Certain Employee Remuneration in Excess of $1,000,000 Under Internal Revenue Code Section 162(m), 86481-86511 [2020-28484]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 85, Number 250 (Wednesday, December 30, 2020)]
[Rules and Regulations]
[Pages 86481-86511]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-28484]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9932]
RIN 1545-BO95


Certain Employee Remuneration in Excess of $1,000,000 Under 
Internal Revenue Code Section 162(m)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document sets forth final regulations under section 
162(m) of the Internal Revenue Code (Code), which for Federal income 
tax purposes limits the deduction for certain employee remuneration in 
excess of $1,000,000. These final regulations implement the amendments 
made to section 162(m) by the Tax Cuts and Jobs Act and finalize the 
proposed regulations published on December 20, 2019. These final 
regulations affect publicly held corporations.

DATES: 
    Effective Date: These regulations are effective on December 30, 
2020.
    Applicability Dates: For dates of applicability, see Sec.  1.162-
33(h).

FOR FURTHER INFORMATION CONTACT: Ilya Enkishev at (202) 317-5600 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document amends the Income Tax Regulations (``Treasury 
regulations'' (26 CFR part 1) under section 162(m)). Section 162(m)(1) 
disallows a deduction by any publicly held corporation for applicable 
employee remuneration paid or otherwise deductible with respect to any 
covered employee to the extent that such remuneration for the taxable 
year exceeds $1,000,000. Section 162(m) was added to the Code by 
section 13211(a) of the Omnibus Budget Reconciliation Act of 1993, 
Public Law 103-66. Proposed regulations under section 162(m) were 
published in the Federal Register on December 20, 1993 (58 FR 66310) 
(1993 proposed regulations). On December 2, 1994, the Department of the 
Treasury (Treasury Department) and the Internal Revenue Service (IRS) 
issued amendments to the proposed regulations (59 FR 61884) (1994 
proposed regulations). On December 20, 1995, the Treasury Department 
and the IRS issued final regulations under section 162(m) (TD 8650) (60 
FR 65534) (1995 regulations).
    Section 162(m) was amended by section 13601 of the Tax Cuts and 
Jobs Act (TCJA) (Pub. L. 115-97, 131 Stat. 2054, 2155 (2017)). Section 
13601 of TCJA amended the definitions of covered employee, publicly 
held corporation, and applicable employee remuneration in section 
162(m). Section 13601 also provided a transition rule applicable to 
certain outstanding compensatory arrangements (commonly referred to as 
the grandfather rule). On August 21, 2018, the Treasury Department and 
the IRS released Notice 2018-68 (2018-36 I.R.B. 418), which provides 
guidance on certain issues under section 162(m).
    On December 20, 2019, the Treasury Department and the IRS published 
proposed regulations (REG-122180-18) relating to the amendments TCJA 
made to section 162(m) in the Federal Register (84 FR 70356) (the 
proposed regulations). The changes to section 162(m) made by section 
13601 of TCJA and the initial guidance provided by

[[Page 86482]]

Notice 2018-68 are described in detail in the preamble to the proposed 
regulations.
    A public hearing was held on March 9, 2020. The Treasury Department 
and the IRS also received written comments with respect to the proposed 
regulations. All written comments received in response to the proposed 
regulations are available at www.regulations.gov or upon request. After 
full consideration of the comments received on the proposed regulations 
and the testimony heard at the public hearing, this Treasury decision 
adopts the proposed regulations with modifications in response to 
certain comments and testimony, as described in the Summary of Comments 
and Explanation of Revisions section. Comments outside of the scope of 
the proposed regulations generally are not addressed in this preamble 
but may be considered in connection with future guidance projects.

Summary of Comments and Explanation of Revisions

I. Overview

    Section 13601 of TCJA significantly amended section 162(m). 
Consistent with the proposed regulations, these final regulations add a 
section to the Treasury regulations to reflect these amendments. 
Amended section 162(m) applies to taxable years beginning after 
December 31, 2017, except to the extent transition and grandfather 
rules described in section VI of this preamble apply. Because the 1995 
regulations continue to apply to deductions related to amounts of 
remuneration to which the grandfather rule applies, the 1995 
regulations are retained as a separate section in the Treasury 
regulations under section 162(m).
    These final regulations retain the basic approach and structure of 
the proposed regulations, with certain revisions (including revised 
examples). This Summary of Comments and Explanation of Revisions 
discusses those revisions, as well as comments received in response to 
the proposed regulations.

II. Publicly Held Corporation

A. In General

    As amended by TCJA, section 162(m)(2) defines the term ``publicly 
held corporation'' as any corporation that is an issuer (as defined in 
section 3 of the Securities Exchange Act of 1934 (Exchange Act)) of 
securities that are required to be registered under section 12 of the 
Exchange Act, or that is required to file reports under section 15(d) 
of the Exchange Act. These final regulations adopt the rule in the 
proposed regulations providing that, for ease of administration, a 
corporation is a publicly held corporation if, as of the last day of 
its taxable year, its securities are required to be registered under 
section 12 of the Exchange Act or it is required to file reports under 
section 15(d) of the Exchange Act.
    These final regulations also adopt the rules set forth in the 
proposed regulations for determining whether a publicly traded 
partnership, a corporation that owns an entity that is disregarded as 
an entity separate from its owner within the meaning of Sec.  301.7701-
2(c)(2)(i), or an S corporation (including an S corporation parent of a 
qualified subchapter S subsidiary (as defined in section 1361(b)(3)(B)) 
(QSub) is a publicly held corporation as defined in section 162(m)(2). 
Consistent with the proposed rules, these final regulations also 
provide that a real estate investment trust (REIT), as defined in 
section 856(a), that owns a qualified real estate investment trust 
subsidiary as defined in section 856(i)(2) (QRS), is a publicly held 
corporation if the QRS issues securities required to be registered 
under section 12(b) of the Exchange Act, or is required to file reports 
under section 15(d) of the Exchange Act.

B. Affiliated Groups

    These final regulations adopt the rules set forth in the 1995 
regulations and the proposed regulations providing that the term 
``publicly held corporation'' includes an affiliated group of 
corporations (affiliated group), as defined in section 1504 (determined 
without regard to section 1504(b)), that includes one or more publicly 
held corporations, and that a subsidiary corporation that meets the 
definition of publicly held corporation is separately subject to 
section 162(m). These final regulations also adopt the rules set forth 
in the proposed regulations providing that an affiliated group includes 
a parent corporation that is privately held if one or more of its 
subsidiary corporations is a publicly held corporation, and that an 
affiliated group may include more than one publicly held corporation as 
defined in section 162(m)(2).
    In response to the proposed regulations, a commenter suggested that 
an affiliated group with more than one publicly held corporation should 
have only one set of covered employees for the affiliated group 
(instead of one set of covered employees for each separate publicly 
held corporation that is a member of the affiliated group). These final 
regulations do not adopt this suggestion because each corporation in an 
affiliated group is a separate taxpayer and section 162(m)(3) provides 
that each taxpayer that is a publicly held corporation has its own set 
of covered employees. Instead, as provided in the 1995 regulations and 
in the proposed regulations, these final regulations provide that, in 
an affiliated group, each corporation that is a publicly held 
corporation is separately subject to section 162(m) and, therefore, has 
its own set of covered employees.
    These final regulations adopt the rules set forth in the 1995 
regulations and the proposed regulations addressing situations in which 
a covered employee of a publicly held corporation that is a member of 
an affiliated group performs services for another member of the 
affiliated group. These final regulations provide that compensation \1\ 
paid by all members of the affiliated group is aggregated and that any 
amount disallowed as a deduction by section 162(m) is prorated among 
the payor corporations in proportion to the amount of compensation paid 
to the covered employee by each corporation in the taxable year. For 
situations in which a covered employee is paid compensation during a 
taxable year by more than one publicly held corporation that are 
members of the same affiliated group, these final regulations adopt the 
rules set forth in the proposed regulations providing that the amount 
of the deduction that is disallowed for compensation paid to a covered 
employee is determined separately with respect to each payor 
corporation that is a publicly held corporation. These final 
regulations clarify that compensation paid by a member of an affiliated 
group that is not a publicly held corporation to an employee who is a 
covered employee of two or more other members of the affiliated group 
is prorated for purposes of the determining the deduction disallowance 
among the members that are publicly held corporations of which the 
employee is a covered employee.
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    \1\ For simplicity, where possible, these final regulations use 
the term ``compensation'' instead of ``applicable employee 
remuneration.'' These terms have the same meaning in these final 
regulations.
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C. Foreign Private Issuers

    Pursuant to the amended definition of publicly held corporation in 
section 162(m)(2), the proposed regulations provide that a foreign 
private issuer \2\ (FPI) is a publicly held corporation if it is 
required to register securities under section 12 of the Exchange Act or 
file reports under section 15(d) of the

[[Page 86483]]

Exchange Act. The legislative history to TCJA indicates that Congress 
intended section 162(m) to apply to FPIs.\3\
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    \2\ The term ``foreign private issuer'' is defined in 21 CFR 
240.3b-4(c).
    \3\ The legislative history to TCJA provides that the amendment 
to the definition of publicly held corporation under section 162(m) 
``extends the applicability of section 162(m) to include . . . all 
foreign companies publicly traded through ADRs.'' House Conf. Rpt. 
115-466, 489 (2017). The Blue Book similarly states that ``the 
provision extends the applicability of section 162(m) to include all 
foreign companies publicly traded through ADRs.'' Staff of the Joint 
Committee on Taxation, General Explanation of Public Law 115-97 
(Blue Book), at 261 (December 20, 2018).
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    In response to Notice 2018-68, commenters suggested that the 
proposed regulations provide that section 162(m) does not apply to FPIs 
because FPIs are not required to disclose compensation of their 
officers on an individual basis under the Exchange Act, unless similar 
disclosure is required by their home country.\4\ The commenters 
asserted that determining compensation on an individual basis (in order 
to determine the three most highly compensated executive officers) 
would require the FPIs to expend significant time and money in adopting 
the necessary internal procedures to make the determination consistent 
with Exchange Act requirements that are inapplicable to them. The 
proposed regulations do not adopt these suggestions.
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    \4\ Before TCJA, the IRS ruled in several private letter rulings 
that section 162(m), as in effect at that time, did not apply to 
FPIs because FPIs are not required to disclose compensation of their 
officers on an individual basis under the Exchange Act, and, 
therefore, did not have covered employees. A private letter ruling 
may be relied upon only by the taxpayer to whom the ruling was 
issued and does not constitute generally applicable guidance. See 
section 11.02 of Revenue Procedure 2020-1, 2020-01 I.R.B. 144. TCJA 
amended section 162(m) to provide that a requirement to disclose 
compensation is not determinative of whether an officer is a covered 
employee.
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    However, the preamble to the proposed regulations requested 
comments as to whether a safe harbor exemption from the definition of a 
publicly held corporation under section 162(m) was appropriate for FPIs 
that are not required to disclose compensation of their officers on an 
individual basis in their home countries and, if so, how such a safe 
harbor could be designed. In response to this request for comments a 
commenter suggested that these final regulations should exempt any FPI 
from the definition of publicly held corporation, unless the FPI is 
required to disclose compensation of its officers on an individual 
basis in its home country. Another commenter suggested that these final 
regulations should exclude FPIs from the definition of publicly held 
corporation because determining compensation on an individual basis (in 
order to determine the three most highly compensated executive 
officers) requires extensive calculations consistent with executive 
compensation disclosure rules under the Exchange Act that are not 
applicable to FPIs. The commenters did not provide any analysis in 
support of a safe harbor rule or address how a safe harbor could be 
designed and administered. These final regulations do not adopt these 
suggestions because the scope of the exemption suggested for FPIs from 
the definition of publicly held corporation is inconsistent with the 
statutory language and the legislative history. Rather, these final 
regulations adopt the rules set forth in the proposed regulations 
providing that a FPI is a publicly held corporation if it is required 
to register securities under section 12 of the Exchange Act or file 
reports under section 15(d) of the Exchange Act.

III. Covered Employee

A. In General

    As amended by TCJA, section 162(m)(3) defines the term ``covered 
employee'' as an employee of the taxpayer if (1) the employee is the 
principal executive officer (PEO) or principal financial officer (PFO) 
of the taxpayer at any time during the taxable year, or was an 
individual acting in such a capacity, (2) the total compensation of the 
employee for the taxable year is required to be reported to 
shareholders under the Exchange Act by reason of the employee being 
among the three highest compensated officers for the taxable year 
(other than the PEO and PFO), or (3) the individual was a covered 
employee of the taxpayer (or any predecessor) for any preceding taxable 
year beginning after December 31, 2016. TCJA also added flush language 
to provide that a covered employee includes any employee of the 
taxpayer whose total compensation for the taxable year places the 
individual among the three highest compensated officers for the taxable 
year (other than any individual who is the PEO or PFO of the taxpayer 
at any time during the taxable year, or was an individual acting in 
such a capacity) even if the compensation of the officer is not 
required to be reported to shareholders under the Exchange Act.
    These final regulations adopt the rules set forth in the proposed 
regulations providing that a covered employee for any taxable year 
means any employee of the publicly held corporation who is among the 
three highest compensated executive officers for the taxable year, 
regardless of whether the executive officer is serving as an executive 
officer at the end of the publicly held corporation's taxable year, and 
regardless of whether the executive officer's compensation is subject 
to disclosure for the publicly held corporation's last completed fiscal 
year under the applicable SEC rules. The determination that an officer 
is a covered employee because the officer is one of the three highest 
compensated executive officers, even if the officer's compensation is 
not required to be disclosed under the SEC rules, is based on the flush 
language to section 162(m)(3), the legislative history,\5\ and the SEC 
executive compensation disclosure rules.\6\ These final regulations 
also adopt the rule in the proposed regulations providing that the 
amount of compensation used to identify the three most highly 
compensated executive officers is determined pursuant to the executive 
compensation disclosure rules under the Exchange Act, substituting the 
publicly held corporation's taxable year for references to the 
corporation's fiscal year for purposes of applying the disclosure rules 
under the Exchange Act.
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    \5\ See House Conf. Rpt. 115-466, 489 (2017).
    \6\ 17 CFR 229.402(a)(3) (Item 402 of Regulation S-K).
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    In response to the proposed regulations, a commenter suggested 
that, with respect to the three highest compensated executive officers 
(other than the PEO and PFO), the term ``covered employee'' should 
include only executive officers whose compensation is required to be 
disclosed pursuant to the SEC executive compensation disclosure rules. 
These final regulations do not adopt this suggestion because it is 
inconsistent with the flush language of section 162(m)(3) providing 
that, even if the compensation of an executive officer is not required 
to be reported to shareholders under the Exchange Act, the officer is a 
covered employee if the officer's total compensation for the taxable 
year, determined in accordance with the SEC disclosure rules, places 
the officer among the three highest compensated officers for the 
taxable year (other than the PEO and PFO).
    Section 162(m)(3)(C) provides that the term ``covered employee'' 
includes any employee who was a covered employee of any predecessor of 
the publicly held corporation for any preceding taxable year beginning 
after December 31, 2016. The proposed regulations provide rules for 
determining the predecessor of a publicly held corporation for various 
corporate transactions. With respect to asset acquisitions, the 
proposed regulations provide that, if an acquiror

[[Page 86484]]

corporation acquires at least 80% of the operating assets (determined 
by fair market value on the date of acquisition) of a publicly held 
target corporation, then the target corporation is a predecessor of the 
acquiror corporation. A commenter suggested that these final 
regulations clarify that the operating assets refer to gross operating 
assets instead of net operating assets. These final regulations adopt 
this suggestion.
    The proposed regulations also provide rules for determining the 
covered employees of an owner of a disregarded entity, and an S 
corporation that owns a QSub. No comments were received with respect to 
these provisions of the proposed regulations. Accordingly, these final 
regulations adopt the rules set forth in the proposed regulations and, 
consistent with those rules, provide additional rules for purposes of 
determining the covered employees of a REIT that owns a QRS.

B. Covered Employees Limited to Executive Officers

    Under the definition of covered employee in section 162(m)(3) as 
amended by TCJA, a PEO and PFO are covered employees by virtue of 
holding those positions or acting in those capacities. The three 
highest compensated officers (other than the PEO or PFO) are covered 
employees by reason of their compensation. Pursuant to section 
162(m)(3)(B), the three highest compensated officers are determined 
based on the methods by which these officers are identified for 
purposes of the executive compensation disclosure rules under the 
Exchange Act. With respect to the three highest compensated officers 
for a taxable year, consistent with the disclosure rules under the 
Exchange Act, the proposed regulations provide that only an executive 
officer, as defined in 17 CFR 240.3b-7 (Rule 3b-7), may qualify as a 
covered employee. In relevant part, Rule 3b-7 provides that 
``[e]xecutive officers of subsidiaries may be deemed executive officers 
of the registrant if they perform . . . policy making functions for the 
registrant.'' A commenter suggested that these final regulations 
provide that an executive officer of a subsidiary may be a covered 
employee of the publicly held corporation that is the registrant only 
if the officer is also an officer of that publicly held corporation. 
These final regulations do not adopt this suggestion because it is 
inconsistent with Rule 3b-7.

C. Covered Employees After Separation From Service

    Section 162(m)(3)(C), as amended by TCJA, provides that a covered 
employee includes ``a covered employee of the taxpayer (or any 
predecessor) for any preceding taxable year beginning after December 
31, 2016.'' The legislative history to TCJA provides that:

if an individual is a covered employee with respect to a corporation 
for a taxable year beginning after December 31, 2016, the individual 
remains a covered employee for all future years. Thus, an individual 
remains a covered employee with respect to compensation otherwise 
deductible for subsequent years, including for years during which 
the individual is no longer employed by the corporation and years 
after the individual has died.

(House Conf. Rpt. 115-466, 489 (2017)). The Blue Book reiterated the 
legislative history in explaining the amended definition of covered 
employee. See Blue Book at page 260.

    Consistent with section 162(m)(3)(C), as amended by TCJA, and the 
legislative history, the proposed regulations provide that a covered 
employee identified for taxable years beginning after December 31, 
2016, will continue to be a covered employee for all subsequent taxable 
years, including years during which the individual is no longer 
employed by the corporation and years after the individual has died. A 
commenter suggested that, based on the statutory text of both section 
162(m) and section 4960, which was enacted by TCJA, Congress intended 
the term ``employee'' in section 162(m) to be limited to a current 
employee. The commenter pointed out that section 4960(c)(2) provides, 
in relevant part, that ``the term `covered employee' means any employee 
(including any former employee)'' and noted that the words ``including 
any former employee'' are absent from the definition of covered 
employee in section 162(m)(3). The commenter reasoned that, because 
Congress enacted section 4960 and amended the definition of covered 
employee in section 162(m) in the same legislation (TCJA), the absence 
of these words limits the definition of covered employee to a current 
employee for purposes of section 162(m).
    The Treasury Department and the IRS have concluded that the better 
analysis is that Congress intended to apply both section 162(m) and 
section 4960 to current and former employees. Congress may accomplish 
the same objective in two separate legislative provisions without using 
identical statutory language. As explained in section III.D of the 
preamble to the proposed regulations, the reference to an employee in 
section 162(m) provides no indication that the term ``employee'' is 
limited to a current employee, since a reference in the Code to an 
``employee'' has frequently been interpreted in regulations as a 
reference to both a current and a former employee.\7\ In addition, as 
previously noted, the legislative history to section 162(m) makes clear 
that Congress intended the term ``covered employee'' to include a 
former employee.\8\ Accordingly, these final regulations adopt the 
proposed regulations without change.
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    \7\ See section III.D of the preamble to the proposed 
regulations. For example, under Sec.  1.105-11(c)(3)(iii), the 
nondiscrimination rules of section 105(h)(3) apply to former 
employees even though the Code uses only the term ``employees.''
    \8\ House Conf. Rpt. 115-466, supra, at 489.
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IV. Applicable Employee Remuneration

A. In General

    Section 162(m)(4)(A) defines the term ``applicable employee 
remuneration'' with respect to any covered employee for any taxable 
year as the aggregate amount allowable as a deduction for the taxable 
year (determined without regard to section 162(m)) for remuneration for 
services performed by such employee (whether or not during the taxable 
year). Section 162(m)(4)(F) provides that remuneration shall not fail 
to be applicable employee remuneration merely because it is includible 
in the income of, or paid to, a person other than the covered employee, 
including after the death of the covered employee. For simplicity, the 
proposed regulations and these final regulations use the term 
``compensation'' instead of ``applicable employee remuneration'' 
wherever possible. Like the proposed regulations, these final 
regulations provide that compensation means the aggregate amount 
allowable as a deduction under chapter 1 of the Code for the taxable 
year (determined without regard to section 162(m)) for remuneration for 
services performed by a covered employee, whether or not the services 
were performed during the taxable year, and that compensation includes 
an amount that is includible in the income of, or paid to, a person 
other than the covered employee, including after the death of the 
covered employee

B. Compensation Paid by a Partnership to a Covered Employee

    Section 162(m)(1) provides that ``[i]n the case of any publicly 
held corporation, no deduction shall be allowed under this chapter for 
applicable employee remuneration with respect to any covered 
employee.'' As

[[Page 86485]]

explained in section IV.B of the preamble to the proposed regulations, 
this statutory provision serves as the basis for the rule in the 
proposed regulations that a publicly held corporation that holds a 
partnership interest must take into account its distributive share of 
the partnership's deduction for compensation paid to the publicly held 
corporation's covered employee and aggregate that distributive share 
with the corporation's otherwise allowable deduction for compensation 
paid directly to that employee in applying the deduction limitation 
under section 162(m).
    In response to this provision of the proposed regulations, 
commenters suggested that remuneration paid by a partnership is not 
compensation for purposes of section 162(m) because the partnership is 
neither a publicly held corporation nor a member of an affiliated 
group. Section 162(m) does not limit the application of section 162(m) 
in that manner. Rather, section 162(m) applies to all compensation, 
which includes ``all amounts allowable as a deduction . . . for 
remuneration for services performed by such employee (whether or not 
during the taxable year).'' While the comments suggest a reading of 
section 162(m)(1) that services must be performed in the employee's 
capacity as an employee and must be performed for the publicly held 
corporation, neither of these requirements appear in the statute. In 
addition, adoption of the commenters' suggestion could lead to the use 
of partnerships as a method of avoiding application of section 162(m), 
a result that the Treasury Department and IRS conclude is not intended 
by the statute.
    Commenters also suggested that remuneration paid by a partnership 
should be compensation for purposes of section 162(m) only if the 
publicly held corporation has an 80% or greater interest in the 
partnership because the definition of an affiliated group requires 80% 
ownership by vote and value among the members of the affiliated group. 
The Treasury Department and the IRS did not adopt this rule because the 
analogy to the affiliated group proffered by the commenters does not 
take into account that the tax treatment of a partner in a partnership 
differs from the tax treatment of a corporation that owns stock in 
another corporation. Although a consolidated group of corporations may 
obtain a tax result similar to a deduction flow through, a subsidiary's 
compensation deduction does not flow through to the parent corporation 
in a non-consolidated group of corporations. In contrast, when a 
publicly held corporation is a partner in a partnership, a share of the 
partnership's items of income, gain, loss, and deduction generally is 
allocated to the publicly held corporation in accordance with 
partnership agreement, subject to section 704. Furthermore, that 
allocation may occur regardless of the level of ownership by the 
publicly held corporation.
    These final regulations adopt the provisions of the proposed 
regulations and provide that a publicly held corporation must take into 
account its distributive share of a partnership's deduction for 
compensation paid to the publicly held corporation's covered employee 
in determining the amount allowable to the corporation as a deduction 
for compensation under section 162(m). Consistent with an example in 
the proposed regulations and incorporated into these final regulations, 
these final regulations clarify that the publicly held corporation's 
distributive share of the partnership's deduction for compensation paid 
by the partnership to a covered employee in connection with the 
performance of services includes the partnership's deduction for a 
payment to the covered employee for services under section 707(a) or 
section 707(c).
    In response to a commenter's request for clarification on the 
application of the rule that a publicly held corporation must take into 
account its distributive share of a partnership's compensation payment 
to the publicly held corporation's covered employee, the Treasury 
Department and the IRS confirm that these final regulations address 
only application of the section 162(m) compensation deduction 
limitation to the publicly held corporation's distributive share of the 
payment. The commenter also noted that this partnership rule results in 
a different application of section 162(m) depending on whether a 
publicly held corporation's covered employee receives compensation for 
services from a partnership in which the publicly held corporation is a 
partner or from a corporate subsidiary of the partnership. Assuming the 
partnership is respected for U.S. Federal income tax purposes, section 
162(m) generally would not apply to compensation paid to a publicly 
held corporation's covered employee by a corporate subsidiary of a 
partnership for services performed as an employee of the subsidiary 
because, in this circumstance, the corporate subsidiary would not be a 
member of the publicly held corporation's affiliated group.
    In recognition of the prior lack of clarity in this area, the 
proposed regulations provide a special applicability date for this 
rule, as well as limited transition relief applicable to arrangements 
in which a publicly held corporation holds a partnership interest. 
Specifically, to ensure that compensation agreements were not formed or 
otherwise structured to circumvent the rule regarding partnerships 
after publication of the proposed regulations and prior to the 
publication of these final regulations, the proposed regulations set 
forth a special applicability date that would apply the rule to any 
deduction for compensation paid by a partnership that is otherwise 
allowable for a taxable year ending on or after December 20, 2019 (the 
publication date of the proposed regulations), but would not apply the 
rule to compensation paid pursuant to a written binding contract in 
effect on December 20, 2019 that is not materially modified after that 
date.
    Commenters requested additional transition relief for this rule. A 
commenter suggested a transition relief period of 7 years from the date 
of publication of these final regulations.\9\ Other commenters 
suggested that transition relief should apply for taxable years 
beginning before the publication of these final regulations. In the 
alternative, these commenters suggested transition relief for 
compensation arrangements in effect on December 22, 2017 (the date of 
TJCA enactment), regardless of whether the partnership is obligated to 
pay the amount of compensation under applicable law, which would 
provide for more expansive transition relief than set forth in the 
proposed regulations.
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    \9\ This commenter also suggested a transition relief period of 
10 years for taxpayers that, prior to the IRS first announcing the 
no-rule position on this issue in Revenue Procedure 2010-3, received 
private letter rulings providing that section 162(m) did not limit 
the deduction of the publicly held corporation for compensation paid 
to a covered employee by a partnership in which the publicly held 
corporation held a partnership interest. The IRS announced the no-
rule position in 2010 in section 5.06 of Revenue Procedure 2010-3, 
2010-1 I.R.B. 110, which provided that ``[w]hether the deduction 
limit under Sec.  162(m) applies to compensation attributable to 
services performed for a related partnership'' was an area under 
study in which rulings or determination letters will not be issued 
until the IRS resolves the issue through publication of a revenue 
ruling, revenue procedure, regulations, or otherwise.
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    As the preamble to the proposed regulations explains, the 
transition relief for this definition of compensation must be designed 
to ensure that compensation agreements are not formed or otherwise 
structured to circumvent the proposed rules after publication of the 
proposed regulations and prior to the publication of these

