Limit on Deductions for Executive Compensation at Public Companies

Stephen D. Kirkland CPA, CMC, CFC, CFF
July 25, 2012 — 3,482 views  
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Section 162(m) of the Internal Revenue Code limits a publicly-held corporation’s tax deduction for compensation paid to a “covered employee” to a maximum of $1,000,000 per year. 

A corporation is publicly-held if it has any class of common equity securities required to be registered under section 12 of the Securities Exchange Act of 1934. 

A “covered employee” is an individual who is the corporation’s Chief Executive Officer or one of the four highest-compensated officers for the year, other than the CEO.  

Officers leaving before the last day of the tax year with no intention of returning are not considered to be covered employees.  Compensation paid to these former officers is therefore not subject to the deduction limit of § 162(m).

Certain types of compensation are not subject to the $1,000,000 limit and are not included in the calculation:

(1) Commissions paid “solely on account of income generated directly by the” individual’s performance.

(2) Performance-based compensation paid “solely on account of the attainment of one or more performance goals.” 

(3) Contributions to qualified retirement plans.

(4) Tax-excludable employee welfare benefits, such as health insurance.

5) Certain amounts earned under a pre-1993 written contract.  See § 162(m)(4)(D). 

Since few senior executives are paid commissions, many companies rely heavily on the exception for performance-based compensation.  To meet this exception, the goals must be approved in advance by a compensation committee of the board of directors.  That committee must include at least two outside directors.  Further, the goals must be disclosed to shareholders and approved in advance by a majority of the shareholders.  The compensation committee must certify that the performance goals were met before payment is made.  The goals must be objective, such as increasing the company’s stock price, market share, sales or earnings-per-share to certain levels.  Simply maintaining the current stock price is enough, but continued employment with the company alone is not enough.

The $1,000,000 limit is reduced by any amount disallowed as a deduction under § 280G, which applies to golden parachute payments.

tock options and stock appreciation rights are generally not included in compensation for purposes of § 162(m) if they meet the requirements for performance-based compensation.  However, some grants of restricted stock may not qualify for the exclusion, depending upon the circumstances.  See Treasury Reg. § 1.162-27(e) which includes numerous examples. 

The regulations under § 162(m) are lengthy but should be perused before executive compensation plans are finalized by a publicly-held company.

The federal tax laws also limit deductions for executive compensation amounts paid by closely-held companies.  Section 162 allows these companies to deduct compensation paid to shareholder-employees only to the extent that the amounts are reasonable compensation for services rendered.  Non-profit organizations should also ensure that compensation amounts they pay are reasonable to avoid the § 4958 excise taxes imposed on “excess benefit transactions.”  See  for more information on determining reasonable compensation.


Stephen D. Kirkland CPA, CMC, CFC, CFF

Atlantic Executive Consulting Group, LLC

Stephen earned a Bachelor’s degree in Accounting at Emory University and a Master of Tax Accounting at the University of Alabama. He is a compensation consultant and expert witness with Atlantic Executive Consulting Group.