United States: Guidance On Section 162(m) Modifications—A Not So Benevolent Grandfather And Details About Covered Employees Are Uncovered

Last Updated: September 11 2018
Article by Debra B. Hoffman

Long-awaited guidance on Section 162(m) of the Internal Revenue Code (the "Code"), has finally arrived. On August 21, 2018, the IRS issued Notice 2018-68, which provides guidance on certain changes made to Section 162(m) by the Tax Cuts and Jobs Act (the "Act"). The guidance is limited to (a) the identification of covered employees and (b) the so-called "Grandfather Rule." The Notice does not address all of the issues raised by the Act's changes to Section 162(m) and it makes clear that the Grandfather Rule will be narrowly interpreted. The guidance is effective for tax years ending on or after September 10, 2018 and will be incorporated into future regulations. The material provisions of the guidance are summarized below.

Identification of Covered Employees

Under Section 162(m), as amended by the Act, a "covered employee" means a public corporation's (1) principal executive officer (PEO), (2) principal financial officer (PFO), and (3) three highest paid officers (other than the PEO and PFO) whose compensation for the tax year is required to be reported in the company's proxy under the securities laws (or whose compensation would be required to be reported if the company was required to file a proxy for such year). If a person is a covered employee for any tax year beginning after December 31, 2016, the person will remain a covered employee for all future tax years. This is a departure from the requirements of Section 162(m) prior to the amendments, where the status of a person as a covered employee for any tax year was based only on his or her status on the last day of such tax year.

The Notice confirms the following points relating to the identification of covered employees:

  • Covered employees for tax years beginning prior to January 1, 2018 are to be determined under the provisions of Section 162(m) as in effect prior to the Act. Covered employees determined under the pre-Act provisions of Section 162(m) for the 2017 tax year will be considered covered employees for all future tax years.
  • No end of year requirement applies for purposes of determining whether an employee is a covered employee for such year under Section 162(m) as amended by the Act. For example, an individual who serves as the PEO for a brief period during a tax year, but who is no longer the PEO at the end of the tax year, will still be considered a covered employee for that year and all future years.
  • Officers of public corporations can be covered employees even when disclosure of their compensation is not required under the securities rules—such as when a proxy is not required. The compensation to be used for determining the three most highly compensated officers is to be determined consistent with the securities rules.
  • If an employee becomes a covered employee solely as a result of the amendment of Section 162(m) by the Act (as is the case with PFOs), payments made to such individual pursuant to a written binding contract in effect on November 2, 2017 will not be subject to Section 162(m), subject to the modification rules described below. All payments under the written binding contract are covered by this rule, whether or not they were intended to be performance-based compensation under Section 162(m) as in effect prior to the changes made by the Act.

Grandfather Rule

The Act provides that compensation paid pursuant to a written binding contract that was in effect on November 2, 2017 and that is not materially modified in any material respect on or after such date will be "grandfathered" and will continue to be analyzed for purposes of Section 162(m) pursuant to the rules that were in effect prior to the changes made by the Act (the "Grandfather Rule"). In particular, prior to the Act, compensation that satisfied the requirements for "performance-based compensation" was excluded in determining whether a covered employee's compensation exceeded the applicable $1,000,000 deduction limit (the "performance-based compensation exception"). The Act eliminated the performance-based compensation exception for any compensation payable beginning with the 2018 tax year. However, compensation that continues to satisfy the performance-based compensation exception as in effect prior to the Act and that is paid pursuant to a written binding contract that satisfies the Grandfather Rule will continue to be fully deductible (subject to the modification rules described below).

There has been a significant amount of uncertainty regarding the application of the Grandfather Rule, particularly with respect to what constitutes a "written binding contract" and a "material modification." Although the new guidance does not completely clarify these matters, it sheds light on the following issues:

  • Compensation is payable under a written binding contract in effect on November 2, 2017 only to the extent that the company is obligated under applicable law (emphasis added) to pay the compensation under the contract if the employee performs the services or satisfies the applicable vesting conditions.

