IRS Proposes Regs Expanding 162(m) to Ten Employees

Back in 2021, the American Rescue Plan Act amended Section 162(m) to cover an additional five highest paid employees. The new requirement isn’t effective until 2027 but the IRS recently proposed regulations addressing some of the questions raised by it.  

A Bit of History

Did you know that when Section 162(m) was originally introduced into Congress, it was drafted to apply to all employees? That turned out to be too controversial and the bill was rejected. It was subsequently redrafted to apply to only the CEO, CFO, and the next top three highest paid officers (a maximum of five officers) and it is this version that was enacted into law in 1993.

Here’s another fun fact: the number of employees covered under Section 162(m) dropped to a maximum of four in 2007. At that time, a change in the SEC rules governing who is considered to be a named executive officer for proxy disclosure purposes inadvertently caused the CFO to no longer be covered under Section 162(m) (which references the proxy disclosure regulations for purposes of determining who is covered). 

In 2017, the Tax Cuts and Jobs Act rectified this gap by amending Section 162(m) to expressly stipulate that the CFO is a covered employee. But it did more than that. It also stipulated that anyone serving as CEO or CFO during the year is covered under 162(m) even if no longer serving at the end of the year and that former officers who would have been among the top three highest paid officers except for the fact that they terminated prior to the end of the year are also covered.

Lastly, the TCJA implemented the “once covered, always covered” rule: beginning with 2017, any employees covered under Section 162(m) remain covered for the duration of the time they receive compensation from the company, regardless of role or amount of compensation received.

Although we tend to think of Section 162(m) as covering the top five highest paid officers, as a result of the TCJA amendments, the number of officers covered under Section 162(m) can now be considerably more than five.

Section 162(m) and the American Rescue Plan Act of 2021

Under Section 9708 of the American Rescue Plan Act of 2021, the number of employees covered under Section 162(m) will increase by another five employees. These five additional covered employees don’t have to be officers. Up until the ARPA, anyone covered under Section 162(m) had to be an officer (or former officer). But this new group of five can be any employee.

The Proposed Rules

The proposed rules clarify a number of practical implementation questions related to determining the additional five covered employees. I describe the highlights of the proposal below.

The Five Newly Covered Employees: The additional five highest paid employees can include any common law employee of the company who was employed during the tax year, regardless of whether they are employed by the company on the last day of the tax year and, as noted above, regardless of whether they are officers.

Affiliated and Unaffiliated Companies: These additional five highest paid employees can include employees of affiliated companies (including foreign companies) and even employees of unaffiliated companies, such as a PEO, if substantially all the services the employees perform during the year are for the covered company. The rules here are complicated—consult your tax advisors if this could apply to your company.

Compensation: For purposes of determining which are the next five highest paid employees, “compensation” is defined as any compensation that would otherwise be deductible by the corporation. This differs from how the compensation of the first three highest paid officers is determined, which is based on their compensation disclosed in the Summary Compensation Table in the company’s proxy statement. It is helpful that the regs take a different approach because, as noted above, these five highest paid employees can include individuals who aren’t officers; using all otherwise deductible compensation saves the company from having to expand the number of employees included in the SCT calculations.

Once Covered, Always Covered: The additional five covered employees won’t be subject to the “once covered, always covered” rule. Thus, if their compensation in future years is not sufficient to place them among the highest paid employees, they will no longer be covered.

However, these additional five employees can include employees who are already covered under the “once covered, always covered” rule. Thus, it’s possible that this new requirement won’t impact some companies. If the next five highest paid employees are all already covered, the total covered employees won’t increase.

Effective Date

The rules will be effective for tax years beginning after the later of December 31, 2026, or the date of publication of the final rules in the Federal Register. 

More Information

For more information on this and other key developments to keep an eye on in 2025, be sure to check out the NASPP webinar “Need to Know Equity Compensation Developments for 2025.”