[[Page 86486]]

final regulations. In consideration of commenters' requests for 
additional transition relief, these final regulations modify the 
applicability date of the definition of compensation under Sec.  1.162-
33(c)(3)(ii) to provide additional limited transition relief. Under 
these final regulations, the definition of compensation under Sec.  
1.162-33(c)(3)(ii) includes an amount equal to a publicly held 
corporation's distributive share of a partnership's deduction for 
compensation expense attributable to the compensation paid by the 
partnership after December 18, 2020, the date on which these final 
regulations were made publicly available on the IRS website at https://www.irs.gov. Because the date that these final regulations are made 
publicly available is prior to the date that they are published in the 
Federal Register, using the earlier date for the expiration of the 
additional transition relief is appropriate to ensure that compensation 
is not paid to circumvent these final regulations. In addition, these 
final regulations continue to provide that this aspect of the 
definition of compensation does not apply to compensation paid after 
December 30, 2020 if the compensation is paid pursuant to a written 
binding contract that is in effect on December 20, 2019, and that is 
not materially modified after that date.

C. Compensation for Services in a Capacity Other Than as a Common Law 
Employee

    The proposed regulations provide that compensation subject to 
section 162(m) includes remuneration for services performed by a 
covered employee in any capacity, including as a common law employee, a 
director, or an independent contractor. As explained in section IV. C 
of the preamble to the proposed regulations, this rule is based on the 
lack of a specific limitation in the statutory language regarding the 
capacity in which the covered employee must perform the services for 
which remuneration is paid, and it is supported by the legislative 
history to the enactment of section 162(m) in 1993 \10\ and the 
preamble to the 1993 proposed regulations.\11\
---------------------------------------------------------------------------

    \10\ The legislative history to the enactment of section 162(m) 
provides that:
    Unless specifically excluded, the deduction limitation applies 
to all remuneration for services, including cash and the cash value 
of all remuneration (including benefits) paid in a medium other than 
cash. If an individual is a covered employee for a taxable year, the 
deduction limitation applies to all compensation not explicitly 
excluded from the deduction limitation, regardless of whether the 
compensation is for services as a covered employee and regardless of 
when the compensation was earned.
    House Conf. Rpt. 103-213, 585 (1993).
    \11\ The preamble to the 1993 proposed regulations provides 
that, ``[t]he deduction limit of section 162(m) applies to any 
compensation that could otherwise be deducted in a taxable year, 
except for enumerated types of payments set forth in section 
162(m)(4)'' (58 FR 66310, 66310).
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    In response to the proposed regulations, commenters suggested that, 
based on the language of section 162(m)(4)(A), compensation subject to 
section 162(m) should include only compensation for services performed 
by a covered employee as an employee of the publicly held corporation. 
The commenters reasoned that, because section 162(m)(4)(A) uses the 
phrase ``for remuneration for services performed by such employee'' 
(emphasis added) in defining compensation subject to section 162(m), 
only compensation for services provided as an employee is subject to 
section 162(m).\12\
---------------------------------------------------------------------------

    \12\ In suggesting that the statute should be read to exclude 
payments for services performed as an independent contractor from 
compensation subject to section 162(m), commenters point to a 
private letter ruling issued in 1997 (PLR 9745002). In the letter 
ruling, based on the facts presented, the IRS ruled that, for 
purposes of section 162(m), compensation excludes consulting fees 
for services performed by a covered employee as an independent 
contractor. A private letter ruling may be relied upon only by the 
taxpayer to whom the ruling was issued and does not constitute 
generally applicable guidance. See section 11.02 of Revenue 
Procedure 2020-1, 2020-01 I.R.B. 144.
---------------------------------------------------------------------------

    While the statute may be read in the manner suggested by the 
commenters, there is nothing in the language that compels this reading, 
nor does the legislative history to the enactment of section 162(m) 
suggest that compensation subject to section 162(m) was intended to 
include only compensation for services as an employee. Section 
162(m)(4)(A), which was not amended by TCJA, provides that ``the term 
`applicable employee remuneration' means, with respect to any covered 
employee for any taxable year, the aggregate amount allowable as a 
deduction under this chapter for such taxable year . . . for 
remuneration for services performed by such employee (whether or not 
during the taxable year).'' The legislative history provides that 
section 162(m) ``applies to all compensation . . . regardless of 
whether the compensation is for services as a covered employee and 
regardless of when the compensation was earned.'' \13\ Consistent with 
this legislative history, the 1995 regulations defined the term 
compensation as ``the aggregate amount allowable as a deduction . . . 
for remuneration for services performed by a covered employee, whether 
or not the services were performed during the taxable year.'' \14\ 
Thus, neither the statute nor the 1995 regulations specifically limit 
the compensation subject to section 162(m) to remuneration paid to the 
covered employee for services as an employee.
---------------------------------------------------------------------------

    \13\ House Conf. Rpt. 103-213, 585 (1993).
    \14\ Section 1.162-27(c)(3)(i). The preamble to the 1993 
proposed regulations reiterates this principle, as quoted earlier.
---------------------------------------------------------------------------

    Commenters also suggested that section 162(m) does not apply to 
compensation for services as an independent contractor because by 
excluding from the definition of compensation payments that may be made 
only to an employee, section 162(m)(4)(C) indicates that compensation 
subject to section 162(m) is limited to compensation for services as an 
employee. Section 162(m)(4)(C) excludes from the definition of 
compensation: ``(i) any payment referred to in so much of section 
3121(a)(5) as precedes subparagraph (E) thereof, and (ii) any benefit 
provided to or on behalf of an employee if at the time such benefit is 
provided it is reasonable to believe that the employee will be able to 
exclude such benefit from gross income under this chapter.''
    Section 162(m)(4)(i), by cross-referencing sections 3121(a)(5)(A)-
(D), generally excludes from compensation contributions by an employer 
on an employee's behalf to certain types of qualified retirement plans 
and payments from those types of plans to the employee. Thus, 
contributions to these arrangements for which an employer would 
otherwise have a deduction available will not be treated as 
compensation and the deduction will not be limited by section 162(m). 
Section 162(m)(4)(C)(ii) serves a similar function by excluding from 
compensation (and thus not limiting the compensation deduction) certain 
employee benefits that would be excludible from the employee's income. 
These exclusions of benefit payments from the definition of 
``applicable employee remuneration'' reflect only that an individual 
must be an active employee of the publicly held corporation (or a 
predecessor) at some

[[Page 86487]]

point in order to become a covered employee, and that the individual 
typically would participate in these types of employee benefit 
arrangements as an employee (often continuing participation that 
started before the individual became a covered employee).
    Importantly, the TCJA amendments to section 162(m) changed the 
context in which the question as to whether non-employee compensation 
is subject to the deduction limitation is analyzed. Prior to TCJA, the 
section 162(m) deduction limitation could be avoided by ensuring that 
any compensation in excess of $1,000,000 paid to a covered employee 
qualified as performance-based compensation or was paid to the covered 
employee after separation from service or after termination of the 
individual's status as a covered employee. For example, if a PEO ceased 
serving as PEO or as an executive officer but continued as an employee 
of the publicly held corporation for later taxable years, the former 
PEO could be compensated without taking into account the potential for 
a limitation on the deduction due to section 162(m).
    The TCJA amendment of section 162(m) eliminates the exclusion from 
the deduction limitation for compensation paid after the individual is 
no longer a covered employee. Under the amended section 162(m) rules, 
once an individual is identified as a covered employee, the individual 
continues to be a covered employee, and all compensation paid to that 
individual is subject to the deduction limitation, even after the 
individual is no longer employed by the publicly held corporation. As 
explained in the legislative history, this result was intended.\15\
---------------------------------------------------------------------------

    \15\ House Conf. Rpt. 115-466, 489 (2017).
---------------------------------------------------------------------------

    The commenters' suggestion that section 162(m) does not apply to 
compensation for services as an independent contractor would lead to 
uncertainty and administrative burdens for both the taxpayer and the 
IRS, as well as to the potential for abusive arrangements structured to 
avoid the application of section 162(m) to covered employees who have 
terminated employment (or who have purportedly terminated employment). 
Given that the amendments to section 162(m) no longer limit the 
deduction disallowance to taxable years in which a covered employee is 
employed on the last day of the taxable year, and the lack of statutory 
language or legislative history specifically indicating an intent to 
restrict the deduction limitation to compensation earned by the 
individual in the capacity as an employee, the Treasury Department and 
the IRS have determined that the more appropriate construction of the 
statutory language defining ``applicable employee remuneration'' is to 
include all compensation paid to a covered employee regardless of the 
capacity in which the covered employee performed services to earn that 
compensation.

V. Privately Held Corporations That Become Publicly Held

    These final regulations adopt the rules set forth in the proposed 
regulations providing that, in the case of a privately held corporation 
that becomes a publicly held corporation, section 162(m) limits the 
deduction for any compensation that is otherwise deductible for the 
taxable year ending on or after the date that the corporation becomes a 
publicly held corporation, and that a corporation is considered to 
become publicly held on the date that its registration statement 
becomes effective under the Securities Act or the Exchange Act. These 
final regulations also adopt the transition relief set forth in the 
proposed regulations providing that a privately held corporation that 
becomes a publicly held corporation on or before December 20, 2019, 
generally may rely on the transition rules provided in Sec.  1.162-
27(f)(1) and (2) of the 1995 regulations.\16\ In response to a question 
from a commenter, these final regulations clarify that a subsidiary 
that is a member of an affiliated group may rely on transition relief 
provided in Sec.  1.162-27(f)(4) of the 1995 regulations if it becomes 
a separate publicly held corporation (for example, in a spin-off 
transaction) on or before December 20, 2019.
---------------------------------------------------------------------------

    \16\ Specifically, a privately held corporation that becomes a 
publicly held corporation before December 20, 2019, may rely on the 
transition rules provided in Sec.  1.162-27(f)(1) until the earliest 
of the events described in Sec.  1.162-27(f)(2). As provided in the 
1995 regulations, a corporation that is a member of an affiliated 
group that includes a publicly held corporation is considered 
publicly held and, thus, may not rely on the transition relief 
provided in Sec.  1.162-27(f)(1).
---------------------------------------------------------------------------

    Consistent with comments received prior to issuance of the proposed 
regulations, a commenter suggested that these final regulations should 
continue to provide transition relief similar to that provided in Sec.  
1.162-27(f)(1) and (2) of the 1995 regulations for privately held 
corporations that become publicly held after December 20, 2019. Those 
sections of the 1995 regulations were formulated based on the 
legislative history to the enactment of section 162(m) and were 
intended to permit a transition period to meet the shareholder approval 
requirement for qualified performance-based compensation so that the 
resulting compensation would not be subject to the deduction limitation 
under section 162(m). TCJA eliminated the exclusion from the definition 
of compensation for qualified performance-based compensation. Thus, a 
transition period to accommodate a shareholder approval process is no 
longer needed. There is no indication in the language of the amended 
section 162(m) or the legislative history to the amendments that the 
transition period was intended be extended even though the original 
basis for its adoption no longer exists. Accordingly, the suggestion is 
not adopted in these final regulations.

