Maximizing Deductions in Light of the Section 162(m) Guidance September 6, 2018
Today s Webinar Presenters Mike Melbinger Employee Benefits and Executive Compensation Chicago mmelbinger@winston.com Nyron Persaud Employee Benefits and Executive Compensation New York npersaud@winston.com Ruth Wimer Employee Benefits and Executive Compensation Washington, DC 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 Any individual serving as CEO or in a similar capacity Any individual whose compensation is required to be reported in the Summary Compensation Table by reason of being among the 4 highest compensated officers (other than the CEO) New Rule Any individual serving as CEO or in a similar capacity Any individual serving as CFO or in a similar capacity Notice 2007-49 clarified that CFO is excluded and only 3 highest compensated officers included Among the 3 highest compensated executive officers (other than CEO and CFO) 10
New Section 162(m) vs. SEC Rule New Rule Any individual serving as CEO or in a similar capacity Any individual serving as CFO or in a similar capacity Among the 3 highest compensated executive officers (other than CEO and CFO) SEC Rule Any individual serving as CEO or in a similar capacity Any individual serving as CFO or in a similar capacity Among the 3 highest compensated executive officers (other than CEO and 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
Enforceability Under Applicable Law A contract must obligate the company under applicable law (e.g., state contract law) to pay compensation if the employee performs the requisite services and otherwise satisfies the conditions set forth in the agreement, such that the employee can seek to enforce the payment obligation. The Notice does not limit applicable law for this purpose solely to state law. The obligation will be considered binding solely to the extent of the amount stated in the contract. Any payment in excess of the amount the company is legally obligated to pay (other than due to the application of a reasonable interest rate or investment returns), would not be grandfathered. The legal determination of whether an arrangement is a written binding contract and how long the contract remains in effect, is crucial to the grandfather rule. Counsel should assist public company clients in determining whether their November 2, 2017 compensation arrangements, including both individual agreements and broader based plans, qualify as written binding contracts. This analysis would require identification of the applicable state and local law, as well as Federal statutory and common law. 16
Contractual Promise of Future Participation While the legally binding written contract must have been in effect as of November 2, 2017, the employee did not have to be eligible to participate in the arrangement or plan as of that date. However, the covered employee must have been employed by the company, or otherwise had a legally binding right to later participation in the arrangement, as of November 2, 2017. Example: In January 2015, an individual who is not a covered-employee executes a deferred compensation agreement providing for a payment of $3,000,000 if he continues to provide services through December 31, 2017. In October 2017, however, he terminates employment with that company and executes a new employment agreement with a new company as CFO. The employment agreement provides that, in April 2018, the CFO will participate in the nonqualified deferred compensation plan available to all executives of the company and that his benefit accrued on that date will be $3,000,000. On April 1, 2021, the CFO receives a payment of $4,500,000, which is the entire benefit accrued under the plan. The CFO is a covered employee solely as a result of the TCJA s amendment to 162(m)(3). Even though he was not eligible to participate in the nonqualified deferred compensation plan on November 2, 2017, he was employed on November 2, 2017 and had the right to participate in the plan under a written binding contract as of that date. $3,000,000 of the $4,500,000 payment made in April 2021 is deductible and $1,500,000 is not. 17
Contracts that Give the Company Discretion to Reduce Amounts Many November 2, 2017 arrangements provided significant discretion for companies to adjust executive compensation in light of changing circumstances or include unlimited negative discretion which taken to the extreme, would allow the company to reduce the payment amount to zero, even when performance and service requirements were met. To the extent that an executive s compensation is legally binding and enforceable, the grandfather rule may apply to protect the company s deduction. However, to the extent that compensation is subject to employer discretion, the grandfather rule is far less likely to apply unless such amounts are legally enforceable under state or other applicable law. Example: In February 2017, a company establishes a bonus plan under which the CEO will receive a cash bonus of $1,500,000 if a specified performance goal is satisfied. The compensation committee retains the right, even if the performance goal is met, to reduce the bonus payment to not less than $400,000 if, in its judgment, other subjective factors warrant a reduction. In 2018, the compensation committee reduces the award to $500,000. In this example, only $400,000 of the $500,000 payment is deductible, but the failure of the compensation committee to exercise negative discretion to reduce the award to $400,000, instead of $500,000, does not result in a material modification of the contract. 18
