On December 31, 2021, the securities of 
Corporation W are not required to be registered under Section 12 of 
the Exchange Act because Corporation W qualifies for an exemption 
pursuant to Rule 240.12g3-2(b) of the Exchange Act. Furthermore, on 
December 31, 2021, Corporation W is not required to file reports 
under section 15(d) of the Exchange Act.
    (2) Conclusion. Corporation W is not a publicly held corporation 
for its 2021 taxable year because, as of the last day of that 
taxable year, the securities underlying the ADRs are not required to 
be registered under section 12 of the Exchange Act and Corporation W 
is not required to file reports under section 15(d) of the Exchange 
Act. The conclusion would be the same if Corporation W had its 
securities traded in the over-the-counter market other than in the 
form of ADRs.
    (K) Example 11 (Securities of foreign private issuer in the form 
of ADRs quoted on Over the Counter Bulletin Board)--(1) Facts. The 
facts are the same as in paragraph (c)(1)(v)(J) of this section 
(Example 10), except that Corporation W has its securities quoted on 
the Over the Counter Bulletin Board (OTCBB) in the form of ADRs. 
Because Corporation W qualifies for an exemption pursuant to Rule 
12g3-2(b) of the Exchange Act (17 CFR 240.12g3-2(b)), Corporation W 
is not required to register its securities underlying the ADRs under 
section 12 of the Exchange Act. However, the depositary bank is 
required to register the ADRs under the Securities Act. Section 
6530(b)(1) of the OTCBB Rules requires that a foreign equity 
security may be quoted on the OTCBB only if the security is 
registered with the SEC pursuant to section 12 of the Exchange Act 
and the issuer of the security is current in its reporting 
obligations. To comply with section 6530(b)(1) of the OTCBB Rules, 
on February 5, 2021, Corporation W files a registration statement 
for its class of securities underlying the ADRs under section 12(g) 
of the Exchange Act. On February 26, 2021, the Exchange Act 
registration statement for Corporation W's securities is declared 
effective by the SEC. As of December 31, 2021, Corporation W is 
subject to the reporting obligations under the section 12 of the 
Exchange Act as a result of section 12 registration.
    (2) Conclusion. Corporation W is not a publicly held corporation 
for its 2021 taxable year because, as of the last day of that 
taxable year, its ADRs and the securities underlying the ADRs are 
not required by the Exchange Act to be registered under section 12, 
and Corporation W is not required to file reports under section 
15(d) of the Exchange Act. The conclusion would be the same if 
Corporation W had its securities traded on the OTCBB other than in 
the form of ADRs.
    (L) Example 12 (Securities of foreign private issuer in the form 
of ADRs listed on a national securities exchange without a capital 
raising transaction)--(1) Facts. For its fiscal and taxable years 
ending December 31, 2021, Corporation V is a foreign private issuer. 
Corporation V wishes to list its securities on the New York Stock 
Exchange (NYSE) in the form of ADRs without a capital raising 
transaction. Under the Exchange Act, Corporation V is required to 
register its securities underlying the ADRs under section 12(b) of 
the Exchange Act. Because the ADRs and the deposited securities are 
separate securities, the depositary bank is required to register the 
ADRs under the Securities Act. On February 2, 2021, Corporation V's 
registration statement under section 12(b) of the Exchange Act in 
connection with the underlying securities, and the depositary bank's 
registration statement under the Securities Act in connection with 
the ADRs, are declared effective by the SEC. On March 1, 2021, 
Corporation V's securities begin trading on the NYSE in the form of 
ADRs. As of December 31, 2021, Corporation V is not required to file 
reports under section 15(d) of the Exchange Act; however, the 
securities underlying the ADRs are required to be registered under 
section 12(b) of the Exchange Act.
    (2) Conclusion. Corporation V is a publicly held corporation for 
its 2021 taxable year because, as of the last day of that taxable 
year, the securities underlying the ADRs are required to be 
registered under section 12 of the Exchange Act. The conclusion 
would be the same if Corporation V had its securities listed on the 
NYSE other than in the form of ADRs.
    (M) Example 13 (Securities of foreign private issuer in the form 
of ADRs listed on a national securities exchange with a capital 
raising transaction)--(1) Facts. The facts are the same as in 
paragraph (c)(1)(v)(L) of this section (Example 12), except that 
Corporation V wishes to raise capital and have its securities listed 
on the NYSE in the form of ADRs. Corporation V is required to 
register the offer of securities underlying the ADRs under the 
Securities Act and to register the class of those securities under 
section 12(b) of the Exchange Act. The depositary bank is required 
to register the ADRs under the Securities Act. On February 2, 2021, 
Corporation V's registration statements under the Securities Act and 
section 12(b) of the Exchange Act, and the registration statement 
for the ADRs under the Securities Act, are declared effective by the 
SEC. As of December 31, 2021, Corporation V is not required to file 
reports under section 15(d) of the Exchange Act; however, the 
securities underlying the ADRs are required to be registered under 
section 12(b) of the Exchange Act.
    (2) Conclusion. Corporation V is a publicly held corporation for 
its 2021 taxable year because, as of the last day of that taxable 
year, its securities underlying the ADRs are required to be 
registered under section 12 of the Exchange Act. The conclusion 
would be the same if Corporation V had its securities listed on the 
NYSE other than in the form of ADRs.
    (N) Example 14 (Foreign private issuer incorporates subsidiary 
in the United States to issue debt securities and subsequently 
issues a guarantee)--(1) Facts. Corporation T is a corporation 
incorporated in Country S (which is not the United States). For its 
fiscal and taxable years ending December 31, 2021, Corporation T is 
a foreign private issuer. Corporation T wishes to access the U.S. 
capital markets. Corporation T incorporates Corporation U in the 
United States to issue debt securities. On January 15, 2021, the SEC 
declares Corporation U's Securities Act registration statement 
effective. Corporation U is a wholly-owned subsidiary of Corporation 
T. To enhance the credit of Corporation U and the marketability of 
Corporation U's debt securities, Corporation T issues a guarantee of 
Corporation U's securities and, as required, registers the guarantee 
under the Securities Act on the registration statement that the SEC 
declares effective on January 15, 2021. On December 31, 2021, 
Corporations T and U are required to file reports under section 
15(d) of the Exchange Act.
    (2) Conclusion. Corporations T and U are publicly held 
corporations for their 2021 taxable years because they are required 
to file reports under section 15(d) of the Exchange Act as of the 
last day of their taxable years.
    (O) Example 15 (Affiliated group composed of two corporations, 
one of which is a publicly held corporation)--(1) Facts. Employee D, 
a covered employee of Corporation N, performs services and receives 
compensation from Corporations N and O, members of an affiliated 
group of corporations. Corporation N, the parent corporation, is a 
publicly held corporation. Corporation O is a direct subsidiary of 
Corporation N and is a privately held corporation. The total 
compensation paid to Employee D from all affiliated group members is 
$3,000,000 for the taxable year, of which Corporation N pays 
$2,100,000 and Corporation O pays $900,000.

[[Page 70375]]

    (2) Conclusion. Because the compensation paid by all affiliated 
group members is aggregated for purposes of section 162(m)(1), 
$2,000,000 of the aggregate compensation paid is nondeductible. 
Corporations N and O each are treated as paying a ratable portion of 
the nondeductible compensation. Thus, two thirds of each 
corporation's payment will be nondeductible. Corporation N has a 
nondeductible compensation expense of $1,400,000 ($2,100,000 x 
$2,000,000/$3,000,000). Corporation O has a nondeductible 
compensation expense of $600,000 ($900,000 x $2,000,000/$3,000,000).
    (P) Example 16 (Affiliated group composed of two corporations, 
one of which is a publicly held corporation)--(1) Facts. The facts 
are the same as in paragraph (c)(1)(v)(O) of this section (Example 
15), except that, Corporation O is a publicly held corporation and 
Corporation N is a privately held corporation, and Employee D is a 
covered employee of Corporation O (instead of Corporation N).
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(v)(T) of this section (Example 15). Even though Corporation O 
is a subsidiary that is a publicly held corporation, it is still a 
member of the affiliated group comprised of Corporations N and O. 
Accordingly, $2,000,000 of the aggregate compensation paid is 
nondeductible. Thus, Corporations N and O each are treated as paying 
a ratable portion of the nondeductible compensation.
    (Q) Example 17 (Affiliated group composed of two publicly held 
corporations)--(1) Facts. The facts are the same as in paragraph 
(c)(1)(v)(O) of this section (Example 15), except that Corporation O 
is also a publicly held corporation. As in paragraph (c)(1)(v)(O) of 
this section (Example 15), Employee D is not a covered employee of 
Corporation O.
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(v)(O) of this section (Example 15). Even though Corporation O 
is a subsidiary that is a publicly held corporation, it is still a 
member of the affiliated group comprised of Corporations N and O. 
Corporations N and O are payor corporations that are members of an 
affiliated group for purposes of prorating the amount disallowed as 
a deduction. Accordingly, $2,000,000 of the aggregate compensation 
paid is nondeductible. Thus, Corporations N and O each are treated 
as paying a ratable portion of the nondeductible compensation.
    (R) Example 18 (Affiliated group composed of two publicly held 
corporations)--(1) Facts. The facts are the same as in paragraph 
(c)(1)(v)(Q) of this section (Example 17), except that Employee D is 
also a covered employee of Corporation O.
    (2) Conclusion. Even though Corporations N and O are each 
publicly held corporations and separately subject to this section, 
they are still members of the affiliated group comprised of 
Corporations N and O. Because Employee D is a covered employee of 
both Corporations N and O, which are each a separate publicly held 
corporation, the determination of the amount disallowed as a 
deduction is made separately for each publicly held corporation. 
Accordingly, Corporation N has a nondeductible compensation expense 
of $1,100,000 (the excess of $2,100,000 over $1,000,000), and 
Corporation O has no nondeductible compensation expense because the 
amount it paid to Employee D was below $1,000,000.
    (S) Example 19 (Affiliated group composed of three corporations, 
one of which is a publicly held corporation)--(1) Facts. Employee C, 
a covered employee of Corporation P, performs services for, and 
receives compensation from, Corporations P, Q, and R, members of an 
affiliated group of corporations. Corporation P, the parent 
corporation, is a publicly held corporation. Corporation Q is a 
direct subsidiary of Corporation P, and Corporation R is a direct 
subsidiary of Corporation Q. Corporations Q and R are both privately 
held corporations. The total compensation paid to Employee C from 
all affiliated group members is $3,000,000 for the taxable year, of 
which Corporation P pays $1,500,000, Corporation Q pays $900,000, 
and Corporation R pays $600,000.
    (2) Conclusion. Because the compensation paid by all affiliated 
group members is aggregated for purposes of section 162(m)(1), 
$2,000,000 of the aggregate compensation paid is nondeductible. 
Corporations P, Q, and R are each treated as paying a ratable 
portion of the nondeductible compensation. Thus, two thirds of each 
corporation's payment will be nondeductible. Corporation P has a 
nondeductible compensation expense of $1,000,000 ($1,500,000 x 
$2,000,000/$3,000,000). Corporation Q has a nondeductible 
compensation expense of $600,000 ($900,000 x $2,000,000/$3,000,000). 
Corporation R has a nondeductible compensation expense of $400,000 
($600,000 x $2,000,000/$3,000,000).
    (T) Example 20 (Affiliated group composed of three corporations, 
one of which is a publicly held corporation)--(1) Facts. The facts 
are the same as in paragraph (c)(1)(v)(S) of this section (Example 
19), except that Corporation Q is a publicly held corporation and 
Corporation P is a privately held corporation, and Employee C is a 
covered employee of Corporation Q (instead of Corporation P).
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(v)(S) of this section (Example 19). Even though Corporation Q 
is a subsidiary that is a publicly held corporation, it is still a 
member of the affiliated group comprised of Corporations P, Q, and 
R. Accordingly, $2,000,000 of the aggregate compensation paid is 
nondeductible. Thus, Corporations P, Q, and R are each treated as 
paying a ratable portion of the nondeductible compensation.
    (U) Example 21 (Affiliated group composed of three corporations, 
two of which are publicly held corporations)--(1) Facts. The facts 
are the same as in paragraph (c)(1)(v)(T) of this section (Example 
20), except that Corporation R is also a publicly held corporation. 
As in paragraph (c)(1)(v)(T) of this section (Example 20), 
Corporation Q is a publicly held corporation, Corporation P is a 
privately held corporation, and Employee C is a covered employee of 
Corporation Q but not a covered employee of Corporation R.
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(v)(T) of this section (Example 20). Even though Corporation R 
is a subsidiary that is a publicly held corporation, it is still a 
member of the affiliated group comprised of Corporations P, Q, and 
R. Accordingly, $2,000,000 of the aggregate compensation paid is 
nondeductible. Thus, Corporations P, Q, and R are each treated as 
paying a ratable portion of the nondeductible compensation.
    (V) Example 22 (Affiliated group composed of three publicly held 
corporations)--(1) Facts. The facts are the same as in paragraph 
(c)(1)(v)(S) of this section (Example 19), except that, Corporations 
Q and R are also publicly held corporations, and Employee C is a 
covered employee of both Corporations P and Q, but is not a covered 
employee of Corporation R.
    (2) Conclusion. Even though Corporations Q and R are 
subsidiaries that are publicly held corporations and separately 
subject to this section, they are still members of the affiliated 
group comprised of Corporations P, Q, and R. Because Employee C is a 
covered employee of both Corporations P and Q, the determination of 
the amount disallowed as a deduction is prorated among Corporation P 
and R, and separately prorated among Corporations Q and R. With 
respect to Corporations P and R, $1,100,000 of the aggregate 
compensation is nondeductible (the difference between the total 
compensation of $2,100,000 paid by Corporations P and R and the 
$1,000,000 deduction limitation). Corporations P and R are each 
treated as paying a ratable portion of the nondeductible 
compensation. Accordingly, Corporation P has a nondeductible 
compensation expense of $785,714 ($1,500,000 x $1,100,000/
$2,100,000), and Corporation R has a nondeductible compensation 
expense of $314,285 ($600,000 x $1,100,000/$2,100,000). With respect 
to Corporations Q and R, $500,000 of the aggregate compensation is 
nondeductible (the difference between the total compensation of 
$1,500,000 paid by Corporations Q and R and the $1,000,000 deduction 
limitation). Accordingly, Corporation Q has a nondeductible 
compensation expense of $300,000 ($900,000 x $500,000/$1,500,000), 
and Corporation R has a nondeductible compensation expense of 
$200,000 ($600,000 x $500,000/$1,500,000). The total amount of 
nondeductible compensation expense with respect to Corporation R is 
$514,285.
    (W) Example 23 (Affiliated group composed of three publicly held 
corporations)--(1) Facts. The facts are the same as in paragraph 
(c)(1)(v)(V) of this section (Example 22), except that Employee C 
does not perform any services for Corporation R and does not receive 
any compensation from Corporation R.
    (2) Conclusion. Even though Corporations Q and R are 
subsidiaries that are publicly held corporations and separately 
subject to this section, they are still members of the affiliated 
group comprised of Corporations P, Q, and R. Because Employee C 
performs services only for Corporations P and Q and because Employee 
C is a covered employee of both Corporations P and Q, which are each 
a separate publicly held corporation, the determination of the 
amount disallowed as a deduction is made separately for each

[[Page 70376]]

publicly held corporation. Accordingly, Corporation P has a 
nondeductible compensation expense of $500,000 (the excess of 
$1,500,000 over $1,000,000), and Corporation Q has no nondeductible 
compensation expense because the amount it paid to Employee C was 
below $1,000,000.
    (X) Example 24 (Affiliated group composed of three corporations, 
one of which is a publicly held corporation--(1) Facts. The facts 
are the same as in paragraph (c)(1)(v)(S) of this section (Example 
19), except that Corporation R is a direct subsidiary of Corporation 
P instead of being a direct subsidiary of Corporation Q.
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(v)(S) of this section (Example 19). Corporations P, Q, and R 
are members of an affiliated group. Accordingly, $2,000,000 of the 
aggregate compensation paid is nondeductible. Thus, Corporations P, 
Q, and R are each treated as paying a ratable portion of the 
nondeductible compensation.
    (Y) Example 25 (Affiliated group composed of three publicly held 
corporations)--(1) Facts. The facts are the same as in paragraph 
(c)(1)(v)(X) of this section (Example 24), except that Corporations 
Q and R are also publicly held corporations, and Employee C is a 
covered employee of both Corporations P and Q.
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(v)(V) of this section (Example 22). Even though Corporations 
Q and R are subsidiaries that are publicly held corporations and 
separately subject to this section, they are still members of the 
affiliated group comprised of Corporations P, Q, and R. Because 
Employee C is a covered employee of both Corporations P and Q, the 
determination of the amount disallowed as a deduction is prorated 
among Corporation P and R, and separately among Corporations Q and 
R.
    (Z) Example 26 (Disregarded entity)--(1) Facts. Corporation G is 
a privately held corporation for its 2020 taxable year. Entity H, a 
limited liability company, is wholly-owned by Corporation G and is 
disregarded as an entity separate from its owner under Sec.  
301.7701-2(c)(2)(i). As of December 31, 2020, Entity H is required 
to file reports under section 15(d) of the Exchange Act.
    (2) Conclusion. Because Entity H is required to file reports 
under section 15(d) of the Exchange Act and is disregarded as an 
entity separate from its owner Corporation G, Corporation G is a 
publicly held corporation under paragraph (c)(1)(iii) of this 
section for its 2020 taxable year.

