Sec. 162(m)(5) Implications for TARP Recipients

By Melissa Reinbold, CPA, Trudie Duan, CPA, and Chan-Yu Wang, CPA, Oak Brook, IL

Editor: Frank J. O’Connell Jr., CPA, Esq.

Section 302(a) of the Emergency Economic Stabilization Act of 2008, P.L. 110-343 (EESA), created Sec. 162(m)(5) to impose strict limitations on the deductibility of certain executive remuneration. Section 111 of EESA, as amended by Section 7001 of the American Recovery and Reinvestment Act of 2009, P.L. 111-5 (ARRA), imposed these restrictions on entities that sell assets to Treasury under the Troubled Assets Relief Program (TARP). In addition, entities that had received such assistance prior to the February 17, 2009, effective date of ARRA had contractually obligated themselves to follow the rules of Sec. 162(m)(5) (Department of Treasury, October Interim Final Rule, 73 Fed. Reg. 62205 (10/20/08)). The restrictions of Sec. 162(m)(5) apply for any tax year during which any obligation arising from the receipt of financial assistance under TARP is outstanding. Due to the complexity of Sec. 162(m)(5), understanding the proper application of these rules is important. This item highlights the differences between Sec. 162(m)(5) and Sec. 162(m) as it existed before EESA and demonstrates the application of Sec. 162(m)(5).

Comparison of Secs. 162(m) and 162(m)(5)

Sec. 162(m) limits the deductibility of certain officer compensation in excess of $1 million. It exempts from its limitations certain types of compensation, most importantly compensation meeting certain performance-based criteria. Sec. 162(m) (5) limits executive compensation deductibility to $500,000 and has no exceptions for the types of compensation exempted by Sec. 162(m). Sec. 162(m) applies only to publicly held corporations, while Sec. 162(m)(5) applies to all companies, public and private, that received or will receive TARP financial assistance, including partnerships and S corporations. One key difference between Secs. 162(m) and 162(m)(5) is that the $500,000 executive compensation limitation will apply to all compensation earned in the current year, including amounts paid in a later year, while Sec. 162(m) applies only to compensation otherwise deductible during the current year. Another difference between the two provisions is the executives to whom the compensation limitations apply. Publicly held TARP recipients should analyze the applicability of both Sec. 162(m) and Sec. 162(m)(5). Non–publicly held TARP recipients need only consider Sec. 162(m)(5). The exhibit illustrates various differences between Secs. 162(m) and 162(m)(5).

General Limitation on Executive Remuneration

Shortly after the enactment of EESA, the IRS issued Notice 2008-94 to provide guidance on issues arising from new tax provisions added by EESA, including Sec. 162(m)(5). In addition to clarifying issues concerning when an employer is an applicable employer and who is a covered executive under Sec. 162(m)(5), the notice includes multiple examples of how the remuneration limitation applies.

Example 1: X Corp. receives TARP assistance on January 1, 2009, and remains under TARP until December 31, 2013. Employee A is a covered executive and earns $600,000 of base salary during 2009. Only $500,000 of A’s compensation is deductible; $100,000 is not deductible due to Sec. 162(m)(5).

General Deferred Deduction Executive Remuneration

Per Notice 2008-94, deferred executive remuneration allocable to services performed in a TARP year may not be deducted when paid in a later year to the extent that the $500,000 deduction limit for services performed in the earlier year has already been met.

Example 2: Assume the same facts as in Example 1, except that A earns $400,000 in salary during 2009 and obtains a legally binding right (as defined below) on January 1, 2009, to receive a payment of $250,000, which will not be paid until December 31, 2010. A’s $400,000 compensation is deductible in 2009. In 2010, X’s deduction related to the $250,000 payment is limited to $100,000, which represents the unused portion of the $500,000 limit from 2009.

To What Year Is Deferred Deduction Executive Remuneration Allocable?

Notice 2008-94 further explains how deferred deduction executive remuneration is allocated to the year earned. The notice states that if an executive obtains a legally binding right to remuneration in a specific year of service under a plan or agreement, the benefits payable under that plan are allocated to that period. If the deferred deduction executive remuneration is not allocable to services performed in a specific tax year according to the plan, then the remuneration generally is for services performed during the tax year in which the covered executive obtains a legally binding right to the remuneration.

