The tax bill passed by Congress will affect the tax deductibility of certain executive compensation for US public companies.
Currently, compensation above $1 million for most of a company’s proxy Named Executive Officers (NEOs) is deductible if it’s considered “performance based” under the terms of Section 162(m) of the tax code. Most companies have been able to qualify compensation above the $1 million threshold as performance based through annual and performance-vesting long-term incentives.
Once the tax bill goes into effect, however, no compensation above $1 million for the NEOs will be deductible. This applies to stock options and other types of compensation and will even apply to company CFOs, whose compensation was previously excluded under Section 162(m).
The new bill includes a ‘once covered, always covered’ rule, meaning once an employee becomes an NEO, their compensation from that company will be subject to the deductibility limit in perpetuity, including their post-retirement payments.
The millions of dollars companies will lose in deductions for NEO compensation will be offset somewhat by a lower federal corporate tax rate. Companies will have more flexibility in designing incentive awards and will be able to treat all forms of executive pay consistently for tax deduction purposes. But they should still ensure that executive pay is aligned with the company’s performance and balanced with the interests of shareholders and other stakeholders in the organization.