    (2) Covered employee--(i) General rule. Except as provided in 
paragraph (c)(2)(v) of this section, with respect to a publicly held 
corporation as defined in paragraph (c)(1) of this section (without 
regard to paragraph (c)(1)(ii) of this section), for the publicly held 
corporation's taxable year, a covered employee means any of the 
following--
    (A) The principal executive officer (PEO) or principal financial 
officer (PFO) of the publicly held corporation serving at any time 
during the taxable year, including individuals acting in either such 
capacity.
    (B) The three highest compensated executive officers of the 
publicly held corporation for the taxable year (other than the 
principal executive officer or principal financial officer, or an 
individual acting in such capacity), regardless of whether the 
executive officer is serving at the end of the publicly held 
corporation's taxable year, and regardless of whether the executive 
officer's compensation is subject to disclosure for the last completed 
fiscal year under the executive compensation disclosure rules under the 
Exchange Act. The amount of compensation used to identify the three 
most highly compensated executive officers for the taxable year is 
determined pursuant to the executive compensation disclosure rules 
under the Exchange Act (using the taxable year as the fiscal year for 
purposes of making the determination), regardless of whether the 
corporation's fiscal year and taxable year end on the same date.
    (C) Any individual who was a covered employee of the publicly held 
corporation (or any predecessor of a publicly held corporation, as 
defined in paragraph (c)(2)(ii) of this section) for any preceding 
taxable year beginning after December 31, 2016. For taxable years 
beginning prior to January 1, 2018, covered employees are identified in 
accordance with the rules in Sec.  1.162-27(c)(2).
    (ii) Predecessor of a publicly held corporation--(A) Publicly held 
corporations that become privately held. For purposes of this paragraph 
(c)(2)(ii), a predecessor of a publicly held corporation includes a 
publicly held corporation that, after becoming a privately held 
corporation, again becomes a publicly held corporation for a taxable 
year ending before the 36-month anniversary of the due date for the 
corporation's U.S. Federal income tax return (disregarding any 
extensions) for the last taxable year for which the corporation was 
previously publicly held.
    (B) Corporate reorganizations. A predecessor of a publicly held 
corporation includes a publicly held corporation the stock or assets of 
which are acquired in a corporate reorganization (as defined in section 
368(a)(1)).
    (C) Corporate divisions. A predecessor of a publicly held 
corporation includes a publicly held corporation that is a distributing 
corporation (within the meaning of section 355(a)(1)(A)) that 
distributes the stock of a controlled corporation (within the meaning 
of section 355(a)(1)(A)) to its shareholders in a distribution or 
exchange qualifying under section 355(a)(1) (corporate division). The 
rule of this paragraph (c)(2)(ii)(C) applies only with respect to 
covered employees of the distributing corporation who commence the 
performance of services for the controlled corporation (or for a 
corporation affiliated with the controlled corporation that receives 
stock of the controlled corporation in the corporate division) within 
the period beginning 12 months before and ending 12 months after the 
distribution.
    (D) Affiliated groups. A predecessor of a publicly held corporation 
includes a publicly held corporation that becomes a member of an 
affiliated group (as defined in paragraph (c)(1)(ii) of this section).
    (E) Asset acquisitions. If a publicly held corporation, including 
one or more members of an affiliated group as defined in paragraph 
(c)(1)(ii) of this section (acquiror), acquires at least 80% of the 
operating assets (determined by fair market value on the date of 
acquisition) of another publicly held corporation (target), then the 
target is a predecessor of the acquiror. For an acquisition of assets 
that occurs over time, only assets acquired within a 12-month period 
are taken into account to determine whether at least 80% of the 
target's operating assets were acquired. However, this 12-month period 
is extended to include any continuous period that ends on, or begins 
on, any day during which the acquiror has an arrangement to purchase, 
directly or indirectly, assets of the target. Additions to the assets 
of target by a shareholder made as part of a plan or arrangement to 
avoid the application of this subsection to acquiror's purchase of 
target's assets are disregarded in applying this paragraph. This 
paragraph (c)(2)(ii)(E) applies only with respect to covered employees 
of the target who commence the performance of services for the acquiror 
(or a corporation affiliated with the acquiror) within the period 
beginning 12 months before and ending 12 months after the date of the 
transaction as defined in paragraph (c)(2)(ii)(I) of this section 
(incorporating any extensions to the 12-month period made pursuant to 
this paragraph).
    (F) Predecessor of a predecessor. For purposes of this paragraph 
(c)(2)(ii), a reference to a predecessor of a corporation includes each 
predecessor of the corporation and the predecessor or predecessors of 
any prior predecessor or predecessors.
    (G) Corporations that are not publicly held at the time of the 
transaction and sequential transactions--(1) Predecessor corporation is 
not publicly held at the time of the transaction. If a corporation that 
was previously publicly held (the

[[Page 70377]]

first corporation) would be a predecessor to another corporation (the 
second corporation) under the rules of this paragraph (c)(2)(ii) but 
for the fact that it is not a publicly held corporation at the time of 
the relevant transaction (or transactions), the first corporation is a 
predecessor of a publicly held corporation if the second corporation is 
a publicly held corporation at the time of the relevant transaction (or 
transactions) and the relevant transaction (or transactions) take place 
during a taxable year ending before the 36-month anniversary of the due 
date for the first corporation's U.S. Federal income tax return 
(excluding any extensions) for the last taxable year for which the 
first corporation was previously publicly held.
    (2) Second corporation is not publicly held at the time of the 
transaction. If a corporation that is publicly held (the first 
corporation) at the time of the relevant transaction (or transactions) 
would be a predecessor to another corporation (the second corporation) 
under the rules of this paragraph (c)(2)(ii) but for the fact that the 
second corporation is not a publicly held corporation at the time of 
the relevant transaction (or transactions), the first corporation is a 
predecessor of a publicly held corporation if the second corporation 
becomes a publicly held corporation for a taxable year ending before 
the 36-month anniversary of the due date for the first corporation's 
U.S. Federal income tax return (excluding any extensions) for the first 
corporation's last taxable year in which the transaction is taken into 
account.
    (3) Neither corporation is publicly held at the time of the 
transaction. If a corporation that was previously publicly held (the 
first corporation) would be a predecessor to another corporation (the 
second corporation) under the rules of this paragraph (c)(2)(ii) but 
for the fact that neither it nor the second corporation is a publicly 
held corporation at the time of the relevant transaction (or 
transactions), the first corporation is a predecessor of a publicly 
held corporation if the second corporation becomes a publicly held 
corporation for a taxable year ending before the 36-month anniversary 
of the due date for the first corporation's U.S. Federal income tax 
return (excluding any extensions) for the last taxable year for which 
the first corporation was previously publicly held.
    (4) Sequential transactions. If a corporation that was previously 
publicly held (the first corporation) would be a predecessor to another 
corporation (the second corporation) under the rules of this paragraph 
(c)(2)(ii) but for the fact that the first corporation is (or its 
assets are) transferred to one or more intervening corporations prior 
to being transferred to the second corporation, and if each intervening 
corporation would be a predecessor of a publicly held corporation with 
respect to the second corporation if the intervening corporation or 
corporations were publicly held corporations, then paragraphs 
(c)(2)(ii)(G)(1) through (3) of this section also apply without regard 
to the intervening corporations.
    (H) Elections under sections 336(e) and 338. For purposes of this 
paragraph (c)(2), when a corporation makes an election to treat as an 
asset purchase either the sale, exchange, or distribution of stock 
pursuant to regulations under section 336(e) or the purchase of stock 
pursuant to regulations under section 338, the corporation that issued 
the stock is treated as the same corporation both before and after such 
transaction.
    (I) Date of transaction. For purposes of this paragraph (c)(2)(ii), 
the date that a transaction is treated as having occurred is the date 
on which all events necessary for the transaction to be described in 
the relevant provision have occurred.
    (J) Publicly traded partnership. For purposes of applying this 
paragraph (c)(2)(ii), a publicly traded partnership is a predecessor of 
a publicly held corporation if under the same facts and circumstances a 
corporation substituted for the publicly traded partnership would be a 
predecessor of the publicly held corporation, and at the time of the 
transaction the publicly traded partnership is treated as a publicly 
held corporation as defined in paragraph (c)(1)(i) of this section. In 
making this determination, the rules in paragraphs (c)(2)(ii)(A) 
through (I) of this section apply to publicly traded partnerships by 
analogy.
    (iii) Disregarded entities. If a publicly held corporation under 
paragraph (c)(1) of this section owns an entity that is disregarded as 
an entity separate from its owner under Sec.  301.7701-2(c)(2)(i) of 
this chapter, then the covered employees of the publicly held 
corporation are determined pursuant to paragraphs (c)(2)(i) and (ii) of 
this section. The executive officers of the entity that is disregarded 
as an entity separate from its corporate owner under Sec.  301.7701-
2(c)(2)(i) of this chapter are neither covered employees of the entity 
nor of the publicly held corporation unless they meet the definition of 
covered employee in paragraphs (c)(2)(i) and (ii) of this section with 
respect to the publicly held corporation, in which case they are 
covered employees for its taxable year.
    (iv) Qualified subchapter S subsidiaries. If a publicly held 
corporation under paragraph (c)(1) of this section owns an entity that 
is a QSub under section 1361(b)(3)(B), then the covered employees of 
the publicly held corporation are determined pursuant to paragraphs 
(c)(2)(i) and (ii) of this section. The executive officers of the QSub 
are neither covered employees of the QSub nor of the publicly held 
corporation unless they meet the definition of covered employee in 
paragraphs (c)(2)(i) and (ii) of this section with respect to the 
publicly held corporation, in which case they are covered employees for 
its taxable year.
    (v) Covered employee of an affiliated group. A person who is 
identified as a covered employee in paragraphs (c)(2)(i) through (iv) 
of this section for a publicly held corporation's taxable year is also 
a covered employee for the taxable year of a publicly held corporation 
as defined in paragraph (c)(1)(ii) of this section.
    (vi) Examples. The following examples illustrate the provisions of 
this paragraph (c)(2). For each example, assume that the corporation 
has a taxable year that is a calendar year and has a fiscal year ending 
December 31 for reporting purposes under the Exchange Act. 
Additionally, for each example, unless explicitly provided, assume that 
none of the employees were covered employees for any taxable year 
preceding the first taxable year set forth in that example (since being 
a covered employee for a preceding taxable year would provide a 
separate and independent basis for classifying that employee as a 
covered employee for a subsequent taxable year).

    (A) Example 1 (Covered employees of members of an affiliated 
group)--(1) Facts. Corporations A, B, and C are direct wholly-owned 
subsidiaries of Corporation D. Corporation D is a publicly held 
corporation as defined in paragraph (c)(1)(i) of this section 
because its class of securities is required to be registered under 
section 12 of the Exchange Act as of December 31, 2020. Corporation 
A is a publicly held corporation as defined in paragraph (c)(1)(i) 
of this section because it is required to file reports under section 
15(d) of the Exchange Act as of December 31, 2020. Corporations B 
and C are not publicly held corporations for their 2020 taxable 
years. Employee E served as the PEO of Corporation D from January 1, 
2020, to March 31, 2020. Employee F served as the PEO of Corporation 
D from April 1, 2020, to December 31, 2020. Employee G served as the 
PEO of Corporation A for its entire 2020 taxable year. Employee H 
served as the PEO of Corporation B for its entire 2020 taxable year. 
Employee I served as the PEO of Corporation C for its entire 2020 
taxable year. From April 1, 2020, through September 30,

[[Page 70378]]

2020, Employee E served as an advisor (not as a PEO) to Employee I 
and received compensation from Corporation C for these services. In 
2020, all four corporations paid compensation to their respective 
PEOs.
    (2) Conclusion (Employees F and E). Because both Employees E and 
F served as the PEO during Corporation D's 2020 taxable year, both 
Employees E and F are covered employees for Corporation D's 2020 and 
subsequent taxable years. Corporations D and C are members of an 
affiliated group as defined in paragraph (c)(1)(ii) of this section. 
Because Employee E received compensation from Corporations D and C, 
the compensation paid by both corporations is aggregated. Any amount 
disallowed as a deduction by this section is prorated between 
Corporations D and C in proportion to the amount of compensation 
paid to Employee E by each corporation in 2020.
    (3) Conclusion (Employee G). Because Employee G served as a PEO 
of Corporation A, a publicly held corporation, Employee G is a 
covered employee of Corporation A for its 2020 and subsequent 
taxable years.
    (4) Conclusion (Employee H). Even though Employee H served as 
the PEO of Corporation B, Employee H is not a covered employee of 
Corporation B for its 2020 taxable year, because Corporation B is 
considered a publicly held corporation solely by reason of being a 
member of an affiliated group as defined in paragraph (c)(1)(ii) of 
this section.
    (5) Conclusion (Employee I). Even though Employee I served as 
the PEO of Corporation C, Employee I is not a covered employee of 
Corporation C for its 2020 taxable year, because Corporation C is 
considered a publicly held corporation solely by reason of being a 
member of an affiliated group as defined in paragraph (c)(1)(ii) of 
this section. The aggregation of the compensation paid to Employee E 
by Corporations D and C (for purposes of determining the amount of 
deduction disallowed by this section) is immaterial to determining 
whether Employee I is a covered employee of Corporation C.
    (B) Example 2 (Covered employees of a publicly held 
corporation)--(1) Facts. Corporation J is a publicly held 
corporation. Corporation J is not a smaller reporting company or 
emerging growth company for purposes of reporting under the Exchange 
Act. For 2020, Employee K served as the sole PEO of Corporation J 
and Employees L and M both served as the PFO of Corporation J at 
different times during the year. Employees N, O, and P were, 
respectively, the first, second, and third highest compensated 
executive officers of Corporation J for 2020 other than the PEO and 
PFO, and all three retired before the end of 2020. Employees Q, R, 
and S were, respectively, Corporation J's fourth, fifth, and sixth 
highest compensated executive officers other than the PEO and PFO 
for 2020, and all three were serving at the end of 2020. On March 1, 
2021, Corporation J filed its Form 10-K, Annual Report Pursuant to 
Section 13 or 15(d) of the Securities Exchange Act of 1934 with the 
SEC. With respect to Item 11, Executive Compensation (as required by 
Part III of Form 10-K, or its successor), Corporation J disclosed 
the compensation of Employee K for serving as the PEO, Employees L 
and M for serving as the PFO, and Employees Q, R, and S pursuant to 
Item 402 of Regulation S-K, 17 CFR 229.402(a)(3)(iii). Corporation J 
also disclosed the compensation of Employees N and O pursuant to 
Item 402 of Regulation S-K, 17 CFR 229.402(a)(3)(iv).
    (2) Conclusion (PEO). Because Employee K served as the PEO 
during 2020, Employee K is a covered employee for Corporation J's 
2020 taxable year.
    (3) Conclusion (PFO). Because Employees L and M served as the 
PFO during 2020, Employees L and M are covered employees for 
Corporation J's 2020 taxable year.
    (4) Conclusion (Three Highest Compensated Executive Officers). 
Even though the executive compensation disclosure rules under the 
Exchange Act require Corporation J to disclose the compensation of 
Employees N, O, Q, R, and S for 2020, Corporation J's three highest 
compensated executive officers who are covered employees for its 
2020 taxable year are Employees N, O, and P, because these are the 
three highest compensated executive officers other than the PEO and 
PFO for 2020.
    (C) Example 3 (Covered employees of a smaller reporting 
company)--(1) Facts. The facts are the same as in paragraph 
(c)(2)(vi)(B) of this section (Example 2), except that Corporation J 
is a smaller reporting company or emerging growth company for 
purposes of reporting under the Exchange Act. Accordingly, with 
respect to Item 11, Executive Compensation (as required by Part III 
of Form 10-K, or its successor), Corporation J disclosed the 
compensation of Employee K for serving as the PEO, Employees Q and R 
pursuant to Item 402(m) of Regulation S-K, 17 CFR 229.402(m)(2)(ii), 
and Employees N and O pursuant to Item 402(m) of Regulation S-K, 17 
CFR 229.402(m)(2)(iii).
    (2) Conclusion. The result is the same as in paragraph 
(c)(2)(vi)(L) of this section (Example 2). For purposes of 
identifying a corporation's covered employees, it is not relevant 
whether the reporting obligation under the Exchange Act for smaller 
reporting companies and emerging growth companies apply to the 
corporation, nor is it relevant whether the specific executive 
officers' compensation must be disclosed pursuant to the disclosure 
rules under the Exchange Act applicable to the corporation.
    (D) Example 4 (Covered employees of a publicly held corporation 
that is not required to file a Form 10-K)--(1) Facts. The facts are 
the same as in paragraph (c)(2)(vi)(B) of this section (Example 2), 
except that on February 4, 2021, Corporation J files Form 15, 
Certification and Notice of Termination of Registration under 
Section 12(g) of the Securities Exchange Act of 1934 or Suspension 
of Duty to File Reports under Sections 13 and 15(d) of the 
Securities Exchange Act of 1934 (or its successor), to terminate the 
registration of its securities. Corporation J's duty to file reports 
under Section 13(a) of the Exchange Act is suspended upon the filing 
of the Form 15 and, as a result, Corporation J is not required to 
file a Form 10-K and disclose the compensation of its executive 
officers for 2020.
    (2) Conclusion. The result is the same as in paragraph 
(c)(2)(vi)(B) of this section (Example 2). Covered employees include 
executive officers of a publicly held corporation even if the 
corporation is not required to disclose the compensation of its 
executive officers under the Exchange Act. Therefore, Employees K, 
L, M, N, O, and P are covered employees for 2020. The conclusion 
would be different if Corporation J filed Form 15, Certification and 
Notice of Termination of Registration under Section 12(g) of the 
Securities Exchange Act of 1934 or Suspension of Duty to File 
Reports under Sections 13 and 15(d) of the Securities Exchange Act 
of 1934 (or its successor), to terminate the registration of its 
securities prior to December 31, 2020. In that case, Corporation J 
would not be a publicly held corporation for its 2020 taxable year, 
and, therefore, Employees K, L, M, N, O, and P would not be covered 
employees for Corporation J's 2020 taxable year.
    (E) Example 5 (Covered employees of two publicly held 
corporations after a corporate transaction)--(1) Facts. Corporation 
T is a domestic publicly held corporation for its 2019 taxable year. 
Corporation U is a domestic privately held corporation for its 2019 
and 2020 taxable years. On July 31, 2020, Corporation U acquires for 
cash 80% of the only class of outstanding stock of Corporation T. 
The group (comprised of Corporations U and T) elects to file a 
consolidated Federal income tax return. As a result of this 
election, Corporation T has a short taxable year ending on July 31, 
2020. Corporation T does not change its fiscal year for reporting 
purposes under the Exchange Act to correspond to the short taxable 
year. Corporation T remains a domestic publicly held corporation for 
its short taxable year ending on July 31, 2020, and its subsequent 
taxable year ending on December 31, 2020, for which it files a 
consolidated Federal income tax return with Corporation U. For 
Corporation T's taxable year ending July 31, 2020, Employee V serves 
as the only PEO, and Employee W serves as the only PFO. Employees X, 
Y, and Z are the three most highly compensated executive officers of 
Corporation T for the taxable year ending July 31, 2020, other than 
the PEO and PFO. As a result of the acquisition, effective July 31, 
2020, Employee V ceases to serve as the PEO of Corporation T. 
Instead, Employee AA begins serving as the PEO of Corporation T on 
August 1, 2020. Employee V continues to provide services for 
Corporation T and never serves as PEO again (or as an individual 
acting in such capacity). For Corporation T's taxable year ending 
December 31, 2020, Employee AA serves as the only PEO, and Employee 
W serves as the only PFO. Employees X, Y, and Z continue to serve as 
executive officers of Corporation T during the taxable year ending 
December 31, 2020. Employees BB, CC, and DD are the three most 
highly compensated executive officers of Corporation T, other than 
the PEO and PFO, for the taxable year ending December 31, 2020.
    (2) Conclusion (Employee V). Because Employee V served as the 
PEO during Corporation T's short taxable year ending July 31, 2020, 
Employee V is a covered