    • Most incentive plans (for example, annual bonus plans) that were designed to comply with the performance-based compensation exception authorize an administering committee, in its discretion, to reduce (but not increase) the amount of compensation payable under the plan. In particular, negative discretion was a key component of "umbrella" plans pursuant to which a large pool was established based on the satisfaction of established performance targets and the pool was "allocated" among executives. In actual practice, however, actual compensation was paid based on satisfaction of underlying targets (usually different from the targets used to determine the size of the pool) that were more indicative of the performance of the company's business performance and the amount of compensation actually payable to an executive was significantly lower than the allocated portion of the pool (that is, the allocated portion of the pool was reduced to match the underlying targets and compensation limitations). Frequently, the amount payable pursuant to the underlying targets was also subject to further discretionary reduction. Under the new guidance, whether such plans will fit within the Grandfather Rule will depend on the type and level of discretion reserved as well as the application of state laws to the payments under the plan. In any event, all plans, including in particular umbrella plans will need to be carefully analyzed to determine whether and to what extent the compensation payable thereunder can fit within the Grandfather Rule.
  • A written binding contract that was in effect on November 2, 2017 and that is materially modified on or after that date is taken out of the Grandfather Rule as of the date of the material modification. Any amounts payable under the contract prior to the date of the material modification are covered by the Grandfather Rule and the contract, as modified, is treated as a new contract as of the date of the material modification.
  • Material modifications include:

    • Compensation Increases. An amendment to a contract to increase the compensation payable under the contract is a material modification. Similarly, a supplemental agreement that provides for increased compensation is treated as an amendment of the original contract if the facts demonstrate that the compensation under the supplemental agreement is paid on substantially the same conditions as the compensation under the original contract. Supplemental payments consisting of reasonable cost of living increases from the prior year are not considered a material modification.
    • Payment Acceleration and Deferral. An amendment to accelerate payment is a material modification unless the payment is discounted to present value. An amendment to defer payment is a material modification unless earnings on the deferred amount are based either on (a) a reasonable interest rate or (b) a pre-determined actual investment subject to gains and losses.
    • Renewal. The renewal of an existing contract is a material modification.

      • A contract that is terminable or cancelable by the company without the employee's consent after November 2, 2017 is treated as renewed as of the date that the termination or cancellation, if made, would be effective. For example, if a contract provides that it will be automatically renewed as of a certain date unless one party provides notice of termination within a specified period prior to such date, the contract is treated as renewed as of the date that the contract would have terminated had notice been given.
      • If the terms of a contract provide that it will terminate as of a certain date unless either party elects to renew the contract, the contract is treated as modified as of the date that it is renewed.
      • It appears that a contract that permits the employer to terminate the contract unilaterally will be treated as "renewed" as of the first day that termination could have occurred and been effective. This may significantly impact the status of deferred compensation plans, SERPs and long-term incentive plans.
      • Exception: A contract is not treated as terminable or cancelable if it can be terminated or canceled only by terminating an employee's employment. Similarly, a contract is not treated as renewed if, upon termination of the contract, the employee continues in employment. However, any compensation payable after termination of the contract would not be covered by the Grandfather Rule.

What to Do Now

Companies subject to Section 162(m) should consider several action items in light of the guidance:

  • Regularly update (or start keeping) a list of covered employees, which will be needed for future years.
  • Inventory and analyze existing contracts (including plan documents and employment agreements) to determine whether and to what extent payments thereunder can come within the Grandfather Rule. This may entail computing the value of benefits under certain plans (such as SERPs) as of November 2, 2017, which may raise recordkeeping complexities.
  • Determine whether any plans contain provisions that delay payment until the date on which the compensation would be deductible under Section 162(m), and discuss with your advisors how such provisions should be administered given the changes to Section 162(m).
  • Determine whether and to what extent preserving deductions is a priority to the company, and whether it makes sense to preserve any grandfathering that may be available given any associated uncertainty and complexity.

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2018. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions