The $1.9 billion stimulus package enacted three weeks ago contains an 11th-hour provision that increases the number of executives whose compensation is subject to a $1 million tax deduction cap.

Prior to passage of the law, at least five employees were subject to the cap, known as the 162(m) cap: the CEO, CFO and the three highest paid employees other than those two.  

In addition, employees whose compensation was subject to the cap in previous years, in a once-capped, always-capped-type of provision, also continued to be subject to it. 

The recently enacted stimulus expands the cap by subjecting the compensation of the five highest-paid employees, not counting those already subject to it, to the limitation, effective in 2027. 

Importantly, these newly added five employees won’t be subject to the once-capped, always-capped provision. 

The expansion, in Section 9708 of the stimulus, caught tax specialists off guard.

“This addition of the five highest paid employees standard was a surprising late addition made during Senate deliberations of the legislation," a KPMG analysis says. 

Tax strategy

The cap applies to all compensation, including commissions and performance-based payments, but not to contributions to qualified savings plans and tax-exempt benefits like health insurance. 

Even though the expanded cap doesn’t take effect until 2027, companies can optimize their tax strategy by thinking about timing issues now, Allison Hoeinghaus, a managing director of the tax practice at Alvarez & Marsal, told CFO Dive in an email exchange. 

“Since the next five highest paid executives will not automatically be considered a covered employee in all future years …  consideration should be given to whether it makes sense to defer compensation until a later year when the individuals may no longer be subject to this expanded definition,” she said. 

Hoeinghaus thinks this won’t be the last time Congress tries to use the tax code to curb executive pay. 

“Executive compensation will remain a target of future legislation,” she said. “Before these rules come into play, additional laws may be passed that interplay with or augment this new legislation.”

She suggested companies assume more 162(m) exposure could happen in the next few years. It’s “prudent for a company to have the ability to dynamically model” that, she said.