[[Page 70379]]

employee for Corporation T's short taxable year ending July 31, 
2020. Furthermore, Employee V is a covered employee for Corporation 
T's short taxable year ending July 31, 2020, even though Employee 
V's compensation is required to be disclosed pursuant to the 
executive compensation disclosure rules under the Exchange Act only 
for the fiscal year ending December 31, 2020. Because Employee V was 
a covered employee for Corporation T's short taxable year ending 
July 31, 2020, Employee V is also a covered employee for Corporation 
T's short taxable year ending December 31, 2020.
    (3) Conclusion (Employee W). Because Employee W served as the 
PFO during Corporation T's short taxable years ending July 31, 2020, 
and December 31, 2020, Employee W is a covered employee for both 
taxable years. Furthermore, Employee W is a covered employee for 
Corporation T's short taxable year ending July 31, 2020, even though 
Employee W's compensation is required to be disclosed pursuant to 
the executive compensation disclosure rules under the Exchange Act 
only for the fiscal year ending December 31, 2020. Employee W would 
be a covered employee for Corporation T's short taxable year ending 
December 31, 2020, even if Employee W did not serve as the PFO 
during this taxable year because Employee W was a covered employee 
for Corporation T's short taxable year ending July 31, 2020.
    (4) Conclusion (Employee AA). Because Employee AA served as the 
PEO during Corporation T's short taxable year ending December 31, 
2020, Employee AA is a covered employee for this taxable year.
    (5) Conclusion (Employees X, Y, and Z). Employees X, Y, and Z 
are covered employees for Corporation T's short taxable years ending 
July 31, 2020, and December 31, 2020. Employees X, Y, and Z are 
covered employees for Corporation T's short taxable year ending July 
31, 2020, because these employees are the three highest compensated 
executive officers for this taxable year. Employees X, Y, and Z are 
covered employees for Corporation T's short taxable year ending 
December 31, 2020, because they were covered employees for 
Corporation T's short taxable year ending July 31, 2020. 
Accordingly, Employees X, Y, and Z would be covered employees for 
Corporation T's short taxable years ending July 31, 2020, and 
December 31, 2020, even if their compensation would not be required 
to be disclosed pursuant to the executive compensation disclosure 
rules under the Exchange Act.
    (6) Conclusion (Employees BB, CC, and DD). Employees BB, CC, and 
DD are covered employees for Corporation T's short taxable year 
ending December 31, 2020 because these employees are the three 
highest compensated executive officers for this taxable year.
    (F) Example 6 (Predecessor of a publicly held corporation)--(1) 
Facts. Corporation EE is a publicly held corporation for its 2021 
taxable year. Corporation EE is a privately held corporation for its 
2022 and 2023 taxable years. For its 2024 taxable year, Corporation 
EE is a publicly held corporation.
    (2) Conclusion. Corporation EE is a predecessor of a publicly 
held corporation within the meaning of paragraph (c)(2)(ii)(A) of 
this section because it became a publicly held corporation for a 
taxable year ending prior to April 15, 2025. Therefore, for 
Corporation EE's 2024 taxable year, the covered employees of 
Corporation EE include the covered employees of Corporation EE for 
its 2021 taxable year and any additional covered employees 
determined pursuant to paragraph (c)(2) of this section.
    (G) Example 7 (Predecessor of a publicly held corporation)--(1) 
Facts. The facts are the same as in paragraph (c)(2)(vi)(F) of this 
section (Example 6), except that Corporation EE remains a privately 
held corporation until it becomes a publicly held corporation for 
its 2027 taxable year.
    (2) Conclusion. Corporation EE is not a predecessor of a 
publicly held corporation within the meaning of paragraph 
(c)(2)(ii)(A) of this section because it became a publicly held 
corporation for a taxable year ending after April 15, 2025. 
Therefore, any covered employee of Corporation EE for its 2021 
taxable year is not a covered employee of Corporation EE for its 
2027 taxable year due to that individual's status as a covered 
employee of Corporation EE for a preceding taxable year beginning 
after December 31, 2016 (but may be a covered employee due to status 
during the 2027 taxable year).
    (H) Example 8 (Predecessor of a publicly held corporation that 
is party to a merger)--(1) Facts. On June 30, 2021, Corporation FF 
(a publicly held corporation) merged into Corporation GG (a publicly 
held corporation) in a transaction that qualifies as a 
reorganization under section 368(a)(1)(A), with Corporation GG as 
the surviving corporation. As a result of the merger, Corporation FF 
has a short taxable year ending June 30, 2021. Corporation FF is a 
publicly held corporation for this short taxable year. Corporation 
GG does not have a short taxable year and is a publicly held 
corporation for its 2021 taxable year.
    (2) Conclusion. Corporation FF is a predecessor of a publicly 
held corporation within the meaning of paragraph (c)(2)(ii)(B) of 
this section. Therefore, any covered employee of Corporation FF for 
its short taxable year ending June 30, 2021, is a covered employee 
of Corporation GG for its 2021 taxable year. Accordingly, for 
Corporation GG's 2021 and subsequent taxable years, the covered 
employees of Corporation GG include the covered employees of 
Corporation FF (for a preceding taxable year beginning after 
December 31, 2016) and any additional covered employees determined 
pursuant to paragraph (c)(2) of this section.
    (I) Example 9 (Predecessor of a publicly held corporation that 
is party to a merger)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vi)(H) of this section (Example 8), except that, 
after the merger, Corporation GG is a privately held corporation for 
its 2021 taxable year.
    (2) Conclusion. Because Corporation GG is a privately held 
corporation for its 2021 taxable year, it is not subject to section 
162(m)(1) for this taxable year.
    (J) Example 10 (Predecessor of a publicly held corporation that 
is party to a merger)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vi)(I) of this section (Example 9), except 
Corporation GG becomes a publicly held corporation on June 30, 2023, 
and is a publicly held corporation for its 2023 taxable year.
    (2) Conclusion. Because Corporation GG became a publicly held 
corporation for a taxable year ending prior to April 15, 2025, 
Corporation FF is a predecessor of a publicly held corporation 
within the meaning of paragraph (c)(2)(ii)(G) of this section. 
Therefore, any covered employee of Corporation FF for its short 
taxable year ending June 30, 2021, is a covered employee of 
Corporation GG for its 2023 and subsequent taxable years. 
Accordingly, for Corporation GG's 2023 and subsequent taxable years, 
the covered employees of Corporation GG include the covered 
employees of Corporation FF (for a preceding taxable year beginning 
after December 31, 2016) and any additional covered employees 
determined pursuant to paragraph (c)(2) of this section.
    (K) Example 11 (Predecessor of a publicly held corporation that 
is party to a merger)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vi)(J) of this section (Example 10), except that 
Corporation FF is a privately held corporation for its taxable year 
ending June 30, 2021, but was a publicly held corporation for its 
2020 taxable year.
    (2) Conclusion. Even though Corporation FF was a privately held 
corporation when it merged with Corporation GG on June 30, 2021, 
Corporation FF may still be a considered a predecessor corporation 
if Corporation GG becomes a publicly held corporation within a 
taxable year ending prior to April 15, 2024. Because Corporation GG 
became a publicly held corporation for a taxable year ending 
December 31, 2023, Corporation FF is a predecessor of a publicly 
held corporation within the meaning of paragraph (c)(2)(ii)(G) of 
this section. Therefore, any covered employee of Corporation FF for 
its 2020 taxable year is a covered employee of Corporation GG for 
its 2024 and subsequent taxable years. Accordingly, for Corporation 
GG's 2023 and subsequent taxable years, the covered employees of 
Corporation GG include the covered employees of Corporation FF (for 
a preceding taxable year beginning after December 31, 2016) and any 
additional covered employees determined pursuant to paragraph (c)(2) 
of this section.
    (L) Example 12 (Predecessor of a publicly held corporation that 
is party to a merger and subsequently becomes member of an 
affiliated group)--(1) Facts. The facts are the same as in paragraph 
(c)(2)(vi)(I) of this section (Example 9). Additionally, on June 30, 
2022, Corporation GG becomes a member of an affiliated group (as 
defined in paragraph (c)(1)(ii) of this section) that files a 
consolidated Federal income tax return. Corporation II is the parent 
corporation of the group and is a publicly held corporation. 
Employee HH was a covered employee of Corporation FF for its taxable 
year ending June 30, 2021. On July 1, 2022, Employee HH becomes an 
employee of Corporation II.
    (2) Conclusion. By becoming a member of an affiliated group (as 
defined in paragraph (c)(1)(ii) of this section) on June 30, 2022,

[[Page 70380]]

Corporation GG became a publicly held corporation for a taxable year 
ending prior to April 15, 2025. Therefore, Corporation FF is a 
predecessor of a publicly held corporation (Corporation GG) within 
the meaning of paragraph (c)(2)(ii)(G) of this section. Furthermore, 
Corporation FF is a predecessor of a publicly held corporation 
(Corporation II) within the meaning of paragraph (c)(2)(ii)(G) of 
this section. Accordingly, for Corporation II's 2022 and subsequent 
taxable years, Employee HH is a covered employee of Corporation II 
because Employee HH was a covered employee of Corporation FF for its 
taxable year ending June 30, 2021.
    (M) Example 13 Predecessor of a publicly held corporation that 
is party to a merger and subsequently becomes member of an 
affiliated group)--(1) Facts. The facts are the same as in paragraph 
(c)(2)(vi)(L) of this section (Example 12), except that, Corporation 
FF was a privately held corporation for its taxable year ending June 
30, 2021, and Employee HH was a covered employee of Corporation FF 
for its taxable year ending December 31, 2020.
    (2) Conclusion. Even though Corporation FF was a privately held 
corporation when it merged with Corporation GG on June 30, 2021, 
Corporation FF may still be a considered a predecessor corporation 
if Corporation GG becomes a publicly held corporation for a taxable 
year ending prior to April 15, 2024. Because Corporation GG became a 
publicly held corporation for its 2022 taxable year by becoming a 
member of an affiliated group (as defined in paragraph (c)(1)(ii) of 
this section), Corporation FF is a predecessor of a publicly held 
corporation (Corporation GG) within the meaning of paragraph 
(c)(2)(ii)(G) of this section. Furthermore, Corporation FF is a 
predecessor of a publicly held corporation (Corporation II) within 
the meaning of paragraph (c)(2)(ii)(G) of this section. Therefore, 
any covered employee of Corporation FF for its 2020 taxable year is 
a covered employee of Corporation II for its 2022 and subsequent 
taxable years. Accordingly, for Corporation II's 2022 taxable year, 
Employee HH is a covered employee of Corporation II because Employee 
HH was a covered employee of Corporation FF for its 2020 taxable 
year.
    (N) Example 14 (Predecessor of a publicly held corporation that 
is a party to a merger)--(1) Facts. Corporation JJ is a publicly 
held corporation for its 2019 taxable year. Corporation JJ is 
incorporated in State KK. On June 1, 2019, Corporation JJ formed a 
wholly-owned subsidiary, Corporation LL. Corporation LL is a 
publicly held corporation incorporated in State MM. On June 30, 
2021, Corporation JJ merged into Corporation LL under State MM law 
in a transaction that qualifies as a reorganization under section 
368(a)(1)(A), with Corporation LL as the surviving corporation. As a 
result of the merger, Corporation JJ has a short taxable year ending 
June 30, 2021. Corporation JJ is a publicly held corporation for 
this short taxable year.
    (2) Conclusion. Corporation JJ is a predecessor of a publicly 
held corporation within the meaning of paragraph (c)(2)(ii)(B) of 
this section. Therefore, any covered employee of Corporation JJ for 
its short taxable year ending June 30, 2021, is a covered employee 
of Corporation LL for its taxable years ending after June 30, 2021. 
Accordingly, for taxable years ending after June 30, 2021, the 
covered employees of Corporation LL include the covered employees of 
Corporation JJ (for a preceding taxable year beginning after 
December 31, 2016) and any additional covered employees determined 
pursuant to paragraph (c)(2) of this section.
    (O) Example 15 (Predecessor of a publicly held corporation 
becomes member of an affiliated group)--(1) Facts. Corporations NN 
and OO are publicly held corporations for their 2021 and 2022 
taxable years. On June 30, 2021, Corporation OO acquires for cash 
100% of the only class of outstanding stock of Corporation NN. The 
group (comprised of Corporations NN and OO) elects to file a 
consolidated income tax return. As a result of this election, 
Corporation NN has a short taxable year ending on June 30, 2021. 
Corporation NN is a publicly held corporation for its taxable year 
ending June 30, 2021, and a privately held corporation for 
subsequent taxable years. On June 30, 2022, Corporation OO 
completely liquidates Corporation NN.
    (2) Conclusion. After Corporation OO acquired Corporation NN, 
Corporations NN and OO comprised an affiliated group as defined in 
paragraph (c)(1)(ii) of this section. Thus, Corporation NN is a 
predecessor of a publicly held corporation within the meaning of 
paragraph (c)(2)(ii)(D) of this section. Therefore, any covered 
employee of Corporation NN for its short taxable year ending June 
30, 2021, is a covered employee of Corporation OO for its taxable 
years ending after June 30, 2021. Accordingly, for taxable years 
ending after June 30, 2021, the covered employees of Corporation OO 
include the covered employees of Corporation NN (for a preceding 
taxable year beginning after December 31, 2016) and any additional 
covered employees determined pursuant to paragraph (c)(2) of this 
section.
    (P) Example 16 (Predecessor of a publicly held corporation 
becomes member of an affiliated group)--(1) Facts. The facts are the 
same as in paragraph (c)(2)(vi)(O) of this section (Example 15), 
except that Corporation OO is a privately held corporation on June 
30, 2021, and for its 2021 and 2022 taxable years.
    (2) Conclusion. Because Corporation OO is a privately held 
corporation for its 2021 and 2022 taxable years, it is not subject 
to section 162(m)(1) for these taxable years.
    (Q) Example 17 (Predecessor of a publicly held corporation 
becomes member of an affiliated group)--(1) Facts. The facts are the 
same as in paragraph (c)(2)(vi)(P) of this section (Example 16), 
except that on October 1, 2022, Corporation OO's Securities Act 
registration statement in connection with its initial public 
offering is declared effective by the SEC, and Corporation OO is a 
publicly held corporation for its 2022 taxable year.
    (2) Conclusion (Taxable Year Ending December 31, 2021). Because 
Corporation OO is a privately held corporation for its 2021 taxable 
year, it is not subject to section 162(m)(1) for this taxable year.
    (3) Conclusion (Taxable Year Ending December 31, 2022). For the 
2022 taxable year, Corporations NN and OO comprised an affiliated 
group as defined in paragraph (c)(1)(ii) of this section. 
Corporation NN is a predecessor of a publicly held corporation 
within the meaning of paragraph (c)(2)(ii)(D) and (F) of this 
section because Corporation OO became a publicly held corporation 
for a taxable year ending prior to April 15, 2025. Therefore, any 
covered employee of Corporation NN for its short taxable year ending 
June 30, 2021, is a covered employee of Corporation OO for its 2022 
and subsequent taxable years. Accordingly, for Corporation OO's 2022 
and subsequent taxable years, the covered employees of Corporation 
OO include the covered employees of Corporation NN (for a preceding 
taxable year beginning after December 31, 2016) and any additional 
covered employees determined pursuant to paragraph (c)(2) of this 
section.
    (R) Example 18 (Predecessor of a publicly held corporation and 
asset acquisition)--(1) Facts. Corporations PP and QQ are publicly 
held corporations for their 2020 and 2021 taxable years. On June 30, 
2021, Corporation PP acquires for cash 80% of the operating assets 
(determined by fair market value) of Corporation QQ. Employees RR, 
SS, TT, and UU were covered employees for Corporation QQ's taxable 
year ending December 31, 2020. On April 1, 2020, Employee RR becomes 
an employee of Corporation PP. On June 30, 2021, Employee SS becomes 
an employee of Corporation PP. On October 1, 2021, Employee TT 
becomes an employee of Corporation PP. On August 1, 2022, Employee 
UU becomes an employee of Corporation PP.
    (2) Conclusion. Because Corporation PP acquired 80% of 
Corporation QQ's operating assets (determined by fair market value), 
Corporation QQ is a predecessor of a publicly held corporation 
within the meaning of paragraph (c)(2)(ii)(E) of this section. 
Therefore, any covered employee of Corporation QQ for its 2020 
taxable year (who commenced services for Corporation PP within the 
12 months before or the 12 months after the acquisition) is a 
covered employee of Corporation PP for its 2021 and subsequent 
taxable years. Accordingly, for Corporation PP's 2021 and subsequent 
taxable years, the covered employees of Corporation PP include 
Employees RR, SS, and TT, and any additional covered employees 
determined pursuant to paragraph (c)(2) of this section. Because 
Employee UU became an employee of Corporation PP after June 30, 
2022, Employee UU is not a covered employee of Corporation PP for 
its 2022 taxable year, but may be a covered employee of Corporation 
PP by application of paragraph (c)(2) of this section to Employee 
UU's employment at Corporation PP.
    (S) Example 19 (Predecessor of a publicly held corporation and 
asset acquisition)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vi)(R) of this section (Example 18), except that 
Corporation PP is a privately held corporation on June 30, 2021 and 
for its 2021 taxable year.
    (2) Conclusion. Because Corporation PP is a privately held 
corporation for its 2021 taxable year, it is not subject to section 
162(m)(1) for this taxable year.