Renewal of a Legally Binding Contract A legally binding written contract that is considered renewed after November 2, 2017, is outside the grandfather rule. The Notice makes clear that a renewal can occur actively or passively and covers a range of fact patterns. Example: A CFO is a party to a three-year employment agreement providing an annual salary of $2,000,000, beginning on January 1, 2018, and the terms of the agreement provide for automatic extensions after the 3-year term for additional 1-year periods, unless the corporation exercises its option to terminate the agreement within 30 days before the end of the 3-year (or subsequent) term: The CFO s annual salary of $2,000,000 for the 2018, 2019, and 2020 taxable years [before the end of the 3-year terms/renewal] would not be subject to the 162(m) deduction limit. However, the employment agreement would be treated as renewed on January 1, 2021, and 162(m) would apply to any payments made under it on or after that date. Termination of the employment agreement does not require the termination of the CFO s employment relationship with the company. Note that the $2,000,000 only need be promised. It did not have to be performance-based compensation because the CFO was not a covered employee under prior law 19
Renewal of a Legally Binding Contract However, there are three exceptions where renewals do not cause the contract to fall outside the grandfather rule: If the company is legally obligated by the contract at the sole discretion of the employee; If the contract may only be terminated by the employee no longer being employed; or If upon termination or cancelation of the contract the employment relationship continues but is no longer covered by the contract. In the situation where a cover employee continues employment beyond the duration of the contract, compensation after the contract expires will not be grandfathered, but compensation paid pursuant to the contract could remain grandfathered. 20
Notice 2018-68 - Ability to Amend or Terminate Example: In January 2016, a company and CFO enter into a nonqualified deferred compensation arrangement. Under the plan, company will pay CFO s account balance in April 2019, but only if he continues to serve as the CFO through December 31, 2018. Company credits $100,000 to CFO s account annually for 3 years, beginning on December 31, 2016 (and earnings on the account). Plan provides that company may amend the plan to either stop or reduce the amount of future credits to the account balance. In April 2019, company/plan pays the CFO $350,000 (including earnings). The plan only constitutes a written binding contract to pay the $100,000 credited to his account balance on December 31, 2016, because the arrangement would have allowed the company to halt contributions in 2017, prior to crediting of the second $100,000. The remaining $250,000 is subject to the 162(m) deduction limit when distributed in 2019. If the plan credited earnings quarterly, the participant s $110,000 account balance under the plan as of November 2, 2017, would be grandfathered and $240,000 of the $350,000 payment would subject to the 162(m) deduction limit. If employee had been the CEO instead of the CFO, the entire $350,000 payment would subject to the 162(m) deduction limit because it was paid while he was still employed. Grandfathering rules only protect compensation that would have been deductible under 162(m) in the year promised, but for TCJA. That is zero for a CEO (other than performancebased compensation), but unlimited for a CFO. 21
Notice 2018-68 - Amounts Designed to be Performance-Based Compensation For employees who were covered employees even before the adoption of the TCJA, amounts paid in 2018 and after could still be deductible if the amounts or awards would have qualified as performance-based compensation under old Sec. 162(m). Example: In January 2017, the CEO signs a 4-year employment agreement with an annual salary of $1,000,000. Pursuant to the employment agreement, in January 2017, the company grants the CEO non-qualified stock options to purchase 1,000 shares of stock, SARs on 1,000 shares, and 1,000 shares of restricted stock. The restricted stock, options and SARs vest in January 2019. After vesting, the CEO can exercise the options and SARs at any time through January 2027. In January 2021, the CEO exercises the options and SARs. Because the stock options and SARs were designed to satisfy the performance-based compensation requirements and would have been deductible but for the elimination of the exception for qualified performance-based compensation by the TCJA, the compensation attributable to the options and the SARs upon their exercise in 2021 will be grandfathered and deductible. However, the company will not be entitled to a deduction for the compensation attributable to the vesting of the restricted stock in 2019. If the employment agreement had provided that the stock options, SARs, and restricted stock would be granted in January 2018, there would be no written binding contract as of November 2, 2017, and the options and SARS also would have been subject to the 162(m) deduction limit. 22
In Depth Discussion and Analysis of Notice 2018-68: Covered Employee, Written Binding Contract, Material Modification