A legally binding right to remuneration exists to the extent that compensation may not be reduced unilaterally or eliminated once the executive has performed the services creating the right. If the facts and circumstances indicate that any discretion to eliminate or reduce the compensation lacks substantive significance or is contingent on a condition, the employee will still have a legally binding right to the remuneration. If the employee’s right to remuneration is subject to substantial risk of forfeiture that requires the employee to continue performing services, the remuneration is allocated on a pro-rata basis over the period of time that the employee is required to continue to perform services. A substantial risk of forfeiture related to any condition other than the continuing performance of services is disregarded for these purposes.

Example 3: Assume the same facts as in Example 2, except that A is required to be employed on the date of the $250,000 payment. A earns $450,000 base salary in 2010. The $250,000 deferred remuneration is considered earned over two years (from January 1, 2009, to December 31, 2010), a pro-rata portion of which is allocated to each tax year, $125,000 in 2009 and $125,000 in 2010. In 2009, A’s $400,000 compensation is deductible. In 2010, X’s deduction related to the 2009 portion of deferred remuneration ($125,000) is limited to $100,000, which represents the unused portion of the $500,000 limit from 2009. Also in 2010, A’s $450,000 compensation is deductible, but the deferred remuneration related to the 2010 services is limited to $50,000.

Example 4: Assume the same facts as in Example 2, except that A will be paid the $250,000 deferred remuneration in the event that an asset is sold by a specific date in 2011 without regard to continued employment. The risk of forfeiture is disregarded, and the entire $250,000 payment is considered to be for services performed in 2009. The $250,000 payment made in 2011 is deferred deduction executive remuneration allocable to 2009 and is subject to the remaining $100,000 2009 limitation.

Example 5: Assume the same facts as in Example 1, except that on December 31, 2009, A obtains a legally binding right (a nonqualified stock option) to acquire stock with an exercise price equal to the fair market value of the stock on December 31, 2009 (without any requirement of continued employment in order to be able to exercise the right and retain the shares). A exercises the stock option in 2010 and recognizes income of $150,000 in connection with that exercise. The remuneration resulting from exercise of the stock option is for services performed in 2009 and is not deductible because 2009’s entire $500,000 limitation was fully utilized by 2009 base pay in excess of $500,000.

Growth in Deferred Executive Remuneration

Per Notice 2008-94, amounts attributable to growth in deferred compensation over the passage of time, such as interest or return on investment, are subject to the Sec. 162(m)(5) limitation. This creates an additional tracking requirement for future years.

Example 6: Assume the same facts as in Example 1, except that A defers $400,000 of his $600,000 base salary into X’s nonqualified deferred compensation plan, which earns $20,000 interest income during 2009 and $25,000 during 2010. A’s $600,000 salary and $45,000 interest income are all earned in 2009 and must share the same $500,000 deduction limitation even though all but $200,000 is paid out in a future year. Only the first $300,000 of the deferred salary and interest earnings thereon will be deductible regardless of when paid.

Example 7: Assume the same facts as in Example 1, except that A earns $400,000 in total base salary, and X had established a nonqualified supplemental executive retirement plan (SERP) for A’s deferred executive remuneration. Under the terms of the plan, A will become fully vested in his SERP on December 31, 2011, and will be paid a certain amount per year commencing upon retirement and continuing for the next 15 years.

To be fully vested in the SERP, A must meet certain service requirements. A portion of the service requirements had been met prior to X’s participating in TARP. In 2009, the full amount of A’s $400,000 salary is deductible. While there is no deduction in 2009 for the SERP, in future years when SERP payouts occur, deductibility of SERP benefits earned during 2009, 2010, and 2011 (including subsequent earnings thereon) may be limited. To determine the amounts earned in each year, an actuarial schedule may be necessary. If the amount of SERP benefit determined to have been earned in 2009 (even though paid later) is greater than the remaining $100,000 limitation, it will not be deductible. Similar limitations would apply for 2010 and 2011 because the TARP obligation is still outstanding.


The more stringent limitations on executive remuneration set forth in Sec. 162(m)(5) bring new challenges and complexity in their application. Companies receiving TARP financial assistance will need to be diligent both in identifying the years over which affected executives’ compensation is “earned” and in tracking that compensation to its ultimate year of potential deductibility. Due to the nature of deferred compensation, the effects of TARP may be with a company long after the assistance is repaid to the government.


Frank O’Connell Jr. is a partner in Crowe Horwath LLP in Oak Brook, IL.

Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.

For additional information about these items, contact Mr. O’Connell at (630) 574-1619 or

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