Maximizing Deductions in Light of the Section 162(m) Guidance - PowerPoint PPT Presentation

Maximizing Deductions in Light of the Section 162(m) Guidance September 6, 2018

Today’s Webinar Presenters Mike Melbinger Nyron Persaud Ruth Wimer Employee Benefits and Employee Benefits and Employee Benefits and Executive Compensation Executive Compensation Executive Compensation Chicago New York Washington, DC mmelbinger@winston.com npersaud@winston.com rwimer@winston.com 2

Agenda: Brief overview of the changes in Section 162(m) as a • result of the Tax Act In depth discussion and analysis of Notice 2018-68: • Covered employee • Written binding contract • Material modification • “To do” list for maximizing deductions going forward • Alternative compensation strategies • Proxy Statement Reporting and Accounting issues • 3

Brief Overview of the Changes in Section 162(m) as a result of the Tax Act

Section 162(m) – Changes under Tax Act 1. Elimination of the Exclusion for Performance-Based Compensation: • The Tax Act eliminates the performance-based compensation exception from Section 162(m) (as well as the lesser utilized commission-based compensation exception). 2. More Companies Subject to Section 162(m): • The Tax Act extends Section 162(m)’s $1 million limit on deductible compensation to any corporation that files SEC reports. 5

Section 162(m) – Changes under Tax Act 3. Section 162(m) Now Applies to the CFO. 4. Once a Covered Employee, Always a Covered Employee – Tax Act amends Section 162(m) to provide that any individual who is treated as a “covered employee” under the new rules as described below for any taxable year beginning after December 31, 2016 , would continue to be considered a “covered employee” with respect to that company so long as the company continues to provide any remuneration to such individual a) Previously, Code Section 162(m) only applied to individuals who were named executive officers (other than the CFO) at the end of the year in which the tax deduction was claimed b) In 2018 and after, the payment of deferred compensation or an exercise of non-qualified stock options (for example) after an NEO retires (or otherwise terminates employment) would remain subject to the $1 million deductibility limit c) The cap even applies to payment made to a covered employee’s beneficiary after the covered employee’s death 6

Notice 2018-68 • In August 2018, the IRS released Notice 2018-68, its much-anticipated guidance on the circumstances under which certain compensation amounts and payments promised or awarded by a company on or before November 2, 2017, but paid in 2018 or later, could be grandfathered and not subject to the compensation deductibility limits of Code Sec.162(m). • Most of the guidance in Notice 2018-68 is a straightforward interpretation of the new statutory provisions. With respect to the grandfather rule, however, the Notice is more restrictive than we had expected. The Treasury Department and IRS anticipate that further guidance on the amendments made by the Tax Act will be issued in the form of proposed regulations which will also incorporate the guidance provided in the Notice. The Notice explains that eventual proposed regulations will follow the Notice for years ending after September 10, 2018, although any rules that are even harsher with respect to the definition of covered employee or written binding contract will apply prospectively only. • The Notice principally addresses the following three key issues: • Who is a covered employee? • What is a written binding contract? • What is a material modification? 7

In Depth Discussion and Analysis of Notice 2018-68: Covered Employee, Written Binding Contract, Material Modification

Notice 2018-68 - Who is a Covered Employee? • Covered Employee Definition: • Any individual serving as principal executive officer (“PEO” or “CEO”) • After 2017, any individual serving as principal financial officer (“PFO” or “CFO”) • The next 3 highest compensated executive officers (other than the CEO and CFO), whose total compensation for the taxable year is “required” to be reported to stockholders in the proxy statement under the Securities Exchange Act of 1934 • Actual disclosure requirement disregarded for purposes of this determination • No requirement that an employee must have served as an executive officer at the end of the taxable year to be considered a covered employee 9