[[Page 70381]]

    (T) Example 20 (Predecessor of a publicly held corporation and 
asset acquisition)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vi)(S) of this section (Example 19), except that, 
on October 1, 2022, Corporation PP's Securities Act registration 
statement in connection with its initial public offering is declared 
effective by the SEC, and Corporation PP is a publicly held 
corporation for 2022 taxable year.
    (2) Conclusion (2021 taxable year). Because Corporation PP is a 
privately held corporation for its 2021 taxable year, it is not 
subject to section 162(m)(1) for this taxable year.
    (3) Conclusion (2022 taxable year). Corporation QQ is a 
predecessor of a publicly held corporation within the meaning of 
paragraph (c)(2)(ii)(G) of this section because Corporation PP 
became a publicly held corporation for a taxable year ending prior 
to April 15, 2025. Therefore, any covered employee of Corporation QQ 
for its 2020 taxable year is a covered employee of Corporation PP 
for its 2022 and subsequent taxable years. Accordingly, for 
Corporation PP's 2022 and subsequent taxable years, the covered 
employees of Corporation PP include the covered employees of 
Corporation QQ and any additional covered employees determined 
pursuant to paragraph (c)(2) of this section.
    (U) Example 21 (Predecessor of a publicly held corporation and 
asset acquisition)--(1) Facts. Corporations VV, WW, and XX are 
publicly held corporations for their 2020 and 2021 taxable years. 
Corporations VV and WW are members of an affiliated group. 
Corporation WW is a direct subsidiary of Corporation VV. On June 30, 
2021, Corporation VV acquires for cash 40% of the operating assets 
(determined by fair market value) of Corporation XX. On January 31, 
2022, Corporation WW acquires an additional 40% of the operating 
assets (determined by fair market value) of Corporation XX. 
Employees YY, ZZ, and AAA are covered employees for Corporation XX's 
2020 taxable year. Employees BBB and CCC are covered employees for 
Corporation XX's 2021 taxable year. On January 15, 2021, Employee 
AAA becomes an employee of Corporation WW. On July 1, 2021, Employee 
YY becomes an employee of Corporation WW. On February 1, 2022, 
Employees ZZ and BBB become employees of Corporation WW. On June 30, 
2023, Employee CCC becomes an employee of Corporation WW.
    (2) Conclusion. Because an affiliated group, comprised of 
Corporations VV and WW, acquired 80% of Corporation XX's operating 
assets (determined by fair market value), Corporation XX is a 
predecessor of a publicly held corporation within the meaning of 
paragraph (c)(2)(ii)(E) of this section. Therefore, any covered 
employee of Corporation XX for its 2020 and 2021 taxable years (who 
commenced services for Corporation WW within the period beginning 12 
months before and ending 12 months after the acquisition), is a 
covered employee of Corporation WW for its 2021, 2022 and subsequent 
taxable years. Accordingly, for Corporation WW's 2021 and subsequent 
taxable years, the covered employees of Corporation WW include 
Employees AAA and YY, and any additional covered employees 
determined pursuant to paragraph (c)(2) of this section. For 
Corporation WW's 2022 and subsequent taxable years, the covered 
employees of Corporation WW include Employees AAA, YY, ZZ and BBB, 
and any additional covered employees determined pursuant to 
paragraph (c)(2) of this section. Because Employee CCC became an 
employee of Corporation WW after January 31, 2023, Employee CCC is 
not a covered employee of Corporation WW for its 2023 taxable year, 
but may be a covered employee of Corporation WW by application of 
this paragraph (c)(2) to Employee CCC's employment at Corporation 
WW.
    (V) Example 22 (Predecessor of a publicly held corporation and 
asset acquisition)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vi)(U) of this section (Example 21), except that 
Corporations VV and WW are not publicly held corporations on June 
30, 2021, and for their 2021 taxable years.
    (2) Conclusion. Because Corporations VV and WW are not publicly 
held corporations for their 2021 taxable years, they are not subject 
to section 162(m)(1) for this taxable year.
    (W) Example 23 (Predecessor of a publicly held corporation and 
asset acquisition)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vi)(V) of this section (Example 22), except that, 
on October 1, 2022, Corporation VV's Securities Act registration 
statement in connection with its initial public offering is declared 
effective by the SEC, and Corporation VV is a publicly held 
corporation for its 2022 taxable year.
    (2) Conclusion (2021 taxable year). Because Corporations VV and 
WW are not publicly held corporations for their 2021 taxable years, 
they are not subject to section 162(m)(1) for this taxable year.
    (3) Conclusion (2022 taxable year). Corporation XX is a 
predecessor of a publicly held corporation within the meaning of 
paragraph (c)(2)(ii)(G) of this section because the affiliated 
group, comprised of Corporations VV and WW, became a publicly held 
corporation for a taxable year ending prior to April 15, 2024. 
Therefore, any covered employee of Corporation XX for its 2020 
taxable year is a covered employee of Corporation WW for its 2022 
taxable year. Accordingly, for Corporation WW's 2022 and subsequent 
taxable years, the covered employees of Corporation WW include the 
covered employees of Corporation XX (for a preceding taxable year 
beginning after December 31, 2016) and any additional covered 
employees determined pursuant to this paragraph (c)(2).
    (X) Example 24 (Predecessor of a publicly held corporation and a 
division)--(1) Facts. Corporation DDD is a publicly held corporation 
for its 2021 and 2022 taxable years. On March 2, 2021, Corporation 
DDD forms a wholly-owned subsidiary, Corporation EEE, and transfers 
assets to it. On April 1, 2022, Corporation DDD distributes all 
shares of Corporation EEE to its shareholders in a transaction 
described in section 355(a)(1). On April 1, 2022, Corporation EEE's 
Securities Act registration statement in connection with its initial 
public offering is declared effective by the SEC. Corporation EEE is 
a publicly held corporation for its 2022 taxable year. Employee FFF 
serves as the PFO of Corporation DDD from January 1, 2022, to March 
31, 2022. On April 2, 2022, Employee FFF joins Corporation EEE to 
serve as an advisor (as a common law employee) to the PFO of 
Corporation EEE. After March 31, 2022, Employee FFF ceases to 
provide services for Corporation EEE.
    (2) Conclusion. Because the distribution of the stock of 
Corporation EEE is a transaction described under section 355(a)(1), 
Corporation DDD is a predecessor of Corporation EEE within the 
meaning of paragraph (c)(2)(ii)(C) of this section. Accordingly, 
Corporation DDD is a predecessor of Corporation EEE within the 
meaning of paragraph (c)(2)(ii)(A) of this section even if 
Corporation EEE was a privately held corporation prior to its 2022 
taxable year. Because Employee FFF was a covered employee of 
Corporation DDD for its 2022 taxable year, Employee FFF is a covered 
employee of Corporation EEE for its 2022 taxable year. The result is 
the same whether Employee FFF performs services for Corporation EEE 
as a common law employee or an independent contractor.
    (Y) Example 25 (Predecessor of a publicly held corporation and a 
division)--(1) Facts. The facts are the same as in paragraph 
(c)(2)(vi)(X) of this section (Example 24), except that, Corporation 
DDD exchanges 100% of the shares of Corporation EEE with Corporation 
GGG in a transaction described in section 355(a)(1) and Corporation 
EEE does not register any class of securities with the SEC. 
Furthermore, Employee FFF performs services for Corporation GGG 
instead of for Corporation EEE. Corporation GGG is a privately held 
corporation for its 2022 taxable year. On October 1, 2023, 
Corporation GGG's Securities Act registration statement in 
connection with its initial public offering is declared effective by 
the SEC. Corporation GGG is a publicly held corporation for its 2023 
taxable year. On January 1, 2028, Employee FFF begins serving as a 
director of Corporation DDD. Corporation DDD is a publicly held 
corporation for its 2028 taxable year.
    (2) Conclusion (2022 taxable year). Because Corporation GGG is a 
privately held corporation for its 2022 taxable year, section 
162(m)(1) does not limit the deduction for compensation deductible 
for this taxable year.
    (3) Conclusion (2023 taxable year). Because the exchange of the 
stock of Corporation EEE is a transaction described under section 
355(a)(1), because Corporations EEE and GGG are an affiliated group, 
and because Corporation GGG became a publicly held corporation for a 
taxable year ending prior to April 15, 2025, Corporation DDD is a 
predecessor of Corporation GGG within the meaning of paragraphs 
(c)(2)(ii)(D) and (G) of this section. Employee FFF was a covered 
employee of Corporation DDD for its 2022 taxable year, and began 
performing services for Corporation GGG following April 1, 2021, and 
before April 1, 2023. Therefore, Employee FFF is a covered employee 
of Corporation GGG for its 2023 taxable year.
    (4) Conclusion (2028 taxable year). Because Employee FFF served 
as the PFO of

[[Page 70382]]

Corporation DDD from January 1, 2022, to March 31, 2022, Employee 
FFF was a covered employee of Corporation DDD for its 2022 taxable 
year. Because an individual who is a covered employee for a taxable 
year remains a covered employee for all subsequent taxable years 
(even after the individual has separated from service), Employee FFF 
is a covered employee of Corporation DDD for its 2028 taxable year.
    (Z) Example 26 (Predecessor of a publicly held corporation and a 
division)--(1) Facts. The facts are the same as in paragraph 
(c)(2)(vi)(Y) of this section (Example 25), except that, Employee 
FFF begins performing services for Corporation GGG on June 30, 2023, 
instead of on April 2, 2022, and never performs services for 
Corporation DDD after June 30, 2023. Furthermore, on June 30, 2023, 
Employee HHH, a covered employee of Corporation EEE for all of its 
taxable years, begins performing services for Corporation GGG as an 
independent contractor advising its PEO but not serving as a PEO.
    (2) Conclusion (2023 taxable year). Because the exchange of the 
stock of Corporation EEE is a transaction described under section 
355(a)(1) and because Corporation GGG became a publicly held 
corporation for a taxable year ending before April 15, 2025, 
Corporation DDD is a predecessor of Corporation GGG within the 
meaning of paragraphs (c)(2)(ii)(D) and (G) of this section. Even 
though Employee FFF was a covered employee of Corporation DDD for 
its 2022 taxable year, because Employee FFF began performing 
services for Corporation GGG after April 1, 2023, Employee FFF is 
not a covered employee of Corporation GGG for its 2023 taxable year. 
However, if Employee FFF is a PEO, PFO, or one of the three highest 
compensated executives (other than the PEO or PFO) of Corporation 
GGG for its 2023 or subsequent taxable years, then Employee FFF is a 
covered employee of Corporation GGG for such taxable year (and 
subsequent taxable years). Because Employee HHH was a covered 
employee of Corporation EEE for its 2022 taxable year, Employee is a 
covered employee of Corporation GGG for its 2023 taxable year.
    (AA) Example 27 (Predecessor of a publicly held corporation and 
election under section 338(h)(10))--(1) Facts. Corporation III is 
the common parent of a group of corporations filing consolidated 
returns that includes Corporation JJJ as a member. Corporation III 
wholly-owns Corporation JJJ, a publicly held corporation within the 
meaning of paragraph (c)(1)(i) of this section. On June 30, 2021, 
Corporation LLL purchases Corporation JJJ from Corporation III. 
Corporation III and Corporation LLL make a timely election under 
section 338(h)(10) with respect to the purchase of Corporation JJJ 
stock. For its taxable year after the purchase ending December 31, 
2021, Corporation JJJ continues to be a publicly held corporation 
within the meaning of paragraph (c)(1)(i) of this section.
    (2) Conclusion. As provided in paragraph (c)(2)(ii)(H), 
Corporation JJJ is treated as the same corporation for purposes for 
purposes of paragraph (c)(2). Accordingly, any covered employee of 
Corporation JJJ for its short taxable year ending June 30, 2021, is 
a covered employee of Corporation JJJ for its short taxable year 
ending on December 31, 2021, and subsequent taxable years.
    (BB) Example 28 (Disregarded entity)--(1) Facts. Corporation MMM 
is a privately held corporation for its 2020 taxable year. Entity 
NNN is a wholly-owned limited liability company and is disregarded 
as an entity separate from its owner, Corporation MMM, under Sec.  
301.7701-2(c)(2)(i) of this chapter. As of December 31, 2020, Entity 
NNN is required to file reports under section 15(d) of the Exchange 
Act. For the 2020 taxable year, Employee OOO is the PEO and Employee 
PPP is the PFO of Corporation MMM. Employees QQQ, RRR, and SSS are 
the three most highly compensated executive officers of Corporation 
MMM (other than Employees OOO and PPP). Employee TTT is the PFO of 
Entity NNN and does not perform any policy making functions for 
Corporation MMM. Entity NNN has no other executive officers.
    (2) Conclusion. Because Entity NNN is disregarded as an entity 
separate from its owner, Corporation MMM, and is required to file 
reports under section 15(d) of the Exchange Act, Corporation MMM is 
a publicly held corporation under paragraph (c)(1)(iii) of this 
section for its 2020 taxable year. Even though Employee TTT is a PFO 
of Entity NNN, Employee TTT is not considered a PFO of Corporation 
MMM under paragraph (c)(2)(iii) of this section. As PEO and PFO, 
Employees OOO and PPP are covered employees of Corporation MMM under 
paragraph (c)(2)(i) of this section. Additionally, as the three most 
highly compensated executive officers of Corporation MMM (other than 
Employees OOO and PPP), Employees QQQ, RRR, and SSS are also covered 
employees of Corporation MMM under paragraph (c)(2)(i) of this 
section for Corporation MMM's 2020 taxable year because their 
compensation would be disclosed if Corporation MMM were subject to 
the SEC executive compensation disclosure rules. The conclusion 
would be the same if Entity NNN was not required to file reports 
under section 15(d) of the Exchange Act and Corporation MMM was a 
publicly held corporation pursuant to paragraph (c)(1)(i) instead of 
paragraph (c)(1)(iii) of this section.
    (CC) Example 29 (Disregarded entity)--(1) Facts. The facts are 
the same as in paragraph (c)(2)(vi)(BB) of this section (Example 
28), except that Employee TTT performs a policy making function for 
Corporation MMM. If Corporation MMM were subject to the SEC 
executive compensation disclosure rules, then Employee TTT would be 
treated as an executive officer of Corporation MMM pursuant to 17 
CFR 240.3b-7 for purposes of determining the three highest 
compensated executive officers for Corporation MMM's 2020 taxable 
year. Employees QQQ, RRR and SSS are the three most highly 
compensated executive officers of Corporation MMM (other than 
Employees OOO and PPP). Employee TTT is compensated more than 
Employee QQQ, but less than Employees RRR and SSS.
    (2) Conclusion. Because Entity NNN is disregarded as an entity 
separate from its owner, Corporation MMM, and is required to file 
reports under section 15(d) of the Exchange Act, Corporation MMM is 
a publicly held corporation under paragraph (c)(1)(iii) of this 
section for its 2020 taxable year. As PEO and PFO, Employees OOO and 
PPP are covered employees of Corporation MMM under paragraph 
(c)(2)(i) of this section. Employee TTT is one of the three highest 
compensated executive officers for Corporation MMM's taxable year. 
Because Employees TTT, RRR, and SSS are the three most highly 
compensated executive officers of Corporation MMM (other than 
Employees OOO and PPP), they are covered employees of Corporation 
MMM under paragraph (c)(2)(i) of this section for Corporation MMM's 
2020 taxable year because their compensation would be disclosed if 
Corporation MMM were subject to the SEC executive compensation 
disclosure rules. The conclusion would be the same if Entity NNN was 
not required to file reports under section 15(d) of the Exchange Act 
and Corporation MMM was a publicly held corporation pursuant to 
paragraph (c)(1)(i) instead of paragraph (c)(1)(iii) of this 
section.
    (DD) Example 30 (Individual as covered employee of a publicly 
held corporation that includes the affiliated group)--(1) Facts. 
Corporations UUU and VVV are publicly held corporations for their 
2020, 2021, and 2022 taxable years. Corporation VVV is a direct 
subsidiary of Corporation UUU. Employee WWW is an employee, but not 
a covered employee, of Corporation UUU for its 2020, 2021, and 2022 
taxable years. From April 1, 2020, to September 30, 2020, Employee 
WWW performs services for Corporation VVV. Employee WWW does not 
perform any services for Corporation VVV for its 2021 and 2022 
taxable years. Employee WWW is a covered employee of Corporation VVV 
for its 2020, 2021, and 2022 taxable years. For the 2020 taxable 
year, Employee WWW receives compensation for services provided to 
Corporations UUU and VVV only from Corporation UUU in the amount of 
$1,500,000. Employee WWW receives $2,000,000 from Corporation UUU 
for performing services for Corporation UUU during each of its 2021 
and 2022 taxable years. On June 30, 2022, Corporation VVV pays 
$500,000 to Employee WWW from a nonqualified deferred compensation 
plan that complies with section 409A.
    (2) Conclusion (2020 taxable year). Because Employee WWW is a 
covered employee of Corporation VVV and because the affiliated group 
of corporations (composed of Corporations UUU and VVV) is a publicly 
held corporation, Employee WWW is a covered employee of the publicly 
held corporation that is the affiliated group pursuant to paragraph 
(c)(2)(v) of this section. Accordingly, compensation paid by 
Corporations UUU and VVV is aggregated for purposes of section 
162(m)(1) and, as a result, $500,000 of the aggregate compensation 
paid is nondeductible. The conclusion would be the same if 
Corporation UUU was a privately held corporation for its 2020 
taxable year.
    (3) Conclusion (2021 taxable year). Because Employee WWW is a 
covered employee of Corporation VVV pursuant to paragraph 
(c)(2)(i)(C) of this section and because the affiliated group of 
corporations (composed of Corporations UUU and VVV) is a publicly