VI. Grandfather Rule

A. In General

    Section 13601(e) of TCJA generally provides that the amendments to 
section 162(m) apply to taxable years beginning after December 31, 
2017. However, it further provides that those amendments do not apply 
to compensation that is payable pursuant to a written binding contract 
that was in effect on November 2, 2017, and that was not modified in 
any material respect on or after that date (the grandfather rule).
    As discussed in section VI. A of the preamble to the proposed 
regulations, the text of section 13601(e) of TJCA is almost identical 
to the text of pre-TCJA section 162(m)(4)(D), which provided a 
transition rule in connection with the enactment of section 162(m) in 
1993 (the 1993 grandfather rule). Under the 1993 grandfather rule, 
section 162(m) did not apply to compensation payable under a written 
binding contract that was in effect on February 17, 1993, and that was 
not modified thereafter in any material respect before the compensation 
was paid. Section 1.162-27(h) provides guidance on the definitions of 
written binding contract and material modification for purposes of 
applying the 1993 grandfather rule. The proposed regulations adopt 
those definitions for purposes of the grandfather rule under section 
13601(e) of TCJA. These final regulations adopt the provisions of the 
proposed regulations and retain these definitions, including that 
compensation is payable under a written binding contract that was in 
effect on November 2, 2017, only to the extent that the corporation is 
obligated under applicable law to pay the compensation if the employee 
performs services or satisfies the applicable vesting conditions. 
Section 162(m), as amended, applies to any amount of compensation that 
exceeds the amount that applicable law obligates the corporation to pay 
under a written

[[Page 86488]]

binding contract that was in effect on November 2, 2017.
    In response to the proposed regulations, a commenter requested that 
these final regulations adopt a safe harbor based on Generally 
Acceptable Accounting Principles (GAAP). The same suggestion had been 
made prior to issuance of the proposed regulations, and section VI. A 
of the preamble to the proposed regulations describes a number of 
issues with a GAAP safe harbor and asks for comments on how and whether 
these issues could be addressed. The commenter did not address any of 
these issues related to the formulation and application of a GAAP safe 
harbor. Accordingly, these final regulations do not adopt a GAAP safe 
harbor rule.
    Another commenter suggested a safe harbor that would grandfather an 
amount of compensation paid pursuant to a compensation arrangement that 
satisfied three requirements on or before November 2, 2017: (1) The 
arrangement was memorialized in some form of media (for example, 
presentation slides or spreadsheet); (2) the arrangement was 
communicated to its participants (for example, disseminated in hard 
copy, electronically, or via presentation format); and (3) participants 
in the arrangement had a reasonable expectation that they were eligible 
to receive compensation pursuant to the arrangement. This suggested 
safe harbor would require an intensive facts and circumstances analysis 
and raise administrability issues about how to determine the 
participants' expectations regarding the compensation arrangement and 
whether those expectations were reasonable. Furthermore, the suggested 
safe harbor arguably is inconsistent with the statutory language that 
grandfathers an amount of compensation only if the corporation was 
obligated to pay it under applicable law pursuant to a written binding 
contract in effect on November 2, 2017, and not, for example, if an 
employee merely had a reasonable expectation of payment (without regard 
to the corporation's obligation under applicable law). For these 
reasons, these final regulations do not adopt this safe harbor.

B. Compensation Subject to Negative Discretion

    These final regulations adopt the rule set forth in the proposed 
regulations providing that a provision in a compensation agreement that 
purports to provide the employer with the discretion to reduce or 
eliminate a compensation payment (negative discretion) is taken into 
account only to the extent the corporation has the right to exercise 
the negative discretion under applicable law (for example, applicable 
state contract law). If a compensation arrangement allows the 
corporation to exercise negative discretion, compensation payable under 
the arrangement is not grandfathered to the extent the corporation is 
not obligated to pay it under applicable law.
    In response to the proposed regulations, a commenter suggested that 
negative discretion provisions should be disregarded in determining 
whether compensation is grandfathered because numerous performance-
based compensation arrangements provide corporations with such 
discretion. However, the practice of including negative discretion 
provisions in compensation arrangements is based on a well-known and 
longstanding regulatory provision, and Congress could have provided for 
a grandfather rule that addressed performance-based compensation 
arrangements that include a negative discretion provision, but it did 
not. Instead, the grandfather rule refers only to compensation paid 
pursuant to a legally binding contract in effect on the transition 
date. Thus, whether a performance-based compensation arrangement that 
includes a negative discretion provision is a legally binding contract 
is determined based on applicable law.
    Another commenter suggested that a corporation should be deemed not 
to have a right to exercise negative discretion if the terms of the 
agreement provide that the corporation may not exercise this discretion 
if doing so would result in the payment of compensation that would not 
be deductible by reason of section 162(m). Whether a compensation 
agreement that includes a negative discretion provision of this sort 
would be a written binding contract that permitted the exercise of the 
negative discretion after the amendments to section 162(m) or rather 
obligated the employer to pay the compensation because the section 
162(m) amendments negated the employer's ability to exercise the 
negative discretion must be determined based on applicable law. 
Accordingly, these final regulations do not provide a separate standard 
for purposes of applying the grandfather rule to compensation 
agreements that include this type of negative discretion provision (or 
any other type of negative discretion provision).

C. Recovery of Compensation

    The proposed regulations provide that, if the corporation is 
obligated or has discretion to recover compensation paid in a taxable 
year only upon the future occurrence of a condition that is objectively 
outside of the corporation's control, then the corporation's right to 
recovery is disregarded for purposes of determining the grandfathered 
amount for the taxable year. The proposed regulations also provide 
that, if the condition occurs, then only the amount the corporation is 
obligated to pay under applicable law remains grandfathered, taking 
into account the occurrence of the condition. After further 
consideration, the Treasury Department and the IRS recognize that the 
corporation's right to recover compensation is a contractual right that 
is separate from the corporation's binding obligation under the 
contract (as of November 2, 2017) to pay the compensation. Accordingly, 
these final regulations provide that the corporation's right to recover 
compensation does not affect the determination of the amount of 
compensation the corporation has a written binding contract to pay 
under applicable law as of November 2, 2017, whether or not the 
corporation exercises its discretion to recover any compensation in the 
event the condition arises in the future.

D. Account and Nonaccount Balance Plans

    The proposed regulations include examples illustrating the 
application of the grandfather rule to account and nonaccount balance 
nonqualified deferred compensation (NQDC) plans. In response to 
comments, these final regulations clarify the application of the 
grandfather rule to compensation payable under these plans by providing 
detailed rules and thus eliminate the need to retain certain examples 
in these final regulations. Specifically, with respect to an account 
balance plan, these final regulations provide that the grandfathered 
amount under an account balance plan is the amount that the corporation 
is obligated to pay pursuant to the terms of the plan as of November 2, 
2017, as determined under applicable law. If the corporation is 
obligated to pay the employee the account balance that is credited with 
earnings and losses and has no right to terminate or materially amend 
the contract, then the grandfathered amount would be the account 
balance as of November 2, 2017, plus any additional contributions and 
earnings and losses that the corporation is obligated to credit under 
the plan, through the date of payment. These final regulations provide 
an analogous rule for nonaccount balance plans.
    If the terms of the account balance plan that is a written binding 
contract

[[Page 86489]]

as of November 2, 2017, provide that the corporation may terminate the 
plan and distribute the account balance to the employee, then the 
grandfathered amount is the account balance determined as if the 
corporation had terminated the plan on November 2, 2017, or, if later, 
the earliest possible date the plan could be terminated (termination 
date). Furthermore, whether additional contributions and earnings and 
losses credited to the account balance after the termination date, 
through the earliest possible date the account balance could have been 
distributed to the employee, are grandfathered depends on whether the 
terms of the plan require the corporation to make those contributions 
or credit those earnings and losses through the earliest possible date 
the account balance could be distributed if it were terminated as of 
the termination date. These final regulations provide an analogous rule 
for nonaccount balance plans.
    If the terms of the account balance plan provide that the 
corporation may not terminate the contract, but may discontinue future 
contributions to the account balance and distribute the account balance 
in accordance with the terms of the plan, then the grandfathered amount 
is the account balance determined as if the corporation had exercised 
the right to discontinue contributions on November 2, 2017 or, if 
later, the earliest permissible date the corporation could exercise 
that right in accordance with the terms of the plan (the freeze date). 
Furthermore, if the plan required the crediting of earnings and losses 
on the account balance after the freeze date through the payment date, 
then those earnings and losses credited to the grandfathered account 
balance are also grandfathered. These final regulations provide an 
analogous rule for nonaccount balance plans.
    Alternatively, whether the terms of the account balance plan 
provide that the corporation may terminate the plan or, instead, may 
discontinue future contributions, the corporation may elect to treat 
the account balance as of the termination date (or freeze date, if 
applicable) as the grandfathered amount regardless of when the amount 
is paid and regardless of whether it has been credited with earnings or 
losses prior to payment. These final regulations provide an analogous 
rule for nonaccount balance plans. These final regulations adopt this 
alternative grandfather rule that disregards earnings and losses in 
order to minimize the administrative burden of tracking the earnings, 
losses and new contributions (if made) on an account balance plan or 
the increase or decrease in a nonaccount balance benefit after November 
2, 2017. With respect to an account balance plan, the Treasury 
Department and IRS understand that this grandfather rule may result in 
contributions made after November 2, 2017, not being subject to the 
section 162(m) limitation if the contributions offset losses; however, 
the Treasury Department and IRS concluded that under many common 
arrangements the continuous separate tracking of earnings, losses, and 
contributions on the November 2, 2017, account balance through the 
payment date would be burdensome to administer while having a limited, 
if any, impact on the available deduction.

E. Ordering Rule for Payments Consisting of Grandfathered and Non-
Grandfathered Amounts Deductible for Taxable Years Ending Prior to 
December 20, 2019

    These final regulations adopt the ordering rule set forth in the 
proposed regulations for identifying the grandfathered amount when 
payment under a grandfathered arrangement is made in a series of 
payments. Pursuant to the ordering rule, the grandfathered amount is 
allocated to the first otherwise deductible payment paid under the 
arrangement. If the grandfathered amount exceeds the payment, then the 
excess is allocated to the next otherwise deductible payment paid under 
the arrangement. This process is repeated until the entire 
grandfathered amount has been paid.
    For example, assume an employer maintains a nonaccount balance NQDC 
plan (payable as an annuity) as of November 2, 2017, and that the 
grandfathered amount is $2,000,000. Further assume that additional 
benefits accrue under the plan after November 2, 2017, with the result 
that the employee's benefit is payable as an annual annuity of 
$1,500,000 commencing at the employee's retirement for the employee's 
life. Under these final regulations, the entire $1,500,000 paid in the 
first year is grandfathered. In the second year, only $500,000 of the 
$1,500,000 payment is grandfathered; the remaining $1,000,000 paid in 
the second year is not grandfathered. For subsequent taxable years, 
none of the $1,500,000 payments are grandfathered.
    A commenter suggested that for payments otherwise deductible for 
taxable years ending prior to the date the proposed regulations were 
published (December 20, 2019), it would be a reasonable good faith 
interpretation of the statute if the grandfathered amount were 
allocated to the last otherwise deductible payment or to each payment 
on a pro rata basis. The Treasury Department and the IRS agree and 
these final regulations permit the grandfathered amount to be allocated 
to the last otherwise deductible payment or to each payment on a pro 
rata basis for taxable years ending before December 20, 2019. However, 
these final regulations provide that the ordering rule requiring the 
grandfathered amount to be allocated to the first otherwise deductible 
payment paid under the arrangement must be used for taxable years 
ending on or after December 20, 2019, regardless of the method used to 
allocate the grandfathered amount for taxable years ending prior to 
that date.

F. Grandfathered Amount Limited to a Particular Plan or Arrangement

    These final regulations provide that the grandfathered amount 
payable under a plan or arrangement applies solely to the amounts paid 
under that plan or arrangement. Regardless of whether all of the 
grandfathered amount is paid to the employee, no portion of that 
grandfathered amount may be treated as a grandfathered amount under any 
other separate plan or arrangement in which the employee is a 
participant. If, for example, all or a portion of a grandfathered 
amount is forfeited because the employee died before being paid the 
entire amount, then any unpaid portion of the grandfathered amount may 
not be applied as a grandfathered amount to payments under any other 
separate plan or arrangement in which the employee participated.