Notice 2018-68 - Material Modification The grandfather rule permits a deduction for compensation paid to covered employees under a written binding contract in effect as of November 2, 2017, unless the contract is materially modified after that date. A legally binding contract that is materially modified is treated as a new contract as of the date of the modification. Compensation actually paid pursuant to the contract s terms prior to the material modification would remain grandfathered and subject to old Sec. 162(m). Compensation paid after the date of the modification would not be grandfathered. The Notice defines a material modification as one that increases the amount of compensation payable to the employee. If the contract is modified to accelerate the payment of compensation, a material modification will not have occurred where the payment amount is reasonably discounted for the time value of money. If the contract is modified to defer payment of the compensation, an increase in the payment amount would not be a material modification if it is based on either a reasonable rate of interest or the performance of predetermined investments. 24
Notice 2018-68 - Material Modification The Notice defines a material modification as one that increases the amount of compensation payable to the employee. If the contract is modified to accelerate the payment of compensation, a material modification will not have occurred where the payment amount is reasonably discounted for the time value of money. If the contract is modified to defer payment of the compensation, an increase in the payment amount would not be a material modification if it is based on either a reasonable rate of interest or the performance of predetermined investments. 25
Notice 2018-68 - Material Modification Example: In January 2017, a CFO signs a 5-year employment agreement providing for a salary of $1,800,000 per year. In 2018, CFO became a covered employee as a result of the TCJA s. In 2019, the company increases the CFO s compensation with a supplemental payment of $40,000. On January 1, 2020, the company increases the CFO s salary to $2,400,000. The $1,800,000 salary is paid under a written binding contract signed when CFO was not subject to 162(m) and, therefore, is grandfathered unless the change in her compensation in either 2019 or 2020 is a material modification. The $40,000 supplemental payment in 2019 does not constitute a material modification of the written binding contract because the $40,000 payment is less than or equal to a reasonable cost-of-living increase from 2017. The $40,000 supplemental payment is, however, subject to the deduction limitation of Sec. 162(m). The $560,000 salary increase to $2,400,000 in 2020 is a material modification of the written binding contract because the additional compensation is paid on the basis of substantially the same elements or conditions as the compensation that is otherwise paid pursuant to the written binding contract, and it is greater than a reasonable, annual cost-of-living increase. Because written binding contract is materially modified as of January 1, 2020, all compensation paid to CFO in 2020 and thereafter will be subject to the $1 million deduction limit. If CFO had received a restricted stock grant instead of a salary increase, there would not have been a material modification of the written binding contract (although the restricted stock grant would be subject deduction limitation). The additional compensation paid under the grant is based on the stock price and CFO s continued service, not paid on the basis of substantially the same elements and conditions as CFO s salary. 26
Notice 2018-68 - Material Modification The presence of a material modification is a fact-driven question and requires employers to exercise caution up until the point that all payments have been made under any November 2, 2017 arrangement. Affected companies should be extremely careful about modifying arrangements that might still be grandfathered, including modifications to employment agreements and amendments to executive compensation plans. Companies with grandfathered written binding contracts also should be careful when implementing any new arrangements that might be a supplemental contract based on the same criteria as the prior contract, which would be a material modification. 27
To Do List for Maximizing Deductions Going Forward
Action Items to Preserve Grandfathering Protection 1. Inventory all compensation plans, policies, and agreements that could be grandfathered, including employment, change in control, retention, and equity award agreements, non-qualified deferred compensation, short- and long-term incentive plans, and severance plans and agreements 2. List employees covered under any plan or agreement as of November 2, 2017 (not just current NEOs) Apply pre-tax Act law to determine covered employees for 2017 Apply post-tax Act law to determine covered employees after 2017 (e.g., include PFO) 30
Action Items to Preserve Grandfathering Protection (continued) 3. Work with legal counsel to determine the extent to which each plan and agreement creates a legally binding obligation for the company to pay a specific amount of compensation, including for use by auditors to calculate the Deferred Tax Asset on the company's balance sheet Enforceability, Fixed promises, Discretion, Expiration, automatic renewal, or termination, other than solely by employee, Any amendments or supplements 4. Determine how long grandfather protection will be available to these amounts 31
Action Items to Preserve Grandfathering Protection (continued) 5. Refrain from making any changes or amendments or providing for any compensation increases without carefully considering whether the change could constitute a material modification 6. Continue to maintain compensation committee of outside directors 7. Continue to have compensation committee determine and certify achievement of performance goals 32