[[Page 70383]]

held corporation, Employee WWW is a covered employee of the publicly 
held corporation that is the affiliated group pursuant to paragraph 
(c)(2)(v) of this section. Accordingly, compensation paid by 
Corporations UUU and VVV is aggregated for purposes of section 
162(m)(1) and, as a result, $1,000,000 of the aggregate compensation 
paid is nondeductible. The conclusion would be the same if 
Corporation UUU was a privately held corporation for its 2021 
taxable year.
    (4) Conclusion (2022 taxable year). Because Employee WWW is a 
covered employee of Corporation VVV pursuant to paragraph 
(c)(2)(i)(C) of this section and because the affiliated group of 
corporations (composed of Corporations UUU and VVV) is a publicly 
held corporation, Employee WWW is a covered employee of the publicly 
held corporation that is the affiliated group pursuant to paragraph 
(c)(2)(v) of this section. Accordingly, compensation paid by 
Corporations UUU and VVV is aggregated for purposes of section 
162(m)(1) and, as a result, $1,500,000 of the aggregate compensation 
paid is nondeductible. The conclusion would be the same if 
Corporation UUU was a privately held corporation for its 2022 
taxable year.
    (EE) Example 31 (Individual as covered employee of a publicly 
held corporation that includes the affiliated group)--(1) Facts. 
Corporation BBBB is a publicly held corporation for its 2020 through 
2022 taxable years. Corporations YYY and ZZZ are direct subsidiaries 
of Corporation BBBB and are privately held corporations for their 
2020 through 2022 taxable years. Employee AAAA serves as the PFO of 
Corporation BBBB from January 1, 2020 to December 31, 2020, when 
Employee AAAA separates from service. On January 1, 2021, Employee 
AAAA commences employment with Corporation YYY. In 2021, Employee 
AAAA receives compensation from Corporation YYY in excess of 
$1,000,000. On April 1, 2022, Employee AAAA commences employment 
with Corporation ZZZ. On September 30, 2022, Employee AAAA separates 
from service from Corporations YYY and ZZZ. In 2022, Employee AAAA 
receives compensation from Corporations YYY and ZZZ in excess of 
$1,000,000. For the 2021 and 2022 taxable years, Employee AAA does 
not serve as either the PEO or PFO of Corporations YYY and ZZZ, and 
is not one of the three highest compensated executive officers 
(other than the PEO or PFO) of Corporations YYY and ZZZ.
    (2) Conclusion (2021 taxable year). Employee AAAA is a covered 
employee of Corporation BBBB for the 2020 taxable year and 
subsequent taxable years. Because Employee AAAA is a covered 
employee of Corporation BBBB and because the affiliated group of 
corporations (composed of Corporations BBBB, YYY, and ZZZ) is a 
publicly held corporation, Employee AAAA is a covered employee of 
the publicly held corporation that is the affiliated group pursuant 
to paragraph (c)(2)(v) of this section for the 2020 taxable year and 
subsequent taxable years. Therefore, Corporation YYY's deduction for 
compensation paid to Employee AAAA for the 2021 taxable year is 
subject to limitation under section 162(m)(1). The result would be 
the same if Corporation YYY was a publicly held corporation as 
defined in paragraph (c)(1)(i) of this section.
    (3) Conclusion (2022 taxable year). Because Employee AAAA is a 
covered employee of Corporation BBBB and because the affiliated 
group of corporations (composed of Corporations BBBB, YYY, and ZZZ) 
is a publicly held corporation, Employee AAAA is a covered employee 
of the publicly held corporation that is the affiliated group 
pursuant to paragraph (c)(2)(v) of this section. Therefore, 
Corporation YYY's and ZZZ's deduction for compensation paid to 
Employee AAAA for the 2022 taxable year is subject to limitation 
under section 162(m)(1). Because the compensation paid by all 
affiliated group members is aggregated for purposes of section 
162(m)(1), $1,000,000 of the aggregate compensation paid is 
nondeductible. Corporations YYY and ZZZ each are treated as paying a 
ratable portion of the nondeductible compensation. The result would 
be the same if either Corporation YYY or ZZZ (or both) was a 
publicly held corporation as defined in paragraph (c)(1)(i).

    (3) Compensation--(i) In general. For purposes of the deduction 
limitation described in paragraph (b) of this section, compensation 
means the aggregate amount allowable as a deduction under chapter 1 of 
the Internal Revenue Code for the taxable year (determined without 
regard to section 162(m)(1)) for remuneration for services performed by 
a covered employee in any capacity, whether or not the services were 
performed during the taxable year. Compensation includes an amount that 
is includible in the income of, or paid to, a person other than the 
covered employee (including a beneficiary after the death of the 
covered employee) for services performed by the covered employee.
    (ii) Compensation paid by a partnership. For purposes of paragraph 
(c)(3)(i) of this section, compensation includes an amount equal to a 
publicly held corporation's distributive share of a partnership's 
deduction for compensation expense attributable to the remuneration 
paid by the partnership for services performed by a covered employee of 
the publicly held corporation.
    (iii) Exceptions. Compensation does not include--
    (A) Remuneration covered in section 3121(a)(5)(A) through (D) 
(concerning remuneration that is not treated as wages for purposes of 
the Federal Insurance Contributions Act);
    (B) Remuneration consisting of any benefit provided to or on behalf 
of an employee if, at the time the benefit is provided, it is 
reasonable to believe that the employee will be able to exclude it from 
gross income; or
    (C) Salary reduction contributions described in section 3121(v)(1).
    (iv) Examples. The following examples illustrate the provisions of 
this paragraph (c)(3). For each example, assume that the corporation is 
a calendar year taxpayer.

    (A) Example 1--(1) Facts. Corporation Z is a publicly held 
corporation for its 2020 taxable year, during which Employee A 
serves as the PEO of Corporation Z and also serves on the board of 
directors of Corporation Z. In 2020, Corporation Z paid $1,200,000 
to Employee A plus an additional $50,000 fee for serving as chair of 
the board of directors of Corporation Z. These amounts are otherwise 
deductible for Corporation Z's 2020 taxable year.
    (2) Conclusion. The $1,200,000 paid to Employee A in 2020 plus 
the additional $50,000 director's fee paid to Employee A in 2020 are 
compensation within the meaning of paragraph (c)(3) of this section. 
Therefore, Corporation Z's $1,250,000 deduction for the 2020 taxable 
year is subject to limitation under section 162(m)(1).
    (B) Example 2--(1) Facts. Corporation X is a publicly held 
corporation for its 2020 through 2024 taxable years. Employee B 
serves as the PEO of Corporation X for its 2020 taxable year. In 
2020, Corporation X established a new nonqualified retirement plan 
for its executive officers. The retirement plan provides for the 
distribution of benefits over a three-year period beginning after a 
participant separates from service. Employee B separates from 
service in 2021 and becomes a member of the board of directors of 
Corporation X in 2022. In 2022, Employee B receives a $75,000 fee 
for services as a director and $1,500,000 as the first payment under 
the retirement plan. Employee B continues to serve on the board of 
directors until 2023 when Employee B dies before receiving the 
retirement benefit for 2023 and before becoming entitled to any 
director's fees for 2023. In 2023 and 2024, Corporation X pays the 
$1,500,000 annual retirement benefits to Person C, a beneficiary of 
Employee B.
    (2) Conclusion (2022 Taxable Year). In 2022, Corporation X paid 
Employee B $1,575,000, including $1,500,000 under the retirement 
plan and $75,000 in director's fees. The retirement benefit and the 
director's fees are compensation within the meaning of this 
paragraph (c)(3). Therefore, Corporation X's $1,575,000 deduction 
for the 2022 taxable year is subject to limitation under section 
162(m)(1).
    (3) Conclusion (2023 and 2024 Taxable Years). In 2023 and 2024, 
Corporation X made payments to Person C of $1,500,000 under the 
retirement plan. The retirement benefits are compensation within the 
meaning of this paragraph (c)(3). Therefore, Corporation X's 
deduction for each annual payment of $1,500,000 for the 2023 and 
2024 taxable years is subject to limitation under section 162(m)(1).
    (D) Example 3--(1) Facts. Corporation T is a publicly held 
corporation for its 2021 taxable year. Corporation S is a privately 
held corporation for its 2021 taxable year. On January 2, 2021, 
Corporations S and T form

[[Page 70384]]

a general partnership. Under the partnership agreement, Corporations 
S and T each have a 50% share of the partnership's income, loss, and 
deductions. For the taxable year ending December 31, 2021, Employee 
D, a covered employee of Corporation T, performs services for the 
partnership, and the partnership pays $800,000 to Employee D for 
these services, $400,000 of which is allocated to Corporation T.
    (2) Conclusion. Because Corporation T's distributive share of 
the partnership's $400,000 deduction is attributable to the 
compensation paid by the partnership for services performed by 
Employee D, a covered employee of Corporation T, the $400,000 is 
compensation within the meaning of this paragraph (c)(3) and section 
162(m)(1) limits Corporation T's deduction for this expense for the 
2021 taxable year. Corporation T's $400,000 share of the 
partnership's deduction is aggregated with Corporation T's deduction 
for compensation paid to Employee D, if any, in determining the 
amount allowable as a deduction to Corporation T for remuneration 
paid to Employee D for Corporation T's 2021 taxable year. See Sec.  
1.702-1(a)(8)(iii). The result is the same whether the covered 
employee performs services for the partnership as a common law 
employee, an independent contractor, or a partner, and whether the 
payment for services is a payment under section 707(a) or a 
guaranteed payment under section 707(c).

    (4) Securities Act. The Securities Act means the Securities Act of 
1933.
    (5) Exchange Act. The Exchange Act means the Securities Exchange 
Act of 1934.
    (6) SEC. The SEC means the United States Securities and Exchange 
Commission.
    (7) Foreign Private Issuer. A foreign private issuer means an 
issuer as defined in 17 CFR 240.3b-4(c).
    (8) American Depositary Receipt (ADR). An American Depositary 
Receipt means a negotiable certificate that evidences ownership of a 
specified number (or fraction) of a foreign private issuer's securities 
held by a depositary (typically, a U.S. bank).
    (9) Privately held corporation. A privately held corporation is a 
corporation that is not a publicly held corporation as defined in 
paragraph (c)(1) of this section (without regard to paragraph 
(c)(1)(ii) of this section).
    (d) Corporations that become publicly held--(1) In general. In the 
case of a corporation that was a privately held corporation and then 
becomes a publicly held corporation, the deduction limitation of 
paragraph (b) of this section applies to any compensation that is 
otherwise deductible for the taxable year ending on or after the date 
that the corporation becomes a publicly held corporation. A corporation 
is considered to become publicly held on the date that its registration 
statement becomes effective either under the Securities Act or the 
Exchange Act. The rules in this section apply to a partnership that 
becomes a publicly traded partnership that is a publicly held 
corporation within the meaning of paragraph (c)(1)(i) of this section.
    (2) Example. The following example illustrates the provision of 
this paragraph (d).

    (i) Facts. In 2021, Corporation E plans to issue debt securities 
in a public offering registered under the Securities Act. 
Corporation E is not required to file reports under section 15(d) of 
the Exchange Act with respect to any other class of securities and 
does not have another class of securities required to be registered 
under section 12 of the Exchange Act. On December 18, 2021, the 
Securities Act registration statement for Corporation Z's debt 
securities is declared effective by the SEC.
    (ii) Conclusion. Corporation E is considered to become a 
publicly held corporation on December 18, 2021 because it is now 
required to file reports under section 15(d) of the Exchange Act. 
The deduction limitation of paragraph (b) of this section applies to 
any remuneration that is otherwise deductible for Corporation E's 
taxable year ending on or after December 18, 2021.

    (e) Coordination with disallowed excess parachute payments under 
section 280G. The $1,000,000 limitation in paragraph (b) of this 
section is reduced (but not below zero) by the amount (if any) that 
would have been included in the compensation of the covered employee 
for the taxable year but for being disallowed by reason of section 
280G. For example, assume that during a taxable year a corporation pays 
$1,500,000 to a covered employee. Of the $1,500,000, $600,000 is an 
excess parachute payment, as defined in section 280G(b)(1), and a 
deduction for that excess parachute payment is disallowed by reason of 
section 280G(a). Because the $1,000,000 limitation in paragraph (b) of 
this section is reduced by the amount of the excess parachute payment, 
the corporation may deduct $400,000 ($1,000,000-$600,000), and $500,000 
of the otherwise deductible amount is nondeductible by reason of 
section 162(m)(1). Thus $1,100,000 (of the total $1,500,000 payment) is 
non-deductible, reflecting the disallowance related to the excess 
parachute payment under section 280G and the application of section 
162(m)(1).
    (f) Coordination with excise tax on specified stock compensation. 
The $1,000,000 limitation in paragraph (b) of this section is reduced 
(but not below zero) by the amount (if any) of any payment (with 
respect to such employee) of the tax imposed by section 4985 directly 
or indirectly by the expatriated corporation (as defined in section 
4985(e)(2)) or by any member of the expanded affiliated group (as 
defined in section 4985(e)(4)) that includes such corporation.
    (g) Transition rules--(1) Amount of compensation payable under a 
written binding contract which was in effect on November 2, 2017--(i) 
General rule. This section does not apply to the deduction for 
remuneration payable under a written binding contract that was in 
effect on November 2, 2017, and that is not modified in any material 
respect on or after such date (a grandfathered amount). Instead, 
section 162(m), as in effect prior to its amendment by Public Law 115-
97, applies to limit the deduction for such remuneration. Accordingly, 
because Sec.  1.162-27 implemented section 162(m), as in effect prior 
to its amendment by Public Law 115-97, the rules of Sec.  1.162-27 
determine the applicability of the deduction limitation under section 
162(m) with respect to the payment of a grandfathered amount. 
Remuneration is a grandfathered amount only to the extent that as of 
November 2, 2017, the corporation was and remains obligated under 
applicable law (for example, state contract law) to pay the 
remuneration under the contract if the employee performs services or 
satisfies the applicable vesting conditions. Accordingly, this section 
applies to the deduction for any amount of remuneration that exceeds 
the grandfathered amount if the employee performs services or satisfies 
the applicable vesting conditions. If a grandfathered amount and non-
grandfathered amount are otherwise deductible for the same taxable year 
and, under the rules of Sec.  1.162-27, the deduction of some or all of 
the grandfathered amount may be limited (for example, the grandfathered 
amount does not satisfy the requirements of Sec.  1.162-27(e)(2) 
through (5) as qualified performance-based compensation), then the 
grandfathered amount is aggregated with the non-grandfathered amount to 
determine the deduction disallowance for the taxable year under section 
162(m)(1) (so that the deduction limit applies to the excess of the 
aggregated amount over $1 million). If a portion of the remuneration 
payable under a contract is a grandfathered amount and a portion is 
subject to this section and payment under the contract is made in a 
series of payments, the grandfathered amount is allocated to the first 
payment of an amount under the contract that is otherwise deductible. 
If the grandfathered amount exceeds the initial payment, the excess is 
allocated