G. Material Modification

1. In General
    These final regulations adopt the rules set forth in the proposed 
regulations related to material modifications. A material modification 
occurs when a contract is amended to increase the amount of 
compensation payable to the employee. If a written binding contract is 
materially modified, it is treated as a new contract entered into as of 
the date of the material modification. Accordingly, if a contract is 
materially modified, amounts received by an employee under the contract 
before the material modification are not affected, but amounts received 
after the material modification are treated as paid pursuant to a new 
contract, rather than as grandfathered. The adoption of a supplemental 
contract or agreement that provides for increased compensation, or the 
payment of additional compensation, results in a material modification 
if the facts and

[[Page 86490]]

circumstances demonstrate that the compensation under the supplement 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.
    If a written binding contract in effect on November 2, 2017, is 
subsequently modified to defer the payment of compensation, any 
compensation paid or to be paid that is in excess of the amount that 
was originally payable to the employee under the contract will not be 
treated as resulting in a material modification if the additional 
amount is based on either a reasonable rate of interest or a 
predetermined actual investment (whether or not assets associated with 
the original amount are actually invested therein) such that the amount 
payable by the employer at the later date will be based on the rate of 
interest or the actual rate of return on the investment (including any 
decrease, as well as any increase, in the value of the investment). 
However, the additional amount paid will not be treated as a 
grandfathered amount. Additionally, a modification of the contract 
after November 2, 2017, to offer an additional or substitute a 
predetermined actual investment as an investment alternative under the 
arrangement is not a material modification.
    A commenter suggested that these final regulations provide that the 
deferral of a grandfathered amount after November 2, 2017, but prior to 
September 10, 2018 (the publication date of Notice 2018-68), is not a 
material modification even if the earnings on the deferred amount are 
not based on either a reasonable rate of interest or a predetermined 
actual investment because taxpayers were not aware prior to the 
publication of the notice that this deferral would constitute a 
material modification. The grandfather rule described in section 
13601(e) of TCJA and its legislative history, including the definition 
and the resulting impact of a material modification, is almost 
identical to the statutory language and legislative history to the 
grandfather rule provided when section 162(m) was enacted in 1993. The 
1995 final regulations interpreting the original grandfather rule in 
the 1993 legislation provided that a deferral of payment of 
compensation will not be treated as a material modification if any 
additional amount paid were determined based on a reasonable rate of 
interest or one or more predetermined actual investments, and there is 
no indication in the grandfather rule in section 13601 of TCJA or its 
legislative history of an intent to adopt a different grandfather 
rule.\17\ Therefore, these final regulations do not adopt the 
commenter's suggestion.
---------------------------------------------------------------------------

    \17\ Section 1.162-27(h)(iii)(B) provides that if the contract 
is modified to defer the payment of compensation, any compensation 
paid in excess of the amount that was originally payable to the 
employee under the contract will not be treated as a material 
modification if the additional amount is based on either a 
reasonable rate of interest or one or more predetermined actual 
investments (whether or not assets associated with the amount 
originally owed are actually invested therein) such that the amount 
payable by the employer at the later date will be based on the 
actual rate of return of the specific investment (including any 
decrease as well as any increase in the value of the investment).
---------------------------------------------------------------------------

2. Extension of an Exercise Period for a Non-Statutory Stock Option
    Commenters asked if extending the exercise period for a non-
statutory stock option \18\ is a material modification. The grandfather 
rule in the proposed regulations provides that compensation 
attributable to the exercise of an option is grandfathered only if, as 
of November 2, 2017, pursuant to terms of the option and under 
applicable law, the employer is obligated to transfer the option's 
underlying shares of stock to the employee upon exercise of the option.
---------------------------------------------------------------------------

    \18\ A non-statutory stock option is an option other than an 
incentive stock option described in section 422 or a stock option 
granted under an employee stock purchase plan described in section 
423.
---------------------------------------------------------------------------

    The Treasury Department and the IRS recognize that, for bona fide 
business reasons, an employer may want to extend an exercise period of 
a stock option or a stock appreciation right (SAR). This often occurs 
when a stock option or SAR grant agreement provides that the exercise 
period will terminate immediately or within a short period following 
the employee's separation from service, but the employer later decides 
to waive that termination or otherwise extend the exercise period for 
some period of time upon the employee's separation from service. These 
concerns led to treating certain extensions of stock options or SARs as 
not being material modifications in the regulations under section 409A. 
For the same reasons, these final regulations incorporate the section 
409A regulatory provisions and provide that, if compensation 
attributable to the exercise of a non-statutory stock option or a SAR 
is grandfathered and the exercise period of the option or SAR is 
extended, then all compensation attributable to the exercise of the 
option or the SAR is grandfathered if the extension complies with Sec.  
1.409A-1(b)(5)(v)(C)(1).\19\
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    \19\ Section 1.409A-1(b)(5)(v)(C)(1) describes the following 
requirements for an extension: (1) At the time of the extension, the 
exercise price is greater than the underlying stock's fair market 
value and (2) the exercise period is extended to a date no later 
than the earlier of the latest date upon which the stock right could 
have expired by its original terms or the 10th anniversary of the 
original date of grant.
---------------------------------------------------------------------------

VII. Coordination With Section 409A

    Section 409A addresses NQDC arrangements and sets forth certain 
requirements that must be met to avoid current income inclusion, a 20% 
additional income tax on the amount includible in income per section 
409A(a)(1)(B)(i)(II), and a second additional income tax based on the 
tax benefit received due to the deferral per section 
409A(a)(1)(B)(i)(I). Recognizing that the TCJA amendments to section 
162(m) required coordination with the section 409A rules in certain 
circumstances, the preamble to the proposed regulations provided that 
certain modifications would be made to the regulations under section 
409A and that taxpayers may rely on the preamble until this guidance is 
issued. Commenters suggested additional modifications to the rules and 
regulations under section 409A to provide further coordination between 
sections 162(m) and 409A. Until guidance under section 409A is issued, 
taxpayers may continue to rely on the preamble to the proposed 
regulations. The Treasury Department and the IRS will continue to 
consider whether additional guidance under section 409A is appropriate.

VIII. Applicability Dates

A. General Applicability Date

    Generally, these final regulations apply to taxable years beginning 
on or after December 30, 2020. However, taxpayers may choose to apply 
these final regulations to a taxable year beginning after December 31, 
2017, provided the taxpayer applies these final regulations in their 
entirety and in a consistent manner to that taxable year and all 
subsequent taxable years. See section 7805(b)(7). Like the proposed 
regulations, these final regulations generally do not expand the 
definition of ``covered employee'' as provided in Notice 2018-68 and do 
not narrow the application of the definition of ``written binding 
contract'' as provided in Notice 2018-68. With respect to the limited 
number of changes that do affect these definitions, a special 
applicability date has been provided as described in section VIII.B of 
this preamble. Accordingly, taxpayers may not rely on Notice 2018-68 
for taxable years ending on or after December 20, 2019, the publication 
date of the proposed regulations.

[[Page 86491]]

B. Special Applicability Dates

    These final regulations include special applicability dates 
covering certain aspects of the following provisions of these final 
regulations:
    1. Definition of covered employee.
    2. Definition of predecessor of a publicly held corporation.
    3. Definition of compensation.
    4. Application of section 162(m) to a deduction for compensation 
otherwise deductible for a taxable year ending on or after a privately 
held corporation becomes a publicly held corporation.
    5. Definitions of written binding contract and material 
modification.
    First, the definition of covered employee applies to taxable years 
ending on or after September 10, 2018, the publication date of Notice 
2018-68, which provided guidance on the definition of covered employee. 
Notice 2018-68 also provided that the Treasury Department and the IRS 
anticipate that the guidance in the notice will be incorporated into 
future regulations that, with respect to the issues addressed in the 
notice, will apply to any taxable year ending on or after September 10, 
2018. These final regulations adopt the definition of covered employee 
in Notice 2018-68 as anticipated, and accordingly the definition of 
covered employee in these final regulations applies to taxable years 
ending on or after September 10, 2018. The Treasury Department and the 
IRS recognize, however, that the rules under Sec.  1.162-
33(c)(2)(i)(B), related to a corporation whose fiscal year and taxable 
year do not end on the same date, were not addressed in Notice 2018-68 
but were discussed initially in the proposed regulations. Accordingly, 
these final regulations provide that, for a corporation the fiscal and 
taxable years of which do not end on the same date, the rule requiring 
the determination of the three most highly compensated executive 
officers to be made pursuant to the rules under the Exchange Act 
applies to taxable years ending on or after December 20, 2019.
    Second, the provisions defining a predecessor corporation of a 
publicly held corporation apply to corporate transactions that occur on 
or after December 30, 2020. These final regulations also include a 
special applicability date for corporations that change from being a 
publicly held corporation to a privately held corporation, and, later, 
back to a publicly held corporation on or after December 30, 2020.
    If a corporate transaction occurs before December 30, 2020, then 
taxpayers may apply either the definition of predecessor of a publicly 
held corporation in Sec.  1.162-33(c)(2)(ii) of these final regulations 
or a reasonable good faith interpretation of the term ``predecessor'' 
in section 162(m)(3)(C) with respect to such transaction. However, with 
respect to any of the following corporate transactions occurring after 
December 20, 2019, and before December 30, 2020, excluding target 
corporations from the definition of the term ``predecessor'' is not a 
reasonable good faith interpretation of the statute: (1) A publicly 
held target corporation the stock or assets of which are acquired by 
another publicly held corporation in a transaction to which section 
381(a) applies, and (2) a publicly held target corporation, at least 
80% of the total voting power of the stock of which, and at least 80% 
of the total value of the stock of which, are acquired by a publicly 
held acquiring corporation (including an affiliated group). No 
inference is intended regarding whether the treatment of a target 
corporation as other than a ``predecessor'' in any other situation is a 
reasonable good faith interpretation of the statute.
    Third, as discussed in section IV.B. of this preamble, these final 
regulations modify the proposed applicability date for the definition 
of compensation under Sec.  1.162-33(c)(3)(ii). Under these final 
regulations, the definition of compensation under Sec.  1.162-
33(c)(3)(ii) includes an amount equal to the publicly held 
corporation's distributive share of a partnership's deduction for 
compensation expense only if the deduction is attributable to 
compensation paid by the partnership after December 18, 2020 (the date 
that these final regulations were made publicly available on the IRS 
website at https://www.irs.gov). However, these final regulations 
continue to provide a transition rule so that this aspect of the 
definition of compensation related to the distributive share of a 
partnership's deduction for compensation expense does not apply to 
compensation paid after December 30, 2020 if the compensation is paid 
pursuant to a written binding contract that is in effect on December 
20, 2019, and that is not materially modified after that date.
    Fourth, the guidance on the applicability of section 162(m)(1) to 
the deduction for any compensation otherwise deductible for a taxable 
year ending on or after the date when a corporation becomes a publicly 
held corporation applies to corporations that become publicly held 
after December 20, 2019. A corporation that was not a publicly held 
corporation and then becomes a publicly held corporation on or before 
December 20, 2019, may rely on the transition relief provided in Sec.  
1.162-27(f)(1) until the earliest of the events provided in Sec.  
1.162-27(f)(2). Furthermore, a subsidiary corporation that is a member 
of an affiliated group (as defined in Sec.  1.162-27(c)(1)(ii)) may 
rely on the transition relief provided in Sec.  1.162-27(f)(4) if it 
becomes a separate publicly held corporation (whether in a spin-off 
transaction or otherwise) on or before December 20, 2019.
    Fifth, the definitions of written binding contract and material 
modification in these final regulations apply to taxable years ending 
on or after September 10, 2018, the publication date of Notice 2018-68, 
which provided guidance defining these terms. Notice 2018-68 also 
provided that the Treasury Department and IRS anticipated that the 
guidance in the notice would be incorporated into future regulations 
that, with respect to the issues addressed in the notice, would apply 
to any taxable year ending on or after September 10, 2018. Because 
these final regulations adopt the definitions of the terms ``written 
binding contract'' and ``material modification'' that were included in 
Notice 2018-68, the guidance on these definitions in these final 
regulations applies to taxable years ending on or after September 10, 
2018.

Effect on Other Documents

    Section 4.01(13) of Revenue Procedure 2020-3, 2020-1 I.R.B. 131 
(providing that ``[w]hether the deduction limit under Sec.  162(m) 
applies to compensation attributable to services performed for a 
related partnership'' is an area in which rulings or determination 
letters will not ordinarily be issued) is obsolete as of December 30, 
2020.

Statement of Availability of IRS Documents

    The IRS Notices, Revenue Rulings, and Revenue Procedures cited in 
this document are published in the Internal Revenue Bulletin (or 
Cumulative Bulletin) and are available from the Superintendent of 
Documents, U.S. Government Publishing Office, Washington, DC 20402, or 
by visiting the IRS website at https://www.irs.gov.

Special Analyses

I. Regulatory Planning and Review

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Department of the Treasury and the Office of 
Management and Budget regarding review of tax regulations.

[[Page 86492]]

II. Regulatory Flexibility Act

    Pursuant to the Regulatory Flexibility Act (RFA) (5 U.S.C. chapter 
6), it is hereby certified that these final regulations would not have 
a significant economic impact on a substantial number of small 
entities. This certification is based on the fact that section 
162(m)(1) applies only to publicly held corporations (for example, 
corporations that list securities on a national securities exchange and 
are rarely small entities) and only impacts those publicly held 
corporations that compensate certain executive officers in excess of $1 
million in a taxable year. Pursuant to section 7805(f), the proposed 
regulations preceding these final regulations were submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business, and no comments were received.

III. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) 
requires that agencies assess anticipated costs and benefits and take 
certain actions before issuing a final rule that includes any Federal 
mandate that may result in expenditures in any one year by a state, 
local, or tribal government, in the aggregate, or by the private 
section, of $100 million in 1995 dollars, update annually for 
inflation. This rule does not include any Federal mandate that may 
result in expenditures by state, local, or tribal governments, or by 
the private section in excess of that threshold.

IV. Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on state and local 
governments, and is not required by statute, or preempts state law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive order. This final rule does not have 
federalism implications and does not impose substantial direct 
compliance costs on state and local governments or preempt state law 
within the meaning of the Executive order.

Drafting Information

    The principal author of these regulations is Ilya Enkishev, Office 
of Associate Chief Counsel (Employee Benefits, Exempt Organizations, 
and Employment Taxes). However, other personnel from the Treasury 
Department and the IRS participated in the development of these 
regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *


0
Par. 2. Section 1.162-27 is amended by revising the section heading and 
paragraphs (a) and (j)(1) to read as follows:


Sec.  1.162-27  Certain employee remuneration in excess of $1,000,000 
not deductible for taxable years beginning on or after January 1, 1994, 
and for taxable years beginning prior to January 1, 2018.

    (a) Scope. This section provides rules for the application of the 
$1 million deduction limitation under section 162(m)(1) for taxable 
years beginning on or after January 1, 1994, and beginning prior to 
January 1, 2018, and, as provided in paragraph (j) of this section, for 
taxable years beginning after December 31, 2017. For rules concerning 
the applicability of section 162(m)(1) to taxable years beginning after 
December 31, 2017, see Sec.  1.162-33. Paragraph (b) of this section 
provides the general rule limiting deductions under section 162(m)(1). 
Paragraph (c) of this section provides definitions of generally 
applicable terms. Paragraph (d) of this section provides an exception 
from the deduction limitation for compensation payable on a commission 
basis. Paragraph (e) of this section provides an exception for 
qualified performance-based compensation. Paragraphs (f) and (g) of 
this section provide special rules for corporations that become 
publicly held corporations and payments that are subject to section 
280G, respectively. Paragraph (h) of this section provides transition 
rules, including the rules for contracts that are grandfathered and not 
subject to section 162(m)(1). Paragraph (j) of this section contains 
the effective date provisions, which also specify when these rules 
apply to the deduction for compensation otherwise deductible in a 
taxable year beginning after December 31, 2017. For rules concerning 
the deductibility of compensation for services that are not covered by 
section 162(m)(1) and this section, see section 162(a)(1) and Sec.  
1.162-7. This section is not determinative as to whether compensation 
meets the requirements of section 162(a)(1). For rules concerning the 
deduction limitation under section 162(m)(6) applicable to certain 
health insurance providers, see Sec.  1.162-31.
* * * * *
    (j) * * *
    (1) In general. Section 162(m) and this section apply to the 
deduction for compensation that is otherwise deductible by the 
corporation in taxable years beginning on or after January 1, 1994, and 
beginning prior to January 1, 2018. Section 162(m) and this section 
also apply to compensation that is a grandfathered amount (as defined 
in Sec.  1.162-33(g)) at the time it is paid to the covered employee or 
otherwise deductible. For examples of the application of the rules of 
this section to grandfathered amounts paid during or otherwise 
deductible for taxable years beginning after December 31, 2017, see 
Sec.  1.162-33(g).
* * * * *

0
Par. 3. Section 1.162-33 is added to read as follows:


Sec.  1.162-33  Certain employee remuneration in excess of $1,000,000 
not deductible for taxable years beginning after December 31, 2017.

    (a) Scope. This section provides rules for the application of the 
$1 million deduction limitation under section 162(m)(1) for taxable 
years beginning after December 31, 2017. For rules concerning the 
applicability of section 162(m)(1) to taxable years beginning on or 
after January 1, 1994, and prior to January 1, 2018, see Sec.  1.162-
27. Paragraph (b) of this section provides the general rule limiting 
deductions under section 162(m)(1). Paragraph (c) of this section 
provides definitions of generally applicable terms. Paragraph (d) of 
this section provides rules for determining when a corporation becomes 
a publicly held corporation. Paragraph (e) of this section provides 
rules for payments that are subject to section 280G (golden parachute 
payments). Paragraph (f) of this section provides a special rule for 
coordination with section 4985 (stock compensation of insiders in 
expatriated corporations). Paragraph (g) of this section provides 
transition rules addressing the amendments made by Public Law 115-97, 
including the rules for contracts that are grandfathered. Paragraph (h) 
of this section sets forth the effective date provisions. For rules 
concerning the deductibility of compensation for services that are not 
covered by section 162(m)(1) and this section, see section 162(a)(1) 
and Sec.  1.162-7. This section is not determinative as to whether 
compensation meets the requirements of section 162(a)(1). For rules 
concerning

[[Page 86493]]

the deduction limitation under section 162(m)(6) applicable to certain 
health insurance providers, see Sec.  1.162-31. For purposes of this 
section, references to an amount being paid to an employee refer to the 
event that otherwise would result in the availability of a deduction to 
the employer with respect to such amount, whether that results from an 
actual payment in cash, transfer of property, or other event.
    (b) Limitation on deduction. Section 162(m)(1) precludes a 
deduction under chapter 1 of the Internal Revenue Code by any publicly 
held corporation for compensation paid to any covered employee to the 
extent that the compensation for the taxable year exceeds $1,000,000.
    (c) Definitions--(1) Publicly held corporation--(i) General rule. A 
publicly held corporation means any corporation that issues securities 
required to be registered under section 12 of the Exchange Act or that 
is required to file reports under section 15(d) of the Exchange Act. In 
addition, a publicly held corporation means any S corporation (as 
defined in section 1361(a)(1)) that issues securities that are required 
to be registered under section 12(b) of the Exchange Act, or that is 
required to file reports under section 15(d) of the Exchange Act. For 
purposes of this section, whether a corporation is publicly held is 
determined based solely on whether, as of the last day of its taxable 
year, the securities issued by the corporation are required to be 
registered under section 12 of the Exchange Act or the corporation is 
required to file reports under section 15(d) of the Exchange Act. 
Whether registration under the Exchange Act is required by rules other 
than those of the Exchange Act is irrelevant to this determination. A 
publicly traded partnership that is treated as a corporation under 
section 7704 (or otherwise) is a publicly held corporation if, as of 
the last day of its taxable year, its securities are required to be 
registered under section 12 of the Exchange Act or it is required to 
file reports under section 15(d) of the Exchange Act.
    (ii) Affiliated groups--(A) In general. A publicly held corporation 
includes an affiliated group of corporations (affiliated group), as 
defined in section 1504 (determined without regard to section 1504(b)), 
that includes one or more publicly held corporations (as defined in 
paragraph (c)(1)(i) of this section). In the case of an affiliated 
group that includes two or more publicly held corporations as defined 
in paragraph (c)(1)(i) of this section, each member of the affiliated 
group that is a publicly held corporation as defined in paragraph 
(c)(1)(i) of this section is separately subject to this section, and, 
due to having at least one member that is a publicly held corporation, 
the affiliated group as a whole is subject to this section. Thus, for 
example, assume that a publicly held corporation (as defined in 
paragraph (c)(1)(i) of this section) is a wholly-owned subsidiary of 
another publicly held corporation (as defined in paragraph (c)(1)(i) of 
this section), which is a wholly-owned subsidiary of a privately held 
corporation. In this case, the two subsidiaries are separately subject 
to this section, and all three corporations are members of an 
affiliated group that is subject to this section. If an individual is a 
covered employee of both subsidiaries, each subsidiary has its own $1 
million deduction limitation with respect to that covered employee. 
Furthermore, each subsidiary has its own set of covered employees as 
defined in paragraphs (c)(2)(i) through (iv) of this section (although 
the same individual may be a covered employee of both subsidiaries).
    (B) Proration of amount disallowed as a deduction. If, in a taxable 
year, a covered employee (as defined in paragraphs (c)(2)(i) through 
(v) of this section) of one member of an affiliated group is paid 
compensation by more than one member of the affiliated group, 
compensation paid by each member of the affiliated group is aggregated 
with compensation paid to the covered employee by all other members of 
the affiliated group (excluding compensation paid by any other publicly 
held corporation in the affiliated group, as defined in paragraph 
(c)(1)(i) of this section, of which the individual is also a covered 
employee as defined in paragraphs (c)(2)(i) through (v) of this 
section). In the event that, in a taxable year, a covered employee (as 
defined in paragraphs (c)(2)(i) through (v) of this section) is paid 
compensation by more than one publicly held corporation in an 
affiliated group and is also a covered employee of more than one 
publicly held payor corporation (as defined in paragraph (c)(1)(i) of 
this section) in the affiliated group, the amount disallowed as a 
deduction is determined separately with respect to each publicly held 
corporation of which the individual is a covered employee. Any amount 
disallowed as a deduction by this section must be prorated among the 
payor corporations (excluding any other publicly held payor corporation 
of which the individual is also a covered employee) in proportion to 
the amount of compensation paid to the covered employee (as defined in 
paragraphs (c)(2)(i) through (v) of this section) by each such 
corporation in the taxable year. For purposes of this paragraph 
(c)(1)(ii)(B), the amount of compensation treated as paid by a payor 
corporation that is not a publicly held corporation (as defined in 
paragraph (c)(1)(i) of this section) is determined by prorating the 
amount actually paid by that payor corporation in proportion to the 
total amount paid by all of the publicly held corporations of which the 
individual is a covered employee (as defined in paragraph (c)(2)(i) 
through (v) of this section). This process is repeated for each 
publicly held payor corporation of which the individual is a covered 
employee.
    (iii) Disregarded entities. For purposes of paragraph (c)(1) of 
this section, a publicly held corporation includes a corporation that 
owns an entity that is disregarded as an entity separate from its owner 
within the meaning of Sec.  301.7701-2(c)(2)(i) of this chapter if the 
disregarded entity issues securities required to be registered under 
section 12(b) of the Exchange Act, or is required to file reports under 
section 15(d) of the Exchange Act.
    (iv) Qualified subchapter S subsidiaries. For purposes of paragraph 
(c)(1) of this section, a publicly held corporation includes an S 
corporation that owns a qualified subchapter S subsidiary as defined in 
section 1361(b)(3)(B) (QSub) if the QSub issues securities required to 
be registered under section 12(b) of the Exchange Act, or is required 
to file reports under section 15(d) of the Exchange Act.
    (v) Qualified real estate investment trust subsidiaries. For 
purposes of paragraph (c)(1) of this section, a publicly held 
corporation includes a real estate investment trust as defined in 
section 856(a) that owns a qualified real estate investment trust 
subsidiary as defined in section 856(i)(2) (QRS), if the QRS issues 
securities required to be registered under section 12(b) of the 
Exchange Act or is required to file reports under section 15(d) of the 
Exchange Act.
    (vi) Examples. The following examples illustrate the provisions of 
this paragraph (c)(1). For each example, assume that no corporation is 
a predecessor of a publicly held corporation within the meaning of 
paragraph (c)(2)(ii) of this section. Furthermore, for each example, 
unless provided otherwise, a reference to a publicly held corporation 
means a publicly held corporation as defined in paragraph (c)(1)(i) of 
this section. Additionally, for each example, assume that the 
corporation is a calendar-year taxpayer and has a fiscal year ending

[[Page 86494]]

December 31 for reporting purposes under the Exchange Act. The examples 
in this paragraph (c)(1)(vi) are not intended to provide guidance on 
the legal requirements of the Securities Act and Exchange Act and the 
rules thereunder (17 CFR part 240).