Old vs. New Section 162(m) Old Rule New Rule Any individual serving as CEO or in a Any individual serving as CEO or in a similar capacity similar capacity Any individual whose compensation is Any individual serving as CFO or in a required to be reported in the Summary similar capacity Compensation Table by reason of being among the 4 highest compensated officers (other than the CEO) Notice 2007-49 clarified that CFO is Among the 3 highest compensated excluded and only 3 highest executive officers (other than CEO and compensated officers included CFO) 10

New Section 162(m) vs. SEC Rule New Rule SEC Rule Any individual serving as CEO or in a Any individual serving as CEO or in a similar capacity similar capacity Any individual serving as CFO or in a Any individual serving as CFO or in a similar capacity similar capacity Among the 3 highest compensated Among the 3 highest compensated executive officers (other than CEO and executive officers (other than CEO and CFO) CFO) who were serving as executive officers at the end of the last completed fiscal year Up to 2 additional individuals who would have been among the 3 highest compensated executive officers but for the fact that the individual was not serving as an executive officer at the end of the last completed fiscal year 11

Once a Covered Employee, Always a Covered Employee • Old Section 162(m): • Covered employee status discontinued once the individual no longer met the definition. • New Section 162(m): • Covered employee status is now permanent, during both employment and thereafter. • Covered employee does not stop, even at the employee’s death. Payments made to a beneficiary of a deceased covered employee are considered as made to the covered employee and subject to $1 million deduction limitation. • Example: A CEO retires in 2021, with vested stock options that were granted in 2018, and a non-qualified deferred compensation plan account of $5,000,000, payable in equal installments over five years. The former CEO dies in 2022, before exercising any of the vested options and after receiving one installment payment from his plan account. In 2023, the beneficiaries of the former CEO exercise the vested options for a $1,500,000 gain and the deferred compensation plan distributed $4,000,000 (the deferred compensation plan provides that a participant’s accounts will be paid out in full upon the participant’s death). If the former CEO receives no other payments from the company in 2023, $1,000,000 of the $5,500,000 “payout” made on behalf of the former CEO will be deductible and the remaining $4,500,000 will not be deductible by the company. 12

Notice 2018-68 - No End of Year Employment Requirement • Example: For 2018, Employee A served as the sole CEO of a publicly held company and Employees B and C both served as the CFO of the company at different times during the year. Employees D, E, and F were, respectively, the first, second, and third most highly compensated executive officers of the company for 2018 (other than the CEO and CFO), but all three retired before the end of 2018. Employees G, H, and I were, respectively, the company’s fourth, fifth, and sixth highest compensated executive officers (other than the CEO and CFO) for 2018, and all three were serving at the end of 2018. In April 2019, the company filed its annual proxy statement and disclosed the compensation of Employee A for serving as the CEO, Employees B and C for serving as the CFO, and Employees G, H, and I pursuant to Item 402(a)(3)(iii) of Regulation S-K. The company also disclosed the compensation of Employees D and E pursuant to Item 402(a)(3)(iv). • Because Employee A served as the CEO during 2018, Employee A is a covered employee for 2018. Because Employees B and C each served as the CFO during 2018, Employees B and C are covered employees for 2018. • Even though the SEC rules require the company to disclose the compensation of Employees D, E, G, H, and I for 2018, the company’s covered employees for 2018 under Sec. 162(m) include Employees D, E, and F, because they are the three highest compensated executive officers other than the CEO and CFO for 2018, even though they were not employed on the last day of the year. 13

In Depth Discussion and Analysis of Notice 2018-68: Covered Employee, Written Binding Contract, Material Modification

Compensation Under a Written Binding Contract in Effect on November 2, 2017 • Most public companies have entered into employment agreements with their senior executive officers. Some companies may have entered into change in control agreements or severance agreements instead of or in addition to the employment agreements. • The interpretation of amounts paid under a written binding contract under the TCJA’s transition rule is unexpectedly harsh. • The grandfather rule allows deductibility for applicable employee remuneration paid to a covered employee under a written binding contract in effect on November 2, 2017, which is not materially modified after that date. • The Notice provides helpful examples of payments that may or may not be grandfathered, depending on the particular facts. 15