[[Page 70385]]

to the next payment of an amount under the contract that is otherwise 
deductible, and this process is repeated until the entire grandfathered 
amount has been paid.
    (ii) Contracts that are terminable or cancelable. If a written 
binding contract is renewed after November 2, 2017, this section (and 
not Sec.  1.162-27) applies to any payments made after the renewal. A 
written binding contract that is terminable or cancelable by the 
corporation without the employee's consent after November 2, 2017, is 
treated as renewed as of the earliest date that any such termination or 
cancellation, if made, would be effective. Thus, for example, if the 
terms of a contract provide that it will be automatically renewed or 
extended as of a certain date unless either the corporation or the 
employee provides notice of termination of the contract at least 30 
days before that date, the contract is treated as renewed as of the 
date that termination would be effective if that notice were given. 
Similarly, for example, if the terms of a contract provide that the 
contract will be terminated or canceled as of a certain date unless 
either the corporation or the employee elects to renew within 30 days 
of that date, the contract is treated as renewed by the corporation as 
of that date (unless the contract is renewed before that date, in which 
case, it is treated as renewed on that earlier date). Alternatively, if 
the corporation will remain legally obligated by the terms of a 
contract beyond a certain date at the sole discretion of the employee, 
the contract will not be treated as renewed as of that date if the 
employee exercises the discretion to keep the corporation bound to the 
contract. A contract is not treated as terminable or cancelable if it 
can be terminated or canceled only by terminating the employment 
relationship of the employee. A contract is not treated as renewed if 
upon termination or cancellation of the contract the employment 
relationship continues but would no longer be covered by the contract. 
However, if the employment continues after such termination or 
cancellation, payments with respect to such post-termination or post-
cancellation employment are not made pursuant to the contract (and, 
therefore, are not grandfathered amounts).
    (iii) Compensation payable under a plan or arrangement. If a 
compensation plan or arrangement is binding, the deduction for the 
amount that the corporation is obligated to pay pursuant to written 
binding contract in effect on November 2, 2017, to an employee pursuant 
to the plan or arrangement is not subject to this section even if the 
employee was not eligible to participate in the plan or arrangement as 
of November 2, 2017, if the employee was employed on November 2, 2017, 
by the corporation that maintained the plan or arrangement, or the 
employee had the right to participate in the plan or arrangement under 
a written binding contract as of that date.
    (iv) Compensation subject to recovery by corporation. If the 
corporation is obligated or has discretion to recover compensation paid 
in a taxable year only upon the future occurrence of a condition that 
is objectively outside of the corporation's control, then the 
corporation's right to recovery is disregarded for purposes of 
determining the grandfathered amount for the taxable year. If the 
condition occurs, only the amount the corporation is obligated to pay 
under applicable law remains grandfathered taking into account the 
occurrence of the condition. Whether or not the corporation exercises 
its discretion to recover any compensation does not affect the amount 
of compensation that the corporation remains obligated to pay under 
applicable law.
    (2) Material modifications--(i) If a written binding contract is 
modified after November 2, 2017, this section (and not Sec.  1.162-27) 
applies to any payments made after the modification. A material 
modification occurs when the contract is amended to increase the amount 
of compensation payable to the employee. If a written binding contract 
is materially modified, it is treated as a new contract entered into as 
of the date of the material modification. Thus, amounts received by an 
employee under the contract before a material modification are not 
affected, but amounts received subsequent to the material modification 
are treated as paid pursuant to a new contract, rather than as paid 
pursuant to a written binding contract in effect on November 2, 2017.
    (ii) A modification of the contract that accelerates the payment of 
compensation is a material modification unless the amount of 
compensation paid is discounted to reasonably reflect the time value of 
money. If the contract is modified to defer the payment of 
compensation, any compensation paid or to be paid that is in excess of 
the amount that was originally payable to the employee under the 
contract will not be treated as resulting in a material modification if 
the additional amount is based on applying to the amount originally 
payable either a reasonable rate of interest or the rate of return on a 
predetermined actual investment as defined in Sec.  31.3121(v)(2)-
1(d)(2)(i)(B) of this chapter, (whether or not assets associated with 
the amount originally owed are actually invested therein) such that the 
amount payable by the employer at the later date will be based on the 
reasonable rate of interest or the actual rate of return on the 
predetermined actual investment (including any decrease, as well as any 
increase, in the value of the investment).
    (iii) The adoption of a supplemental contract or agreement that 
provides for increased compensation, or the payment of additional 
compensation, is a material modification of a written binding contract 
if the facts and circumstances demonstrate that the additional 
compensation to be paid is based on substantially the same elements or 
conditions as the compensation that is otherwise paid pursuant to the 
written binding contract. However, a material modification of a written 
binding contract does not include a supplemental payment that is equal 
to or less than a reasonable cost-of-living increase over the payment 
made in the preceding year under that written binding contract. In 
addition, the failure, in whole or in part, to exercise negative 
discretion under a contract does not result in the material 
modification of that contract.
    (iv) If a grandfathered amount is subject to a substantial risk of 
forfeiture (as defined in Sec.  1.409A-1(d)), then a modification of 
the contract that results in a lapse of the substantial risk of 
forfeiture is not considered a material modification. For compensation 
received pursuant to the substantial vesting of restricted property, or 
the exercise of a stock option or stock appreciation right that do not 
provide for a deferral of compensation (as defined in Sec.  1.409A-
1(b)(5)(i) and (ii)), a modification of a written binding contract in 
effect on November 2, 2017, that results in a lapse of the substantial 
risk of forfeiture (as defined Sec.  1.83-3(c)) is not considered a 
material modification.
    (3) Examples. The following examples illustrate the provisions of 
this paragraph (g). For each example, assume for all relevant years 
that the corporation is a publicly held corporation within the meaning 
of paragraph (c)(1) of this section and is a calendar year taxpayer. 
Furthermore, assume that, for each example, if any arrangement is 
subject to section 409A, then the arrangement complies with section 
409A, and that no arrangement is subject to section 457A.

    (i) Example 1 (Multi-year agreement for annual salary)--(A) 
Facts. On October 2,

[[Page 70386]]

2017, Corporation X executed a 3-year employment agreement with 
Employee A for an annual salary of $2,000,000 beginning on January 
1, 2018. Employee A serves as the PFO of Corporation X for the 2017 
through 2020 taxable years. The agreement provides for automatic 
extensions after the 3-year term for additional 1-year periods, 
unless the corporation exercises its option to terminate the 
agreement within 30 days before the end of the 3-year term or, 
thereafter, within 30 days before each anniversary date. Termination 
of the employment agreement does not require the termination of 
Employee A's employment with Corporation X. Under applicable law, 
the agreement for annual salary constitutes a written binding 
contract in effect on November 2, 2017, to pay $2,000,000 of annual 
salary to Employee A for three years through December 31, 2020.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee A is a 
covered employee for Corporation X's 2018 through 2020 taxable 
years. Because the October 2, 2017, employment agreement is a 
written binding contract to pay Employee A an annual salary of 
$2,000,000, this section does not apply (and Sec.  1.162-27 does 
apply) to the deduction for Employee A's annual salary. Pursuant to 
Sec.  1.162-27(c)(2), Employee A is not a covered employee for 
Corporation X's 2018 through 2020 taxable years. Accordingly, the 
deduction for Employee A's annual salary for the 2018 through 2020 
taxable years is not subject to section 162(m)(1). However, the 
employment agreement is treated as renewed on January 1, 2021, 
unless it is previously terminated, and the deduction limit of this 
section (and not Sec.  1.162-27) will apply to the deduction for any 
payments made under the employment agreement on or after that date.
    (ii) Example 2 (Agreement for severance based on annual salary 
and discretionary bonus)--(A) Facts. The facts are the same as in 
paragraph (g)(3)(i) of this section (Example 1), except that the 
employment agreement also requires Corporation X to pay Employee A 
severance if Corporation X terminates the employment relationship 
without cause within the term of the agreement. The amount of 
severance is equal to the sum of two times Employee A's annual 
salary plus two times Employee A's discretionary bonus (if any) paid 
within 12 months preceding termination. Under applicable law, the 
agreement for severance constitutes a written binding contract in 
effect on November 2, 2017, to pay $4,000,000 (two times Employee 
A's $2,000,000 annual salary) if Corporation X terminates Employee 
A's employment without cause within the term of the agreement.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee A is a 
covered employee for Corporation X's 2018 through 2020 taxable 
years. Because the October 2, 2017, employment agreement is a 
written binding contract to pay Employee A $4,000,000 if Employee A 
is terminated without cause prior to December 31, 2020, this section 
does not apply (and Sec.  1.162-27 does apply) to the deduction for 
$4,000,000 of Employee A's severance. Pursuant to Sec.  1.162-
27(c)(2), Employee A is not a covered employee for Corporation X's 
2018 through 2020 taxable years. Accordingly, the deduction for 
$4,000,000 of Employee A's severance is not subject to section 
162(m)(1). However, the employment agreement is treated as renewed 
on January 1, 2021, unless it is previously terminated, and this 
section (and not Sec.  1.162-27) will apply to the deduction for any 
payments made under the employment agreement, including for 
severance, on or after that date.
    (iii) Example 3 (Agreement for severance based on annual salary 
and discretionary bonus)--(A) Facts. The facts are the same as in 
paragraph (g)(3)(ii) of this section (Example 2), except that, on 
October 31, 2017, Corporation X paid Employee A a discretionary 
bonus of $10,000. Under applicable law, the agreement for severance 
constitutes a written binding contract in effect on November 2, 
2017, to pay $4,000,000 (two times Employee A's $2,000,000 annual 
salary) if Corporation X terminates Employee A's employment without 
cause prior to December 31, 2020, and $20,000 if Corporation X 
terminates Employee A's employment without cause prior to October 
31, 2018. On June 30, 2018, Corporation X terminates Employee A 
without cause and makes a $4,020,000 severance payment to Employee 
A.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee A is a 
covered employee for Corporation X's 2018 taxable year. Because the 
October 2, 2017, agreement is a written binding contract to pay 
Employee A $4,000,000 if Employee A is terminated without cause 
prior to December 31, 2020, and $20,000 if Corporation X terminates 
Employee A's employment without cause prior to October 31, 2018, 
this section does not apply (and Sec.  1.162-27 does apply) to the 
deduction for Employee A's severance payment of $4,020,000. Pursuant 
to Sec.  1.162-27(c)(2), Employee A is not a covered employee for 
Corporation X's 2018 taxable year. Accordingly, the deduction for 
the entire $4,020,000 of Employee A's severance payment is not 
subject to section 162(m)(1).
    (iv) Example 4 (Effect of discretionary bonus payment on 
agreement for severance based on annual salary and discretionary 
bonus)--(A) Facts. The facts are the same as in paragraph (g)(3)(ii) 
of this section (Example 2), except that, on May 14, 2018, 
Corporation X paid a $600,000 discretionary bonus to Employee A and, 
on April 30, 2019, terminated Employee A's employment without cause. 
Pursuant to the terms of the employment agreement for severance, on 
May 1, 2019, Corporation X made a $5,200,000 severance payment (the 
sum of two times the $2,000,000 annual salary and two times the 
$600,000 discretionary bonus) to Employee A.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee A is a 
covered employee for Corporation X's 2019 taxable year. Because the 
October 2, 2017, agreement is a written binding contract to pay 
Employee A $4,000,000 if Employee A is terminated without cause 
prior to December 31, 2020, this section does not apply (and Sec.  
1.162-27 does apply) to the deduction for $4,000,000 of Employee A's 
severance payment. Accordingly, the deduction for $4,000,000 of 
Employee A's severance payment is not subject to section 162(m)(1). 
Because the October 2, 2017, agreement is not a written binding 
contract to pay Employee A a discretionary bonus, the deduction for 
$1,200,000 (based on the discretionary bonus) of the $5,200,000 
payment is subject to this section (and not Sec.  1.162-27).
    (v) Example 5 (Effect of adjustment to annual salary on 
severance)--(A) Facts. The facts are the same as in paragraph 
(g)(3)(ii) of this section (Example 2), except that the employment 
agreement provides for discretionary increases in salary and, on 
January 1, 2019, Corporation X increased Employee A's annual salary 
from $2,000,000 to $2,050,000, an increase that was less than a 
reasonable, cost-of-living adjustment.
    (B) Conclusion (Annual salary): If this Sec.  1.162-33 applies, 
Employee A is a covered employee for Corporation X's 2018 through 
2020 taxable years. Because the October 2, 2017, agreement is a 
written binding contract to pay Employee A an annual salary of 
$2,000,000, this section does not apply (and Sec.  1.162-27 does 
apply) to the deduction for Employee A's annual salary unless the 
change in the salary is a material modification. Even though the 
$50,000 increase is paid on the basis of substantially the same 
elements or conditions as the salary that is otherwise paid under 
the contract, the $50,000 increase does not constitute a material 
modification because it is less than or equal to a reasonable cost-
of-living increase to the $2,000,000 annual salary Corporation X is 
required to pay under applicable law as of November 2, 2017. 
However, the deduction for the $50,000 increase is subject to this 
section (and not Sec.  1.162-27).
    (C) Conclusion (Severance payment): Because the October 2, 2017, 
agreement is a written binding contract to pay Employee A severance 
of $4,000,000, this section would not apply (and Sec.  1.162-27 
would apply) to the deduction for this amount of severance unless 
the change in the employment agreement is a material modification. 
Even though the $100,000 increase in severance (two times the 
$50,000 increase in salary) would be paid on the basis of 
substantially the same elements or conditions as the severance that 
would otherwise be paid pursuant to the written binding contract, 
the $50,000 increase in salary on which it is based does not 
constitute a material modification of the written binding contract 
since it is less than or equal to a reasonable cost-of-living 
increase. However, the deduction for the $100,000 increase in 
severance is subject to this section (and not Sec.  1.162-27).
    (vi) Example 6 (Effect of adjustment to annual salary on 
severance)--(A) Facts. The facts are the same as in paragraph 
(g)(3)(v) of this section (Example 5), except that, on January 1, 
2019, Corporation X increased Employee A's annual salary from 
$2,000,000 to $3,000,000, an increase that exceeds a reasonable, 
cost-of-living adjustment.
    (B) Conclusion (Annual salary): If this Sec.  1.162-33 applies, 
Employee A is a covered employee for Corporation X's 2018 through 
2020 taxable years. Because the October 2, 2017, agreement is a 
written binding contract to pay Employee A an annual salary of 
$2,000,000, this section does not apply (and

[[Page 70387]]

Sec.  1.162-27 does apply) to the deduction for Employee A's annual 
salary unless the change in the employment agreement is a material 
modification. The $1,000,000 increase is a material modification of 
the written binding contract because the additional compensation is 
paid on the basis of substantially the same elements or conditions 
as the compensation that is otherwise paid pursuant to the written 
binding contract, and it exceeds a reasonable, annual cost-of-living 
increase from the $2,000,000 annual salary for 2018 that Corporation 
X is required to pay under applicable law as of November 2, 2017. 
Because the written binding contract is materially modified as of 
January 1, 2019, the deduction for all annual salary paid to 
Employee A in 2019 and thereafter is subject to this section (and 
not Sec.  1.162-27).
    (C) Conclusion (Severance payment): Because the October 2, 2017, 
agreement is a written binding contract to pay Employee A severance 
of $4,000,000, this section would not apply (and Sec.  1.162-27 
would apply) to the deduction for this amount of severance unless 
the change in the employment agreement is a material modification. 
The additional $2,000,000 (two times the $1,000,000 increase in 
annual salary) constitutes a material modification of the written 
binding contract because the $1,000,000 increase in salary on which 
it is based constitutes a material modification of the written 
binding contract since it exceeds a reasonable cost-of-living 
increase from the $2,000,000 annual salary for 2018 that Corporation 
X is required to pay under applicable law as of November 2, 2017. 
Because the agreement is materially modified as of January 1, 2019, 
the deduction for any amount of severance payable to Employee A 
under the severance agreement is subject to this section (and not 
Sec.  1.162-27).
    (vii) Example 7 (Elective deferral of an amount that corporation 
was obligated to pay under applicable law)--(A) Facts. The facts are 
the same as in paragraph (g)(3)(i) of this section (Example 1), 
except that, on December 15, 2018, Employee A makes a deferral 
election under a NQDC plan to defer $200,000 of annual salary earned 
and payable in 2019. Pursuant to the deferred compensation 
agreement, the $200,000, including earnings, is to be paid in a lump 
sum at Employee A's separation from service. The earnings are based 
on the Standard & Poor's 500 Index. Under applicable law, pursuant 
to the written binding contract in effect on November 2, 2017, (and 
absent the deferral agreement) Corporation X would have been 
obligated to pay $200,000 to Employee A in 2019, but is not 
obligated to pay any earnings on the $200,000 deferred pursuant to 
the deferral election Employee A makes on December 15, 2018. 
Employee A separates from service on December 15, 2020. On December 
15, 2020, Corporation X pays $250,000 (the deferred $200,000 of 
salary plus $50,000 in earnings).
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee A is a 
covered employee for Corporation X's 2020 taxable year. Employee A's 
deferred compensation agreement is not a material modification of 
the written binding contract in effect on November 2, 2017, because 
the earnings to be paid under the deferred compensation agreement 
are based on a predetermined actual investment (as defined in Sec.  
31.3121(v)(2)-1(d)(2)(i)(B)). The deduction for the $50,000 of 
earnings to be paid that exceed the amount originally payable to 
Employee A under the written binding contract ($200,000 of salary) 
are subject to this section (and not Sec.  1.162-27). This section 
does not apply (and Sec.  1.162-27 does apply) to the deduction for 
the $200,000 portion of the $250,000 payment because Corporation X 
was obligated under applicable law to pay as of November 2, 2017. 
Pursuant to Sec.  1.162-27(c)(2), Employee A is not a covered 
employee for Corporation X's 2020 taxable year; thus, the deduction 
for the $200,000 payment is not subject to section 162(m)(1).
    (viii) Example 8 (Compensation subject to mandatory recovery by 
corporation)--(A) Facts. Employee B serves as the PFO of Corporation 
Z for its 2017 through 2019 taxable years. On October 2, 2017, 
Corporation Z executed a bonus agreement with Employee B that 
provides for a performance bonus of $3,000,000 to be paid on May 1, 
2019, if Corporation Z's net earnings increase by at least 10% for 
its 2018 taxable year based on the financial statements filed with 
the SEC. The agreement prohibits Corporation Z from reducing the 
amount of the bonus for any reason but provides that, if the bonus 
is paid and subsequently the financial statements are restated to 
show that the net earnings did not increase by at least 10%, then 
Corporation Z shall recover the $3,000,000 from Employee B within 
six months of the restatement. Under applicable law, the agreement 
for the performance bonus constitutes a written binding contract in 
effect on November 2, 2017, to pay $3,000,000 to Employee B if 
Corporation Z's net earnings increase by at least 10% for its 2018 
taxable year based on the financial statements filed with the SEC. 
On May 1, 2019, Corporation Z pays $3,000,000 to Employee B because 
its net earnings increased by at least 10% of its 2018 taxable year.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee B is a 
covered employee for Corporation Z's 2019 taxable year. The terms of 
the contract providing for recovery of the $3,000,000 do not 
preclude Corporation Z from being contractually obligated under 
applicable law to pay $3,000,000 to Employee B if the net earnings 
increase by at least 10% for its 2018 taxable year. Because the 
October 2, 2017, agreement is a written binding contract to pay 
Employee B $3,000,000 if Corporation Z's net earnings increase by at 
least 10% for its 2018 taxable year based on the financial 
statements filed with the SEC, this section does not apply (and 
Sec.  1.162-27 does apply) to the deduction for the $3,000,000 
payment. Pursuant to Sec.  1.162-27(c)(2), Employee B is not a 
covered employee for Corporation Z's 2019 taxable year, so the 
deduction for the $3,000,000 payment is not subject to section 
162(m)(1).
    (ix) Example 9 (Compensation subject to discretionary recovery 
by corporation)--(A) Facts. The facts are the same as in paragraph 
(g)(3)(viii) of this section (Example 8), except that the agreement 
provides that, if the financial statements are restated to show that 
the net earnings did not increase by at least 10%, then Corporation 
Z may, in its discretion, recover all or a portion of the $3,000,000 
bonus from Employee B within six months of the restatement. Under 
applicable law, the agreement constitutes a written binding contract 
in effect on November 2, 2017, to pay $3,000,000 to Employee B if 
the conditions are met. However, under applicable law, taking into 
account the employer's ability to exercise discretion and the 
employer's past exercise of such discretion with respect to a 
recovery in the event of an earnings restatement, on November 2, 
2017, the bonus plan is a written binding contract only with respect 
to $500,000 if Corporation Z's financial statements are restated to 
show that the net earnings did not increase by at least 10%. On May 
1, 2019, Corporation Z pays $3,000,000 to Employee B. On July 1, 
2019, Corporation Z's financial statements are restated to show that 
its net earnings did not increase by at least 10% for its 2018 
taxable year. On July 30, 2019, Corporation Z recovers $1,000,000 
from Employee B.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee B is a 
covered employee for Corporation Z's 2019 taxable year. Because the 
October 2, 2107, agreement is a written binding contract to pay 
Employee B $3,000,000 if the applicable conditions are met, this 
section does not apply (and Sec.  1.162-27 does apply) to the 
deduction for the $3,000,000 provided Corporation Z's financial 
statements are not restated to show that its net earnings did not 
increase by at least 10%. However, because Corporation Z's financial 
statements were so restated, then, on November 2, 2017, under 
applicable law, taking into account the employer's ability to 
exercise discretion and the employer's past exercise of such 
discretion, the bonus plan constitutes a written binding contract to 
pay only $500,000. Because Corporation Z recovered $1,000,000 of the 
$3,000,000 payment, this section does not apply (and Sec.  1.162-27 
does apply) to the deduction for $500,000 of the $2,000,000 that 
Corporation Z did not recover. Pursuant to Sec.  1.162-27(c)(2), 
Employee B is not a covered employee for Corporation Z's 2019 
taxable year, so the deduction for the $500,000 is not subject to 
section 162(m)(1). The deduction for the remaining $1,500,000 is 
subject to this section (and not Sec.  1.162-27).
    (x) Example 10 (Compensation subject to discretionary recovery 
by corporation based on a condition)--(A) Facts. The facts are the 
same as in paragraph (g)(3)(viii) of this section (Example 8), 
except that the agreement does not include a provision regarding an 
earnings restatement. Instead, the agreement provides that 
Corporation Z may, in its discretion, require Employee B to repay 
the $3,000,000 bonus if, within three years from the date of 
payment, Employee B engages in willful or reckless behavior that has 
a material adverse impact on Corporation Z, or is convicted of, or 
pleads nolo contendre or guilty to a felony. Under applicable law, 
the agreement constitutes a written binding contract in effect on 
November 2, 2017, to pay $3,000,000 to Employee B if the conditions 
are met.