    (A) Example 1 (Corporation required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. Corporation Z plans 
to issue debt securities in a public offering registered under the 
Securities Act. Corporation Z is not required to file reports under 
section 15(d) of the Exchange Act for any other class of securities 
and does not have another class of securities required to be 
registered under section 12 of the Exchange Act. On April 1, 2021, 
the SEC declares effective the Securities Act registration statement 
for Corporation Z's debt securities. As a result, Corporation Z is 
required to file reports under section 15(d) of the Exchange Act, 
and this requirement continues to apply as of December 31, 2021.
    (2) Conclusion. Corporation Z is a publicly held corporation for 
its 2021 taxable year because it is required to file reports under 
section 15(d) of the Exchange Act as of the last day of its taxable 
year.
    (B) Example 2 (Corporation not required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. The facts are the 
same as in paragraph (c)(1)(vi)(A) of this section (Example 1), 
except that, on January 1, 2022, pursuant to section 15(d) of the 
Exchange Act, Corporation Z's obligation to file reports under 
section 15(d) is automatically suspended for the fiscal year ending 
December 31, 2022, because Corporation Z meets the statutory 
requirements for an automatic suspension. As of December 31, 2022, 
Corporation Z is not required to file reports under section 15(d) of 
the Exchange Act.
    (2) Conclusion. Corporation Z is not a publicly held corporation 
for its 2022 taxable year because it is not required to file reports 
under section 15(d) of the Exchange Act as of as of the last day of 
its taxable year.
    (C) Example 3 (Corporation not required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. The facts are the 
same as in paragraph (c)(1)(vi)(B) of this section (Example 2), 
except that, on January 1, 2022, pursuant to section 15(d) of the 
Exchange Act, Corporation Z's obligation to file reports under 
section 15(d) is not automatically suspended for the fiscal year 
ending December 31, 2022. Instead, on May 2, 2022, Corporation Z is 
eligible to suspend its section 15(d) reporting obligation under 17 
CFR 240.12h-3 (Rule 12h-3 under the Exchange Act) and files Form 15, 
Certification and Notice of Termination of Registration under 
Section 12(g) of the Securities Exchange Act of 1934 or Suspension 
of Duty to File Reports under Sections 13 and 15(d) of the 
Securities Exchange Act of 1934, (or its successor) to suspend its 
section 15(d) reporting obligation for its fiscal year ending 
December 31, 2022. As of December 31, 2022, Corporation Z is not 
required to file reports under section 15(d) of the Exchange Act.
    (2) Conclusion. Corporation Z is not a publicly held corporation 
for its 2022 taxable year because it is not required to file reports 
under section 15(d) of the Exchange Act as of the last day of its 
taxable year. If Corporation Z had not utilized Rule 12h-3 to 
suspend its section 15(d) reporting obligation, Corporation Z would 
be a publicly held corporation for its 2022 taxable year because it 
would have been required to file reports under section 15(d) of the 
Exchange Act as of the last day of its taxable year.
    (D) Example 4 (Corporation required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. Corporation Y is a 
wholly-owned subsidiary of Corporation X, which is required to file 
reports under the Exchange Act. Corporation Y issued a class of debt 
securities in a public offering registered under the Securities Act, 
and therefore is required to file reports under section 15(d) of the 
Exchange Act for its fiscal year ending December 31, 2020. 
Corporation Y has no other class of securities registered under the 
Exchange Act. In its Form 10-K, Annual Report Pursuant to section 13 
or section 15(d) of the Securities Exchange Act of 1934, (or its 
successor) for the 2020 fiscal year, Corporation Y may omit Item 11, 
Executive Compensation (required by Part III of Form 10-K), which 
requires disclosure of compensation of certain executive officers, 
because it is wholly-owned by Corporation X and the other conditions 
of General Instruction I to Form 10-K are satisfied.
    (2) Conclusion. Corporation Y is a publicly held corporation for 
its 2020 taxable year because it is required to file reports under 
section 15(d) of the Exchange Act as of the last day of its taxable 
year.
    (E) Example 5 (Corporation not required to file reports under 
section 15(d) of the Exchange Act and not required to register 
securities under section 12 of the Exchange Act)--(1) Facts. 
Corporation A has a class of securities registered under section 
12(g) of the Exchange Act. For its 2020 taxable year, Corporation A 
is a publicly held corporation. On September 30, 2021, Corporation A 
is eligible to terminate the registration of its securities under 
section 12(g) of the Exchange Act pursuant to 17 CFR 240.12g-4(a)(2) 
(Rule 12g-4(a)(2) under the Exchange Act), but does not terminate 
the registration of its securities prior to December 31, 2021. 
Because Corporation A did not issue securities in a public offering 
registered under the Securities Act, Corporation A is not required 
to file reports under section 15(d) of the Exchange Act.
    (2) Conclusion. Corporation A is not a publicly held corporation 
for its 2021 taxable year because, as of the last day of its taxable 
year, the securities issued by Corporation A are not required to be 
registered under section 12 of the Exchange Act and Corporation A is 
not required to file reports under section 15(d) of the Exchange 
Act.
    (F) Example 6 (Corporation required to file reports under 
section 15(d) of the Exchange Act)--(1) Facts. The facts are the 
same as in paragraph (c)(1)(vi)(E) of this section (Example 5), 
except that Corporation A previously issued a class of securities in 
a public offering registered under the Securities Act. Furthermore, 
on October 1, 2021, Corporation A terminates the registration of its 
securities under section 12(g) of the Exchange Act. Because 
Corporation A issued a class of securities in a public offering 
registered under the Securities Act and is not eligible to suspend 
its reporting obligation under section 15(d) of the Exchange Act, as 
of December 31, 2021, Corporation A is required to file reports 
under section 15(d) of the Exchange Act.
    (2) Conclusion. Corporation A is a publicly held corporation for 
its 2021 taxable year because it is required to file reports under 
section 15(d) of the Exchange Act as of the last day of its taxable 
year.
    (G) Example 7 (Corporation not required to file reports under 
section 15(d) of the Exchange Act and not required to register 
securities under section 12 of the Exchange Act)--(1) Facts. On 
November 1, 2021, Corporation B is an issuer with only one class of 
equity securities. On November 5, 2021, Corporation B files a 
registration statement for its equity securities under section 12(g) 
of the Exchange Act. Corporation B's filing of its registration 
statement is voluntary because the Exchange Act does not require 
Corporation B to register its class of securities under section 
12(g) of the Exchange Act based on the number and composition of its 
record holders. On December 1, 2021, the SEC declares effective the 
Exchange Act registration statement for Corporation B's securities. 
As of December 31, 2021, Corporation B continues to have its class 
of equity securities registered voluntarily under section 12 of the 
Exchange Act. Corporation B is not required to file reports under 
section 15(d) of the Exchange Act because it did not register any 
class of securities in a public offering under the Securities Act.
    (2) Conclusion. Corporation B is not a publicly held corporation 
for its 2021 taxable year because, as of the last day of that 
taxable year, the securities issued by Corporation B are not 
required to be registered under section 12 of the Exchange Act and 
Corporation B is not required to file reports under section 15(d) of 
the Exchange Act.
    (H) Example 8 (Corporation not required to file reports under 
section 15(d) of the Exchange Act and not required to register 
securities under section 12 of the Exchange Act)--(1) Facts. The 
facts are the same as in paragraph (c)(1)(vi)(G) of this section 
(Example 7), except that, on December 31, 2022, because of a change 
in circumstances, Corporation B must register its class of equity 
securities under section 12(g) of the Exchange Act within 120 days 
of December 31, 2022. On February 1, 2023, the SEC declares 
effective the Exchange Act registration statement for Corporation 
B's securities.
    (2) Conclusion. Corporation B is not a publicly held corporation 
for its 2022 taxable year because, as of the last day of that 
taxable year, Corporation B is not required to file reports under 
section 15(d) of the Exchange Act and the class of equity securities 
issued by Corporation B is not yet required to be registered under 
section 12 of the Exchange Act.
    (I) Example 9 (Securities of foreign private issuer in the form 
of ADRs traded in the over-the-counter market)--(1) Facts. For its 
fiscal

[[Page 86495]]

and taxable years ending December 31, 2021, Corporation W is a 
foreign private issuer. Because Corporation W has not registered an 
offer or sale of securities under the Securities Act, it is not 
required to file reports under section 15(d) of the Exchange Act. 
Corporation W qualifies for an exemption from registration of its 
securities under section 12(g) of the Exchange Act pursuant to 17 
CFR 240.12g3-2(b) (Rule 12g3-2(b) under the Exchange Act). 
Corporation W wishes to have its securities traded in the U.S. in 
the over-the-counter market in the form of ADRs. Because Corporation 
W qualifies for an exemption pursuant to Rule 12g3-2(b), Corporation 
W is not required to register its securities underlying the ADRs 
under section 12 of the Exchange Act; however, the depositary bank 
is required to register the ADRs under the Securities Act. Even 
though the depositary bank is required to register the ADRs under 
the Securities Act, the registration of the ADRs does not result in 
either the depositary bank or Corporation W being required to file 
reports under section 15(d) of the Exchange Act. On February 3, 
2021, the SEC declares effective the Securities Act registration 
statement for the ADRs. On February 4, 2021, Corporation W's ADRs 
begin trading in the over-the-counter market. On December 31, 2021, 
the securities of Corporation W are not required to be registered 
under section 12 of the Exchange Act because Corporation W qualifies 
for an exemption pursuant to Rule 240.12g3-2(b). Furthermore, on 
December 31, 2021, Corporation W is not required to file reports 
under section 15(d) of the Exchange Act.
    (2) Conclusion. Corporation W is not a publicly held corporation 
for its 2021 taxable year because, as of the last day of that 
taxable year, the securities underlying the ADRs are not required to 
be registered under section 12 of the Exchange Act and Corporation W 
is not required to file reports under section 15(d) of the Exchange 
Act. The result would be the same if Corporation W had its 
securities traded in the over-the-counter market other than in the 
form of ADRs.
    (J) Example 10 (Securities of foreign private issuer in the form 
of ADRs quoted on Over the Counter Bulletin Board)--(1) Facts. The 
facts are the same as in paragraph (c)(1)(vi)(I) of this section 
(Example 9), except that Corporation W has its securities quoted on 
the Over the Counter Bulletin Board (OTCBB) in the form of ADRs. 
Because Corporation W qualifies for an exemption pursuant to 17 CFR 
240.12g3-2(b) (Rule 12g3-2(b) under the Exchange Act), Corporation W 
is not required to register its securities underlying the ADRs under 
section 12 of the Exchange Act. However, the depositary bank is 
required to register the ADRs under the Securities Act. In addition, 
section 6530(b)(1) of the OTCBB Rules requires that a foreign equity 
security may be quoted on the OTCBB only if the security is 
registered with the SEC pursuant to section 12 of the Exchange Act 
and the issuer of the security is current in its reporting 
obligations. To comply with the OTCBB Rules, on February 5, 2021, 
Corporation W files a registration statement for its class of 
securities underlying the ADRs under section 12(g) of the Exchange 
Act. On February 26, 2021, the SEC declares effective the Exchange 
Act registration statement for Corporation W's securities. As of 
December 31, 2021, Corporation W is subject to the reporting 
obligations under section 12 of the Exchange Act as a result of the 
section 12 registration.
    (2) Conclusion. Corporation W is not a publicly held corporation 
for its 2021 taxable year because, as of the last day of that 
taxable year, its ADRs and the securities underlying the ADRs are 
not required by the Exchange Act to be registered under section 12 
and Corporation W is not required to file reports under section 
15(d) of the Exchange Act. The Securities Act requirement applicable 
to the bank pursuant to the OTCBB rules is irrelevant. The result 
would be the same if Corporation W had its securities traded on the 
OTCBB other than in the form of ADRs.
    (K) Example 11 (Securities of foreign private issuer in the form 
of ADRs listed on a national securities exchange without a capital 
raising transaction)--(1) Facts. For its fiscal and taxable years 
ending December 31, 2021, Corporation V is a foreign private issuer. 
Corporation V wishes to list its securities on the New York Stock 
Exchange (NYSE) in the form of ADRs without a capital raising 
transaction. Under the Exchange Act, Corporation V is required to 
register its securities underlying the ADRs under section 12(b) of 
the Exchange Act. Because the ADRs and the deposited securities are 
separate securities, the depositary bank is required to register the 
ADRs under the Securities Act. On February 2, 2021, the SEC declares 
effective Corporation V's registration statement under section 12(b) 
of the Exchange Act in connection with the underlying securities, 
and the depositary bank's registration statement under the 
Securities Act in connection with the ADRs. On March 1, 2021, 
Corporation V's securities begin trading on the NYSE in the form of 
ADRs. As of December 31, 2021, Corporation V is not required to file 
reports under section 15(d) of the Exchange Act; however, the 
securities underlying the ADRs are required to be registered under 
section 12(b) of the Exchange Act.
    (2) Conclusion. Corporation V is a publicly held corporation for 
its 2021 taxable year because, as of the last day of that taxable 
year, the securities underlying the ADRs are required to be 
registered under section 12 of the Exchange Act. The result would be 
the same if Corporation V had its securities listed on the NYSE 
other than in the form of ADRs. The result also would be the same if 
Corporation V had wished to raised capital during its 2021 taxable 
year and been required to register the offer of securities 
underlying the ADRs under the Securities Act and to register the 
class of those securities under section 12(b) of the Exchange Act, 
and the depositary bank was required to register the ADRs under the 
Securities Act.
    (L) Example 12 (Foreign private issuer incorporates subsidiary 
in the United States to issue debt securities and subsequently 
issues a guarantee)--(1) Facts. For its fiscal and taxable years 
ending December 31, 2021, Corporation T is a foreign private issuer. 
Corporation T wishes to access the U.S. capital markets. Corporation 
T incorporates Corporation U, a wholly-owned subsidiary, in the U.S. 
to issue debt securities. On January 15, 2021, the SEC declares 
effective Corporation U's Securities Act registration statement. To 
enhance Corporation U's credit and the marketability of Corporation 
U's debt securities, Corporation T issues a guarantee of Corporation 
U's securities and, as required, registers the guarantee under the 
Securities Act on Corporation U's registration statement. On 
December 31, 2021, Corporations T and U are required to file reports 
under section 15(d) of the Exchange Act.
    (2) Conclusion. Corporations T and U are publicly held 
corporations for their 2021 taxable years because they are required 
to file reports under section 15(d) of the Exchange Act as of the 
last day of their taxable years.
    (M) Example 13 (Affiliated group comprised of two corporations, 
one of which is a publicly held corporation)--(1) Facts. Employee D, 
a covered employee of Corporation N, receives compensation from, 
Corporations N and O, members of an affiliated group. Corporation N, 
the parent corporation, is a publicly held corporation. Corporation 
O is a direct subsidiary of Corporation N and is a privately held 
corporation. The total compensation paid to Employee D from the 
affiliated group members is $3,000,000 for the taxable year, of 
which Corporation N pays $2,100,000 and Corporation O pays $900,000.
    (2) Conclusion. Because the compensation paid by all affiliated 
group members is aggregated for purposes of section 162(m)(1), 
$2,000,000 of the aggregate compensation paid is nondeductible. 
Corporations N and O each are treated as paying a ratable portion of 
the nondeductible compensation. Thus, two thirds of each 
corporation's payment will be nondeductible. Corporation N has a 
nondeductible compensation expense of $1,400,000 ($2,100,000 x 
$2,000,000/$3,000,000). Corporation O has a nondeductible 
compensation expense of $600,000 ($900,000 x $2,000,000/$3,000,000).
    (N) Example 14 (Affiliated group comprised of two corporations, 
one of which is a publicly held corporation)--(1) Facts. The facts 
are the same as in paragraph (c)(1)(vi)(M) of this section (Example 
13), except that Corporation O is a publicly held corporation, 
Corporation N is a privately held corporation, and Employee D is a 
covered employee of Corporation O (instead of Corporation N).
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(vi)(M) of this section (Example 13). Even though subsidiary 
Corporation O is the publicly held corporation, Corporations N and O 
still comprise an affiliated group. Accordingly, $2,000,000 of the 
aggregate compensation paid is nondeductible, and Corporations N and 
O each are treated as paying a ratable portion of the nondeductible 
compensation.
    (O) Example 15 (Affiliated group comprised of two publicly held 
corporations)--(1) Facts. The facts are the same as in paragraph 
(c)(1)(vi)(M) of this section (Example 13), except that Corporation 
O is a publicly held corporation. As in paragraph (c)(1)(vi)(M) of 
this section