Action Items to Preserve Grandfathering Protection (continued) Public companies must track any and all covered employees each year from and after 2017, and retain that information until all payments have been made to any such employee, former employee, or the beneficiaries of a former employee. Compensation committees and tax departments may need to periodically review the list to be certain the record is being updated and that its consequences are incorporated into compensation decisions and tax reporting. The company should not just apply this process to its current NEOs. The TCJA dramatically expanded the universe of employees and former employees who are or can become subject to the deductibility cap and the period of time during-for which they are subject to it. Example: Company awards non-qualified stock options vesting after 3 years of service to a middle management employee in 2016. By 2020, the employee has worked her way up to named executive officer. In 2024, she exercises the options. If the company took care to preserve the grandfather status of the 2016 options, it will be entitled to the entire deduction in 2024, despite the fact that the employee is then a covered employee. 33
Document Checklist 1. Employment agreements, 2. Equity award plans, agreements, and grants 3. Non-qualified deferred compensation plans or SERPs 4. Short-term incentive/annual bonus plans 5. Offer letters 6. Retention Agreements, 7. Change in control plans and agreements, 8. Severance plans and agreements, 9. Compensation committee meeting minutes for the past few years (to see if there are any compensation plans that may have been overlooked) 10.Any fringe benefits or special one-time bonus arrangements, e.g., relocation bonus or reimbursement 34
Alternative Compensation Strategies
Notice 2018-68 - Non-Qualified Deferred Compensation Many companies maintain a non-qualified deferred compensation plan and/or a supplemental executive retirement plan (SERP). Under a non-qualified deferred compensation plan or SERP, distribution of a participant s account balance or accrued benefit usually does not occur until after the participant has terminated employment. Therefore, under Code Sec. 162(m) prior to the TCJA amendments, distributions would be fully deductible. The TCJA amendments will make any distribution of non-qualified plan benefits to a participant who is or ever was a covered employee under 162(m) subject to the $1 million deductibility cap, even if the distribution is made after the participant s death, disability, retirement or other termination of employment. However, the account or benefit of a covered employee under a non-qualified plan as of November 2, 2017 (and in some cases additional accruals and contributions after that date, could be grandfathered and not subject to the $1 million cap. 36
Notice 2018-68 - Non-Qualified Deferred Compensation Example: Under a deferred compensation plan, an employee who was not a covered employee in 2015 elected to defer the entire amount [$200,000] of her 2016 annual bonus. The bonus, plus earnings based on a predetermined actual investment, will be paid in a lump sum at her separation from service. In 2018, she is promoted to CEO. In 2020, she separates from service and receives $225,000 (the deferred $200,000 bonus plus $25,000 in earnings). The full $225,000 payment is grandfathered and not subject to the 162(m) deduction limit. 37
Strategies for Mitigating the Loss of Deductibility of Amounts in Excess of $1 Million
Notice 2018-68 Strategies to Mitigate Lost Deductions 1. Scrutinize the Executive Order (EO) Setting and Named Executive Officer (NEO) Selecting Processes 2. Non-Qualified Deferred Compensation or SERP Plans 3. Coordinate Non-Qualified Plan Distributions 4. Voluntary and Mandatory Deferrals of RSUs or Annual Bonus 5. Code Sec. 409A Deferrals 6. Qualified Plan SERP-Switch 7. Incentive Stock Options 8. Coordinate Non-Qualified Option Exercises 9. New Code Sec. 199A (Profits Interests for REITs) 39
Notice 2018-68 Strategies to Mitigate Lost Deductions Non-Qualified Deferred Compensation or SERP Plans Non-qualified plans offer one of the best opportunities to limit the impact of new Sec. 162(m). Because distribution of a covered employee s non-qualified plan benefit of usually occurs after employment termination and can be spread out over a period of time, companies may be able to control the distribution amount in any taxable year, so that, when combined with any other payments to the former employee in that year, the distributions are less than $1 million and, thus, fully deductible. After a covered employee s retirement or other termination of employment, the company still will be able to pay and deduct up to $1 million in benefits each year. The payments made by many, if not most, companies to former covered employees after retirement or termination will be less than $1 million and, therefore, fully deductible. Even in situations where the annual distribution amount, when combined with other deductible payments, cannot be reduced below $1 million, at least the company will be able to postpone the outflow of cash (with no corresponding deduction) for several years 40
