Although the Internal Revenue Code Sections 409A and 162(m) rules are not new, they continue to raise important issues that companies and their employees must be aware of.
Section 409A imposes limits upon plans and agreements of public or private companies that include deferred compensation that ensure “participating employees do not have complete control over determining when income will be recognized for income tax purposes,” says Daniel N. Janich, an officer in the employee benefits practice group in the Chicago office of Greensfelder, Hemker & Gale, PC.
Section 162(m) limits the deductibility of compensation for a public company’s CEO or three other most highly compensated officers (other than the principal financial officer) for a given taxable year to $1 million. Janich says that Section 162(m) “essentially caps the total amount of compensation guaranteed to be paid to the public company’s top executives.”
Recently, the IRS ruled that employment agreements, equity and other incentive plans that permit payments when such officers terminate “without cause” or “for good reason,” or who retire, may no longer be considered “performance-based compensation” that is excluded from Section 162(m)’s limitations.
Smart Business spoke with Janich about what you need to know about these rules and how to make sure your company is following them.
What key things do business owners need to understand about these rules?
With regard to Section 409A, business owners and employees must understand this rule applies in a broad set of factual circumstances. The penalties for a violation will impact the employee, not the company; therefore, it is the employee who must be certain that his or her deferred compensation benefit fully complies with 409A. A 409A violation results in tax penalties, accelerated recognition of income and interest charges.
Section 162(m) is more limited in scope than Section 409A, applying only to a handful of top paid executives of public companies. Unlike in the past, when terminating executives were permitted to waive their performance goals and still receive their incentive compensation benefit as performance-based compensation excluded from Section 162(m)’s deduction limits, the IRS has recently pronounced that such payments will no longer be treated as performance-based compensation if triggered solely by an involuntary termination or retirement.
This position has caused many public companies to restructure their plans and agreements to comply with this interpretation of Section 162(m).