[[Page 70388]]

However, under applicable law, taking into account the employer's 
ability to exercise discretion and the employer's past exercise of 
such discretion, if conditions arise to permit Corporation Z to 
recover the $3,000,000 bonus from Employee B, then the bonus plan 
established on October 2, 2017, constitutes a written binding 
contract to pay only $2,000,000 to Employee B if Corporation Z's net 
earnings increase by at least 10% for its 2018 taxable year based on 
the financial statements filed with the SEC. On May 1, 2019, 
Corporation Z pays $3,000,000 to Employee B. Prior to May 1, 2022, 
Employee B does not engage in willful or reckless behavior that has 
a material adverse impact on Corporation Z, and is not convicted of, 
or plead nolo contendre or guilty to a felony.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee B is a 
covered employee for Corporation Z's 2019 taxable year. Because the 
October 2, 2017, agreement is a written binding contract under 
applicable law to pay Employee B $3,000,000 if the applicable 
conditions are met, this section does not apply (and Sec.  1.162-27 
does apply) to the deduction for the $3,000,000. Pursuant to Sec.  
1.162-27(c)(2), Employee B is not a covered employee for Corporation 
Z's 2019 taxable year, so the deduction for the $3,000,000 is not 
subject to section 162(m)(1).
    (xi) Example 11 (Compensation subject to discretionary recovery 
by corporation based on a condition)--(A) Facts. The facts are the 
same as in paragraph (g)(3)(x) of this section (Example 10), except 
that, on April 1, 2021, Employee B pleads guilty to a felony. 
Because Employee B pled guilty to a felony prior to May 1, 2022, 
Corporation Z has discretion to recover the $3,000,000 bonus from 
Employee B. Corporation Z chooses not to recover any amount of the 
$3,000,000 from Employee B.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee B is a 
covered employee for Corporation Z's 2019 taxable year. Because 
Employee B pled guilty to a felony prior to May 1, 2022, the bonus 
plan constitutes a written binding contract in effect on November 2, 
2017, to pay only $2,000,000 to Employee B if the applicable 
conditions were met. Accordingly, this section does not apply (and 
Sec.  1.162-27 does apply) to the deduction for the $2,000,000 
portion of the $3,000,000. Pursuant to Sec.  1.162-27(c)(2), 
Employee B is not a covered employee for Corporation Z's 2019 
taxable year; thus, the deduction for the $2,000,000 portion of the 
$3,000,000 is not subject to section 162(m)(1). The deduction for 
the remaining $1,000,000 of the $3,000,000 is subject to this 
section (and not Sec.  1.162-27).
    (xii) Example 12 (Election to defer bonus)--(A) Facts. On 
December 31, 2015, Employee C, an employee of Corporation Y, makes 
an election under a NQDC plan to defer the entire amount that would 
otherwise be paid to Employee C on December 31, 2016, under 
Corporation Y's 2016 annual bonus plan. Pursuant to the NQDC plan, 
the earnings on the deferred amount may be based on either of the 
following two investment choices (but not the greater of the two): 
Annual total shareholder return for Corporation Y or Moody's Average 
Corporate Bond Yield. On a prospective basis, Employee C may change 
the investment measure. The deferred amount and the earnings thereon 
are to be paid in a lump sum at Employee C's separation from 
service. Employee C initially elects to have earnings based on 
annual total shareholder return for Corporation Y. On December 31, 
2018, Employee C elects to have earnings based on Moody's Average 
Corporate Bond Yield. The bonus plan provides that Corporation Y may 
not reduce the bonus or any applicable earnings. Employee C earns a 
$200,000 bonus for the 2016 taxable year. Under applicable law, the 
deferred compensation agreement constitutes a written binding 
contract in effect on November 2, 2017, to pay the $200,000 bonus 
plus earnings. Specifically, Corporation Y is obligated to pay 
earnings on the $200,000 deferred pursuant to the deferral election 
Employee C makes on December 31, 2015. On January 1, 2018, Employee 
C is promoted to serve as PEO of Corporation Y and becomes a covered 
employee for the first time. On December 15, 2020, Employee C 
separates from service and Corporation Y pays $225,000 (the deferred 
$200,000 bonus plus $25,000 in earnings) to Employee C.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee C is a 
covered employee for Corporation Y's 2020 taxable year because 
Employee C served as the PEO of Corporation Y during the taxable 
year. The December 31, 2015, agreement is a written binding contract 
to pay the $200,000 bonus plus earnings. Furthermore, Employee C's 
December 31, 2018, election to change the earnings measure does not 
constitute a material modification. Accordingly, this section does 
not apply (and Sec.  1.162-27 does apply) to the deduction for the 
$225,000 payment from Corporation Y to Employee C. Pursuant to Sec.  
1.162-27(c)(2), Employee C is not a covered employee because 
Employee C did not serve as the PEO at the close of the Corporation 
Y's taxable year, so the deduction for the $225,000 payment is not 
subject to section 162(m)(1).
    (xiii) Example 13 (Nonaccount balance plan)--(A) Facts. On 
November 2, 2012, Employee D commences employment with Corporation W 
as its PFO. Employee D separates from service as PFO on January 7, 
2020. For each taxable year, Employee D receives a base salary of 
$2,000,000. On January 1, 2016, Corporation W and Employee D enter 
into a NQDC arrangement that is a nonaccount balance plan (as 
defined in Sec.  1.409A-1(c)(2)(i)(C). Under the terms of the plan, 
Corporation W will pay Employee D a lump sum payment equal to 25% of 
Employee D's base salary in the year of separation from service 
multiplied by 1/12 for each month of service. The plan provides that 
this payment will be made six months after separation from service 
and that Corporation W may, at any time, amend the plan to reduce 
the amount of future benefits; however, Corporation W may not reduce 
the benefit accrued prior to the date of the amendment. Furthermore, 
under the terms of the plan and in accordance with Sec.  1.409A-
3(j)(4)(ix)(C)(3), if Corporation W terminates the plan, the 
payments due under the plan may be accelerated to any date no 
earlier than 12 months after the date of termination and no later 
than 24 months after the date of termination. Under applicable law, 
if an employer terminates a NQDC plan and does not make a payment 
until 12 months after the date of termination, then, to reflect the 
time value of money, the employer is obligated to pay a reasonable 
rate of interest (compounded annually) on any benefit accrued under 
the plan at the date of termination until the date of payment. 
Assume for this purpose that for all applicable periods 3% is a 
reasonable rate of interest. As of November 2, 2017, Employee D has 
60 months of service for Corporation W as calculated under the NQDC 
plan terms. Under applicable law, the plan constitutes a written 
binding contract in effect on November 2, 2017, to pay $2,575,000. 
The $2,575,000 is equal to the amount Corporation W is obligated to 
pay if it terminated the plan on November 2, 2017 (25% x $2,000,000 
x 1/12 x 60 months of service ($2,500,000), plus a 3% reasonable 
rate of interest that the $2,500,000 earns after plan termination 
($75,000)). On January 7, 2020, when Employee D separates from 
service, Corporation D pays $3,583,333.33 (25% x $2,000,000 x 1/12 x 
86 months of service).
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee D is a 
covered employee for Corporation W's 2020 taxable year. Because, as 
of November 2, 2017, the plan is a written binding contract with 
respect to $2,575,000, this section does not apply (and Sec.  1.162-
27 does apply) to the deduction for the $2,575,000 portion of the 
$3,583,333.33 payment. Pursuant to Sec.  1.162-27(c)(2), Employee D 
is not a covered employee, so the deduction for the $2,575,000 
portion of the $3,583,333.33 payment is not subject to section 
162(m)(1). The deduction for the remaining $1,008,333.33 portion of 
the $3,583,333.33 payment is subject to this section (and not Sec.  
1.162-27).
    (xiv) Example 14 (Nonaccount balance plan with offset)--(A) 
Facts. The facts are the same as in paragraph (g)(3)(xiii) of this 
section (Example 13), except that the plan provides that the amount 
to be paid to an employee is decreased by the employee's account 
balance in Corporation W's 401(k) plan on the date of separation 
from service. The terms of the offset comply with section 409A. On 
November 2, 2017, and July 7, 2020, Employee D's account balance in 
the 401(k) plan is $500,000 and $600,000, respectively. Under 
applicable law, the NQDC plan constitutes a written binding contract 
in effect on November 2, 2017, to pay $2,075,000, which is equal to 
the amount of remuneration Corporation W is obligated to pay if it 
terminated the NQDC plan on November 2, 2017. The $2,075,000 is the 
difference between the $500,000 401(k) plan account balance on 
November 2, 2017, and the $2,500,000 accumulated benefit (25% x 
$2,000,000 x 1/12 x 60 months of service), plus the 3% interest that 
the $2,500,000 earns after plan termination ($75,000). On July 7, 
2020, under the terms of the NQDC plan, Corporation D pays 
$2,983,333.33 (the difference between the $600,000 401(k) account 
balance on July 7, 2020, and $3,583,333.33 (25% x $2,000,000 x 1/12 
x 86 months of service)).

[[Page 70389]]

    (B) Conclusion. If this Sec.  1.162-33 applies, Employee D is a 
covered employee for Corporation W's 2020 taxable year. Because, as 
of November 2, 2017, the plan is a written binding contract with 
respect to $2,075,000, this section does not apply (and Sec.  1.162-
27 does apply) to the deduction for $2,075,000 of the $2,983,333.33 
payment. Pursuant to Sec.  1.162-27(c)(2), Employee D is not a 
covered employee, so the deduction for the $2,075,000 portion of the 
$2,983,333.33 payment is not subject to section 162(m)(1). The 
deduction for the remaining $908,333.33 portion of the $2,983,333.33 
payment is subject to this section (and not Sec.  1.162-27).
    (xv) Example 15 (Nonaccount balance plan)--(A) Facts. The facts 
are the same as in paragraph (g)(3)(xiii) of this section (Example 
13), except that the nonaccount balance plan provides that 
Corporation W will pay Employee D a lump sum payment of $5,000,000 
on November 7, 2020, if Employee D provides services from January 1, 
2016, through June 30, 2017. Under applicable law, the plan 
constitutes a written binding contract in effect on November 2, 
2017, to pay $4,712,979.55, which is the sum of $4,575,708.30 (the 
amount of remuneration Corporation W is obligated to pay if it 
reduced the amount of future benefits to $0 on November 2, 2017) and 
the increase in present value of $137,271.55 (the difference between 
$4,575,708.30 and $4,712,979.55 (the present value of $5,000,000 on 
November 2, 2018)). On November 7, 2020, Corporation W makes a lump 
sum payment of $5,000,000 to Employee D.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee D is a 
covered employee for Corporation W's 2020 taxable year. Because, as 
of November 2, 2017, the plan is a written binding contract with 
respect to $4,712,979.55, this section does not apply (and Sec.  
1.162-27 does apply) to the deduction for the $4,712,979.55 portion 
of the $5,000,000 payment. Pursuant to Sec.  1.162-27(c)(2), 
Employee D is not a covered employee, so the deduction for the 
$4,712,979.55 portion of the $5,000,000 payment is not subject to 
section 162(m)(1). The deduction for the remaining $287,020.45 
portion of the $5,000,000 payment is subject to this section (and 
not Sec.  1.162-27).
    (xvi) Example 16 (Performance bonus plan with negative 
discretion)--(A) Facts. Employee E serves as the PEO of Corporation 
V for the 2017 and 2018 taxable years. On February 1, 2017, 
Corporation V establishes a bonus plan, under which Employee E will 
receive a cash bonus of $1,500,000 if a specified performance goal 
is satisfied. The compensation committee retains the right, if the 
performance goal is met, to reduce the bonus payment to no less than 
$400,000 if, in its judgment, other subjective factors warrant a 
reduction. On November 2, 2017, under applicable law which takes 
into account the employer's ability to exercise negative discretion, 
the bonus plan established on February 1, 2017, constitutes a 
written binding contract to pay $400,000. On March 1, 2018, the 
compensation committee certifies that the performance goal was 
satisfied, but exercises its discretion to reduce the award to 
$500,000. On April 1, 2018, Corporation V pays $500,000 to Employee 
E. The payment satisfies the requirements of Sec.  1.162-27(e)(2) 
through (5) as qualified performance-based compensation.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee E is a 
covered employee for Corporation V's 2018 taxable year. Because the 
February 1, 2017, plan is a written binding contract to pay Employee 
E $400,000 if the performance goal is satisfied, this section does 
not apply (and Sec.  1.162-27 does apply) to the deduction for the 
$400,000 portion of the $500,000 payment. Furthermore, the failure 
of the compensation committee to exercise its discretion to reduce 
the award further to $400,000, instead of $500,000, does not result 
in a material modification of the contract. Pursuant to Sec.  1.162-
27(e)(1), the deduction for the $400,000 payment is not subject to 
section 162(m)(1) because the payment satisfies the requirements of 
Sec.  1.162-27(e)(2) through (5) as qualified performance-based 
compensation. The deduction for the remaining $100,000 of the 
$500,000 payment is subject to this section (and not Sec.  1.162-27) 
and therefore the status as qualified performance-based compensation 
is irrelevant to the application of section 162(m)(1) to this 
remaining portion.
    (xvii) Example 17 (Account balance plan)--(A) Facts. Employee F 
serves as the PFO of Corporation U for the 2016 through 2018 taxable 
years. On January 4, 2016, Corporation U and Employee F enter into a 
NQDC arrangement that is an account balance plan. Under the terms of 
the plan, Corporation A will pay Employee X's account balance on 
June 30, 2019, but only if Employee F continues to serve as the PFO 
through December 31, 2018. Pursuant to the terms of the plan, 
Corporation U credits $100,000 to Employee F's account annually on 
December 31 of each year for three years beginning on December 31, 
2016, and credits earnings and losses on the account balance daily. 
The plan also provides that Corporation U may, in its discretion and 
at any time, amend the plan either to stop or to reduce the amount 
of future credits; however, Corporation U may not reduce Employee 
F's account balance credited before the date of any such amendment. 
Under the terms of the plan and in accordance with Sec.  1.409A-
3(j)(4)(ix)(C)(3), if Corporation U terminates the plan, the payment 
under the plan may be accelerated, but may not be made within 12 
months of the date of termination. Under the plan terms and 
applicable law, if Corporation U terminates the plan, then it is 
obligated to pay any earnings that accumulated through the date of 
payment. Under applicable law, the plan constitutes a written 
binding contract in effect on November 2, 2017, to pay $100,000 of 
remuneration that Corporation U credited to the account balance on 
December 31, 2016, plus any earnings credited on that amount through 
November 2, 2018, which is equal to the amount Corporation U is 
obligated to pay if it terminates the plan on November 2, 2017 
(i.e., after that date, Corporation U is obligated to credit 
earnings but not any further contributions). On November 2, 2017, 
Employee E's account balance under the plan is $110,000. On November 
2, 2018, Employee E's account balance under the plan would be 
$115,000 (the $110,000 account balance on November 2, 2017, plus 
$5,000 earnings on that amount). On June 30, 2019, Corporation U 
pays Employee F $350,000, the account balance on June 30, 2019.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee F is a 
covered employee for Corporation U's 2019 taxable year because 
Employee F served as the PFO of Corporation U during the taxable 
year. Because the January 4, 2016, agreement constitutes a written 
binding contract to pay $115,000, this section does not apply (and 
Sec.  1.162-27 does apply) to the deduction for the $115,000 portion 
of the $350,000. Pursuant to Sec.  1.162-27(c)(2), Employee F is not 
a covered employee of Corporation U for the 2019 taxable year, so 
the deduction for the $115,000 portion of the $350,000 is not 
subject to section 162(m)(1). The deduction for the remaining 
$235,000 portion of the payment is subject to this section (and not 
Sec.  1.162-27).
    (xviii) Example 18 (Effect of increasing credits to an account 
balance plan)--(A) Facts. The facts are the same as in paragraph 
(g)(3)(xvii) of this section (Example 17), except that on January 1, 
2018, Corporation U increased the amount it would credit to Employee 
F's account on December 31, 2018 to $200,000. The amount of the 
increase exceeds a reasonable, annual cost-of-living increase. On 
June 30, 2019, Corporation U pays Employee F the account balance of 
$455,000 (including earnings).
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee F is a 
covered employee for Corporation U's 2019 taxable year. The January 
1, 2018 increase in the amount credited to the account balance plan 
is a material modification of the plan because the additional 
compensation (the excess of $200,000 over $100,000) credited under 
the plan is credited on the basis of substantially the same elements 
or conditions as the compensation that would otherwise be credited 
pursuant to the plan ($100,000), and it exceeds a reasonable, annual 
cost-of-living increase. Because the plan is materially modified as 
of January 1, 2018, and all payments under the plan are made on or 
after January 1, 2018, the deduction for all payments under the plan 
is subject to this section (and not Sec.  1.162-27).
    (xix) Example 19 (Equity-based compensation with underlying 
grants made prior to November 2, 2017)--(A) Facts. On January 2, 
2017, Corporation T executed a 4-year employment agreement with 
Employee G to serve as its PEO, and Employee G serves as the PEO for 
the four-year term. Pursuant to the employment agreement, on January 
2, 2017, Corporation T executed a grant agreement and granted to 
Employee G nonqualified stock options to purchase 1,000 shares of 
Corporation T stock, stock appreciation rights (SARs) on 1,000 
shares, and 1,000 shares of Corporation T restricted stock. On the 
date of grant, the stock options had no readily ascertainable fair 
market value as defined in Sec.  1.83-7(b), and neither the stock 
options nor the SARs provided for a deferral of compensation under 
Sec. Sec.  1.409A-1(b)(5)(i)(A) and (B). The stock options,

