Prop. regs. address expanded annual compensation deduction limitation

The IRS issued proposed regulations (REG-118988-22) providing guidance on Sec. 162(m)(3)(C), added by the American Rescue Plan Act of 2021 (ARPA), P.L. 117-2, that expands the Sec. 162(m) annual deduction limitation for employees paid over $1 million to additional employees.

Sec. 162(m)(3)(C) expanded the definition of covered employee for tax years beginning after Dec. 31, 2026, to include any employee among the five highest-compensated employees for the tax year other than the principal executive officer (PEO) or the principal financial officer (PFO) or the three highest-compensated executive officers for the tax year.

The proposed regulations would provide that, for purposes of determining whether under new Sec. 162(m)(3)(C) an employee is one of the five highest-compensated employees, the term “employee” means an “employee” as defined in Sec. 3401(c), which includes a common law employee and an officer of a corporation. The proposed regulations would define compensation as compensation that would (but for Sec. 162(m)) be allowable as a deduction.

The proposed regulations also provide rules for determining who qualifies as one of the five highest-compensated employees of a publicly held corporation where the corporation is a member of an affiliated group.

Application date and comments

The regulations generally are proposed to apply to compensation that is otherwise deductible for tax years beginning after either the later of Dec. 31, 2026, or the date of publication of the proposed regulations as final regulations in the Federal Register, whichever is later.

Comments are due by March 17.

AICPA advocacy

In a letter to Treasury and the IRS, dated Aug. 29, 2022, the AICPA sought clarification by January 2025 on how companies should determine the additional five employees under Sec. 162(m).

— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.