Notice 2018-68 Strategies to Mitigate Lost Deductions Non-Qualified Deferred Compensation or SERP Plans A company that currently maintains a non-qualified plan under which all or a portion of executives account balances and accrued benefits could be grandfathered, should consider adopting a new plan, effective as of January 2018 or 2019. This way, any future plan design changes should not require a material modification of the existing, grandfathered plan. Companies should be careful to allow the type of continued accruals and contributions that the Notice allows, e.g., for an employee who the company was obligated to add to the plan by contract on or before November 2, 2017, under the existing plan. 41
Notice 2018-68 Strategies to Mitigate Lost Deductions Automatic Voluntary Deferral of RSUs or Annual Bonus Companies may consider providing for the automatic deferral of certain compensation amounts, such as RSU awards and all or a portion of the incentive bonus. Essentially, the deferred amounts then would become non-qualified deferred compensation and future annual installment payouts could be limited to $1 million per year or less. Many companies have used automatic voluntary deferral as a part of their compensation programs in the past. Often these companies include offered a kicker to compensate employees for additional risk of unsecured deferral. For example, in June 2019, a company might offer executives and other employees the choice to receive their 2020 incentive bonus in cash or in deferred RSUs with a fair value equal to 125% of the indicated cash amount. Future gain or loss on the deferred amounts could be based solely on the company s stock price, particularly in the case of deferred RSUs. The company could place company stock in a rabbi trust to fund the promised deferral. 42
Notice 2018-68 Strategies to Mitigate Lost Deductions Code Sec. 409A Two different sections of the regulations under Code Sec. 409A provide an exception to the prohibition on delaying or deferring payments and allow a company to decide to defer the payment of compensation to an executive, without an election in advance, if the compensation is not deductible under Code Sec. 162(m). In each case, however, the deferred payment must be made as soon as reasonably practicable following the first date on which the company anticipates that its deduction with respect to such payment will no longer be limited by the application of Sec. 162(m). The new once a covered employee, always a covered employee rule will complicate some companies ability to utilize these exceptions, but should not eliminate them. The exception for further deferral of payments that otherwise would qualify for the short-term deferral exception, also seems to require an element of surprise on the part of the company. This exception requires that the company establish that as of the date the legally binding right to the payment arose, a reasonable person would not have anticipated the application of section 162(m) at the time of the payment. This exception may only be useful for future payments that were promised before November 2, 2017, but not grandfathered. 43
Notice 2018-68 Strategies to Mitigate Lost Deductions Voluntary and mandatory compensation deferrals is one of the most promising strategies for mitigating the potential loss of deduction under Sec. 162(m). Additionally, the deferral of executives compensation has the salutary effect of enhancing the link between executives compensation and their companies long-term performance. Therefore, bank regulators (along with institutional investors and proxy advisory firms) should approve of companies and executives actions to defer equity and cash compensation, particularly if: The deferral plan includes forfeiture and clawback features, Any deferrals related to equity compensation are payable (and/or invested) solely in company stock, and The deferral plan does not result in an increase in total compensation. Mandatory deferrals of incentive compensation in general, and stock-based compensation in particular, was one of the key components of the proposed rules under Dodd-Frank Act Section 956. During the deferral period, compensation would remain subject to a risk of forfeiture, a risk of downward adjustment, and clawback requirements. 44
Proxy Statement Reporting and Accounting Issues
Compensation Committee Actions No Longer Required by Section 162(m) Establishing performance goals within the first 90 days of the year Establishing and applying only objective performance goals Including a per person limit on the number of shares of stock awarded in any year Maintaining a list of performance metrics and including it in the stock plan 46
Compensation Committee Actions No Longer Required by Section 162(m) Certifying that performance goals were attained after close of the year However, grandfathered awards may require certification Avoiding the exercise of discretion to increase awards or payouts or applying subjective performance criteria Grandfathered awards may generally not be increased without blowing the grandfathered status 47
Compensation Committee Independence Requirements Companies no longer need to limit committee membership to outside directors (an old Section 162(m) requirement) However, grandfather awards may require compensation committee composition to meet the requirements of old Section 162(m) Companies now look to stock exchange rules, Section 16 independence requirements, and ISS guidance 48
Questions?
Thank you. Mike Melbinger Employee Benefits and Executive Compensation Chicago mmelbinger@winston.com Nyron Persaud Employee Benefits and Executive Compensation New York npersaud@winston.com Ruth Wimer Employee Benefits and Executive Compensation Washington, DC rwimer@winston.com 51