[[Page 70390]]

SARs, and shares of restricted stock are subject to a substantial 
risk of forfeiture and all substantially vest on January 2, 2020. 
Employee G may exercise the stock options and the SARs at any time 
from January 2, 2020, through January 2, 2027. On January 2, 2020, 
Employee G exercises the stock options and the SARs, and the 1,000 
shares of restricted stock become substantially vested (as defined 
in Sec.  1.83-3(b)). The grant agreement pursuant to which grants of 
the stock options, SARs, and shares of restricted stock are made 
constitutes a written binding contract under applicable law. The 
compensation attributable to the stock options and the SARs satisfy 
the requirements of Sec.  1.162-27(e)(2) through (5) as qualified 
performance-based compensation.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee G is a 
covered employee for Corporation T's 2020 taxable year. Because the 
January 2, 2017, grant agreement constitutes a written binding 
contract, this section does not apply (and Sec.  1.162-27 does 
apply) to the deduction for compensation received pursuant to the 
exercise of the stock options and the SARs, or the restricted stock 
becoming substantially vested (as defined in Sec.  1.83-3(b)). 
Pursuant to Sec.  1.162-27(e)(1), the deduction attributable to the 
stock options and the SARs is not subject to section 162(m)(1) 
because the compensation satisfies the requirements of Sec.  1.162-
27(e)(2) through (5) as qualified performance-based compensation. 
However, the deduction attributable to the restricted stock is 
subject to section 162(m)(1) because the compensation does not 
satisfy the requirements of Sec.  1.162-27(e)(2) through (5) as 
qualified performance-based compensation.
    (xx) Example 20 (Equity-based compensation with underlying 
grants made prior to November 2, 2017 for which vesting is 
accelerated)--(A) Facts. The facts are the same as in paragraph 
(g)(3)(xix) of this section (Example 19), except that, on December 
31, 2018, Corporation T modifies the grant agreement pursuant to 
which grants are made to provide that the stock options, SARs, and 
shares of Corporation T restricted stock are vested as of January 2, 
2019. On January 3, 2019, Employee G exercises the stock options and 
the SARs.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee G is a 
covered employee for Corporation T's 2019 taxable year. The 
modification of the January 2, 2017, grant agreement is not a 
material modification. Because the January 2, 2017, agreement under 
which grants were made constitutes a written binding contract, this 
section does not apply (and Sec.  1.162-27 does apply) to the 
deduction for compensation received pursuant to the exercise of the 
stock options and the SARs, or the restricted stock becoming vested. 
Pursuant to Sec.  1.162-27(e)(2)(iii)(B), the acceleration of 
substantial vesting of the stock options and SARs is not an 
impermissible increase in compensation to disqualify the 
compensation attributable to the stock options and SARs from 
satisfying the requirements of Sec.  1.162-27(e)(2) through (5) as 
qualified performance-based compensation, so the deduction 
attributable to the stock options and the SARs is not subject to 
section 162(m)(1). However, the deduction attributable to the 
restricted stock is subject to section 162(m)(1) because the 
compensation does not satisfy the requirements of Sec.  1.162-
27(e)(2) through (5) as qualified performance-based compensation.
    (xxi) Example 21 (Plan in which an employee is not a participant 
on November 2, 2017)--(A) Facts. On October 2, 2017, Employee H 
executes an employment agreement with Corporation Y to serve as its 
PFO, and commences employment with Corporation Y. The employment 
agreement, which is a written binding contract under applicable law, 
provides that if Employee H continues in his position through April 
1, 2018, Employee H will become eligible to participate in the NQDC 
plan of Corporation Y and that Employee H's benefit accumulated on 
that date will be $3,000,000. On April 1, 2021, Employee H receives 
a payment of $4,500,000 (the increase from $3,000,000 to $4,500,000 
is not a result of a material modification as defined in paragraph 
(g)(2) of this section), which is the entire benefit accumulated 
under the plan through the date of payment.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee H is a 
covered employee for Corporation Y's 2021 taxable year. Even though 
Employee H was not eligible to participate in the NQDC plan on 
November 2, 2017, Employee H had the right to participate in the 
plan under a written binding contract as of that date. Because the 
amount required to be paid pursuant to the written binding contract 
is $3,000,000, this section does not apply (and Sec.  1.162-27 does 
apply) to the deduction for the $3,000,000 portion of the 
$4,500,000. Pursuant to Sec.  1.162-27(c)(2), Employee H is not a 
covered employee of Corporation Y for the 2021 taxable year. 
Accordingly, the deduction for the $3,000,000 portion of the 
$4,500,000 is not subject to section 162(m)(1). The deduction for 
the remaining $1,500,000 portion of the payment is subject to this 
section (and not Sec.  1.162-27).
    (xxii) Example 22 (Material modification of annual salary)--(A) 
Facts. On January 2, 2017, Corporation R executed a 5-year 
employment agreement with Employee I to serve as Corporation R's 
PFO, providing for an annual salary of $1,800,000. The agreement 
constitutes a written binding contract under applicable law. In 2017 
and 2018, Employee I receives the salary of $1,800,000 per year. In 
2019, Corporation R increases Employee I's salary by $40,000, which 
is less than a reasonable cost-of-living increase from $1,800,000. 
On January 1, 2020, Corporation R increases Employee I's salary to 
$2,400,000. The $560,000 increase exceeds a reasonable, annual cost-
of-living increase from $1,840,000.
    (B) Conclusion ($1,840,000 Payment in 2019). If this Sec.  
1.162-33 applies, Employee I is a covered employee for Corporation 
R's 2018 through 2020 taxable years. Because the January 1, 2017, 
agreement is a written binding contract to pay Employee I an annual 
salary of $1,800,000, this section does not apply (and Sec.  1.162-
27 does apply) to the deduction for Employee I's annual salary 
unless the change in the employment agreement is a material 
modification. Pursuant to Sec.  1.162-27(c)(2), Employee I is not a 
covered employee of Corporation R for the 2019 taxable year, so the 
deduction for the $1,800,000 salary is not subject to section 
162(m)(1). Even though the $40,000 increase is made on the basis of 
substantially the same elements or conditions as the salary, the 
$40,000 increase does not constitute a material modification of the 
written binding contract because the $40,000 is less than or equal 
to a reasonable cost-of-living increase applied to the $1,800,000 
annual salary Corporation R owes under the agreement. However, the 
deduction for the $40,000 increase is subject to this section (and 
not Sec.  1.162-27).
    (C) Conclusion (Salary increase to $2,400,000 in 2020). The 
$560,000 increase in salary in 2020 is a material modification of 
the written binding contract because the additional compensation is 
paid on the basis of substantially the same elements or conditions 
as the salary, and it exceeds a reasonable, annual cost-of-living 
increase from $1,840,000. Because the written binding contract is 
materially modified as of January 1, 2020, the deduction for all 
salary paid to Employee I on and after January 1, 2020 is subject is 
subject to this section (and not Sec.  1.162-27).
    (xxiii) Example 23 (Additional payment not considered a material 
modification)--(A) Facts. The facts are the same as in paragraph 
(g)(3)(xxii) of this section (Example 22), except that instead of an 
increase in salary, in 2020 Employee I receives a restricted stock 
grant subject to Employee I's continued employment for the balance 
of the contract.
    (B) Conclusion. The restricted stock grant is not a material 
modification of the written binding contract because any additional 
compensation paid to Employee I under the grant is not paid on the 
basis of substantially the same elements and conditions as Employee 
I's salary. However, the deduction attributable to the restricted 
stock grant is subject to this section (and not Sec.  1.162-27).
    (xxiv) Example 24 (Modification of written binding contract to 
provide for accelerated vesting)--(A) Facts. Employee J serves as 
the PFO of Corporation Q for the 2017 through 2020 taxable years. On 
July 14, 2017, Corporation Q and Employee J enter into an agreement 
providing that Corporation Q will pay $2,000,000 to Employee J if 
Employee J continues to serve as the PFO until the third anniversary 
of the agreement (July 14, 2020). The agreement provides that 
Corporation Q will make the payment on the date Employee J meets the 
service requirement. The right to the $2,000,000 payment is subject 
to a substantial risk of forfeiture as defined in Sec.  1.409A-1(d). 
Under applicable law, the plan constitutes a written binding 
contract in effect on November 2, 2017, to pay $2,000,000 to 
Employee J if Employee J serves as the PFO through July 14, 2020. On 
November 29, 2019, Corporation Q modifies the written binding 
contract to provide for substantial vesting of the $2,000,000 on 
that date and pays the $2,000,000 to Employee J.
    (B) Conclusion. If this Sec.  1.162-33 applies, Employee J is a 
covered employee for Corporation Q's 2019 taxable year because

[[Page 70391]]

Employee J served as the PFO of Corporation Q during the taxable 
year. Because the July 14, 2017, agreement constitutes a written 
binding contract to pay $2,000,000, this section does not apply (and 
Sec.  1.162-27 does apply) to the deduction for the $2,000,000 
unless the contract is materially modified. Pursuant to Sec.  1.162-
27(c)(2), Employee J is not a covered employee of Corporation Q for 
the 2019 taxable year. The change in terms of the contract on 
November 29, 2019, to accelerate vesting but to otherwise pay the 
amounts under the original terms is not a material modification. 
Accordingly, the deduction for the $2,000,000 is not subject to 
section 162(m)(1).

    (h) Effective/Applicability dates--(1) Effective date. These 
regulations are effective on [DATE OF PUBLICATION OF THE FINAL RULE IN 
THE FEDERAL REGISTER].
    (2) Applicability dates--(i) General applicability date. Except as 
otherwise provided in paragraph (h)(2)(ii) of this section, these 
regulations apply to taxable years beginning on or after [DATE OF 
PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER].
    (ii) Special applicability dates--(A) Definition of covered 
employee. The definition of covered employee in paragraph (c)(2)(i) of 
this section applies to taxable years ending on or after September 10, 
2018. However, for a corporation whose fiscal year and taxable year do 
not end on the same date, the rule in paragraph (c)(2)(i)(B) requiring 
the determination of the three most highly compensated executive 
officers to be made pursuant to the rules under the Exchange Act 
applies to taxable years ending on or after December 20, 2019.
    (B) Definition of predecessor of a publicly held corporation--(1) 
Publicly held corporations that become privately held. The definition 
of predecessor of a publicly held corporation in paragraph 
(c)(2)(ii)(A) of this section applies to any publicly held corporation 
that becomes a privately held corporation for a taxable year beginning 
after December 31, 2017, and, subsequently, again becomes a publicly 
held corporation on or after [DATE OF PUBLICATION OF THE FINAL RULE IN 
THE FEDERAL REGISTER]. Accordingly, the definition of predecessor of a 
publicly held corporation in paragraph (c)(2)(ii)(A) of this section 
does not apply to any publicly held corporation that became a privately 
held corporation for a taxable year beginning before January 1, 2018, 
with respect to the earlier period as a publicly held corporation; or a 
publicly held corporation that becomes a privately held corporation for 
a taxable year beginning after December 31, 2017, and, subsequently, 
again becomes a publicly held corporation before [DATE OF PUBLICATION 
OF THE FINAL RULE IN THE FEDERAL REGISTER].
    (2) Corporate transactions. The definition of predecessor of a 
publicly held corporation in paragraphs (c)(2)(ii)(B) through (H) of 
this section applies to corporate transactions that occur (as provided 
in the transaction timing rule of paragraph (c)(2)(ii)(I) of this 
section) on or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE 
FEDERAL REGISTER].
    (C) Definition of compensation. The definition of compensation 
provided in paragraph (c)(3)(ii) of this section (relating to allocable 
shares of partnership deductions for compensation paid) applies to any 
deduction for compensation that is otherwise allowable for a taxable 
year ending on or after December 20, 2019. However, this definition of 
compensation does not apply to compensation paid pursuant to a written 
binding contract that is in effect on December 20, 2019 and that is not 
materially modified after that date. For purposes of this paragraph 
(h)(3), written binding contract and material modification have the 
same meanings as provided in paragraphs (g)(1) and (g)(2) of this 
section.
    (D) Corporations that become publicly held. The rule in paragraph 
(d) of this section (providing that the deduction limitation of 
paragraph (b) of this section applies to a deduction for any 
compensation that is otherwise deductible for the taxable year ending 
on or after the date that a privately held corporation becomes a 
publicly held corporation) applies to corporations that become publicly 
held on or after December 20, 2019. A privately held corporation that 
becomes a publicly held corporation before December 20, 2019 may rely 
on the transition rules provided in Sec.  1.162-27(f)(1) until the 
earliest of the events provided in Sec.  1.162-27(f)(2).
    (E) Transition rules. The transition rules in paragraphs (g)(1) and 
(2) of this section (providing that this section does not apply to 
remuneration payable under a written binding contract which was in 
effect on November 2, 2017, and which is not modified in any material 
respect on or after such date) apply to taxable years ending on or 
after September 10, 2018.
0
Par. 4. Section 1.338-1 is amended by revising paragraph (b)(2)(i) to 
read as follows:


Sec.  1.338-1  General principles, status of old target and new target.

* * * * *
    (b) * * *
    (2) * * *
    (i) The rules applicable to employee benefit plans (including those 
plans described in sections 79, 104, 105, 106, 125, 127, 129, 132, 137, 
and 220), qualified pension, profit-sharing, stock bonus and annuity 
plans (sections 401(a) and 403(a)), simplified employee pensions 
(section 408(k)), tax qualified stock option plans (sections 422 and 
423), welfare benefit funds (sections 419, 419A, 512(a)(3), and 4976), 
voluntary employee benefit associations (section 501(c)(9) and the 
regulations thereunder (26 CFR 1.501(c)(9)-1 through 1.501(c)(9)-8)) 
and certain excessive employee remuneration (section 162(m) and the 
regulations thereunder (26 CFR 1.162-27 and Sec.  1.162-31));
* * * * *

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2019-26116 Filed 12-16-19; 4:15 pm]
BILLING CODE 4830-01-P