[[Page 86496]]

(Example 13), Employee D is not a covered employee of Corporation O.
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(vi)(M) of this section (Example 13). Even though Corporations 
N and O each are publicly held corporations, Corporations N and O 
comprise an affiliated group for purposes of prorating the amount 
disallowed as a deduction. Accordingly, $2,000,000 of the aggregate 
compensation paid is nondeductible, and Corporations N and O each 
are treated as paying a ratable portion of the nondeductible 
compensation.
    (P) Example 16 (Affiliated group comprised of two publicly held 
corporations)--(1) Facts. The facts are the same as in paragraph 
(c)(1)(vi)(O) of this section (Example 15), except that Employee D 
also is a covered employee of Corporation O.
    (2) Conclusion. Corporations N and O each are publicly held 
corporations and separately subject to this section, but also 
comprise an affiliated group. Because Employee D is a covered 
employee of both Corporations N and O, each of which is a separate 
publicly held corporation, the determination of the amount 
disallowed as a deduction is made separately for each publicly held 
corporation. Corporation N has a nondeductible compensation expense 
of $1,100,000 (the excess of $2,100,000 over $1,000,000), and 
Corporation O has no nondeductible compensation expense because the 
amount it paid to Employee D did not exceed $1,000,000.
    (Q) Example 17 (Affiliated group comprised of three 
corporations, one of which is a publicly held corporation)--(1) 
Facts. Employee C, a covered employee of publicly held parent 
Corporation P, receives compensation from Corporations P, Q, and R, 
members of an affiliated group. Corporation Q is a direct subsidiary 
of Corporation P, and Corporation R is a direct subsidiary of 
Corporation Q. Corporations Q and R both are privately held. The 
total compensation paid to Employee C from the affiliated group 
members is $3,000,000 for the taxable year, of which Corporation P 
pays $1,500,000, Corporation Q pays $900,000, and Corporation R pays 
$600,000.
    (2) Conclusion. Because the compensation paid by affiliated 
group members is aggregated for purposes of section 162(m)(1), 
$2,000,000 of the aggregate compensation paid is nondeductible. 
Corporations P, Q, and R each are treated as paying a ratable 
portion of the nondeductible compensation. Thus, two thirds of each 
corporation's payment will be nondeductible. The nondeductible 
compensation expense for Corporation P is $1,000,000 ($1,500,000 x 
$2,000,000/$3,000,000); for Corporation Q is $600,000 ($900,000 x 
$2,000,000/$3,000,000); and for Corporation R is $400,000 ($600,000 
x $2,000,000/$3,000,000).
    (R) Example 18 (Affiliated group comprised of three 
corporations, one of which is a publicly held corporation)--(1) 
Facts. The facts are the same as in paragraph (c)(1)(vi)(Q) of this 
section (Example 17), except that Corporation Q is a publicly held 
corporation and Corporation P is a privately held corporation, and 
Employee C is a covered employee of Corporation Q (instead of 
Corporation P).
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(vi)(Q) of this section (Example 17). Even though Corporation 
Q, the subsidiary, is the publicly held corporation, Corporations P, 
Q, and R comprise an affiliated group. Accordingly, $2,000,000 of 
the aggregate compensation paid is nondeductible, and Corporations 
P, Q, and R each are treated as paying a ratable portion of the 
nondeductible compensation.
    (S) Example 19 (Affiliated group comprised of three 
corporations, two of which are publicly held corporations)--(1) 
Facts. The facts are the same as in paragraph (c)(1)(vi)(R) of this 
section (Example 18), except that Corporation R also is a publicly 
held corporation. As in paragraph (c)(1)(vi)(R) of this section 
(Example 18), Corporation Q is a publicly held corporation, 
Corporation P is a privately held corporation, and Employee C is a 
covered employee of Corporation Q but not a covered employee of 
Corporation R.
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(vi)(R) of this section (Example 18). Even though Corporation 
R also is a publicly held corporation, Corporations P, Q, and R 
comprise an affiliated group. Accordingly, $2,000,000 of the 
aggregate compensation paid is nondeductible, and Corporations P, Q, 
and R each are treated as paying a ratable portion of the 
nondeductible compensation.
    (T) Example 20 (Affiliated group comprised of three publicly 
held corporations)--(1) Facts. The facts are the same as in 
paragraph (c)(1)(vi)(Q) of this section (Example 17), except that 
Corporations Q and R also are publicly held corporations, and 
Employee C is a covered employee of both Corporations P and Q but is 
not a covered employee of Corporation R.
    (2) Conclusion. Even though Corporations P, Q, and R each are 
publicly held corporations, they comprise an affiliated group. 
Because Employee C is a covered employee of both Corporations P and 
Q, the determination of the amount disallowed as a deduction is 
separately prorated among Corporations P and R and among 
Corporations Q and R. For each separate calculation of the total 
amount of the disallowed deduction and the proration of the 
disallowed deduction, the amount paid by Corporation R is taken into 
account in proportion to the total compensation paid by Corporations 
P and Q. With respect to Corporations P and R, $875,000 of the 
aggregate compensation is nondeductible (the excess of $1,875,000 
(the sum of the compensation paid by Corporation P ($1,500,000) and 
the portion of compensation paid by Corporation R that is treated as 
allocable to Employee C being a covered employee of Corporation P 
($600,000 x $1,500,000/($1,500,000 + $900,000) = $375,000) over the 
$1,000,000 deduction limitation). Corporations P and R each are 
treated as paying a ratable portion of the nondeductible 
compensation. Corporation P has a nondeductible compensation expense 
of $700,000 ($1,500,000 x $875,000/$1,875,000), and Corporation R 
has a nondeductible compensation expense of $175,000 ($375,000 x 
$875,000/$1,875,000). For Corporations Q and R, $125,000 of the 
aggregate compensation is nondeductible (the excess of $1,125,000 
(the sum of the compensation paid by Corporation Q ($900,000) and 
the portion of compensation paid by Corporation R that is treated as 
allocable to Employee C being a covered employee of Corporation Q 
($600,000 x $900,000/($1,500,000 + $900,000) = $225,000) over the 
$1,000,000 deduction limitation). Corporation Q has a nondeductible 
compensation expense of $100,000 ($900,000 x $125,000/$1,125,000), 
and Corporation R has a nondeductible compensation expense of 
$25,000 ($225,000 x $125,000/$1,125,000). The total nondeductible 
compensation expense for Corporation R is $200,000.
    (U) Example 21 (Affiliated group comprised of three publicly 
held corporations)--(1) Facts. The facts are the same as in 
paragraph (c)(1)(vi)(T) of this section (Example 20), except that 
Employee C does not receive any compensation from Corporation R.
    (2) Conclusion. Even though Corporations P, Q, and R each are 
publicly held corporations and separately subject to this section, 
they comprise an affiliated group. Because Employee C is a covered 
employee of, and receives compensation from, both Corporations P and 
Q, each of which is a separate publicly held corporation, the 
determination of the amount disallowed as a deduction is made 
separately for Corporations P and Q. Corporation P has a 
nondeductible compensation expense of $500,000 (the excess of 
$1,500,000 over $1,000,000), and Corporation Q has no nondeductible 
compensation expense because the amount it paid to Employee C was 
below $1,000,000.
    (V) Example 22 (Affiliated group comprised of three 
corporations, one of which is a publicly held corporation)--(1) 
Facts. The facts are the same as in paragraph (c)(1)(vi)(Q) of this 
section (Example 17), except that Corporation R is a direct 
subsidiary of Corporation P (and not a direct subsidiary of 
Corporation Q).
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(vi)(Q) of this section (Example 17). Corporations P, Q, and R 
comprise an affiliated group. Accordingly, $2,000,000 of the 
aggregate compensation paid is nondeductible, and Corporations P, Q, 
and R each are treated as paying a ratable portion of the 
nondeductible compensation.
    (W) Example 23 (Affiliated group comprised of three publicly 
held corporations)--(1) Facts. The facts are the same as in 
paragraph (c)(1)(vi)(V) of this section (Example 22), except that 
Corporations Q and R also are publicly held corporations, and 
Employee C is a covered employee of both Corporations P and Q but 
not of Corporation R.
    (2) Conclusion. The result is the same as in paragraph 
(c)(1)(vi)(V) of this section (Example 22). Even though Corporations 
P, Q, and R each are publicly held corporations, they comprise an 
affiliated group. Because Employee C is a covered employee of both 
Corporations P and Q, the amount disallowed as a deduction is 
prorated separately among Corporations P and R and among 
Corporations Q and R.
    (X) Example 24 (Disregarded entity)--(1) Facts. Corporation G is 
privately held for its

[[Page 86497]]

2020 taxable year. Entity H, a limited liability company, is wholly-
owned by Corporation G and is disregarded as an entity separate from 
its owner under Sec.  301.7701-2(c)(2)(i) of this chapter. As of 
December 31, 2020, Entity H is required to file reports under 
section 15(d) of the Exchange Act.
    (2) Conclusion. Because Entity H is required to file reports 
under section 15(d) of the Exchange Act and is disregarded as an 
entity separate from its owner, Corporation G is a publicly held 
corporation for its 2020 taxable year. The result would be the same 
if Corporation G was a REIT under section 856(a) and Entity H was a 
QRS under section 856(i)(2).

    (2) Covered employee--(i) General rule. Except as provided in 
paragraph (c)(2)(vi) of this section, with respect to a publicly held 
corporation as defined in paragraph (c)(1) of this section (without 
regard to paragraph (c)(1)(ii) of this section), for the publicly held 
corporation's taxable year, a covered employee means any of the 
following--
    (A) The principal executive officer (PEO) or principal financial 
officer (PFO) of the publicly held corporation serving at any time 
during the taxable year, including individuals acting in either such 
capacity.
    (B) The three highest compensated executive officers of the 
publicly held corporation for the taxable year (other than the 
principal executive officer or principal financial officer, or an 
individual acting in such capacity), regardless of whether the 
executive officer is serving at the end of the publicly held 
corporation's taxable year, and regardless of whether the executive 
officer's compensation is subject to disclosure for the last completed 
fiscal year under the executive compensation disclosure rules under the 
Exchange Act. For purposes of this paragraph (c)(2)(i)(B), the term 
``executive officer'' means an executive officer as defined in 17 CFR 
240.3b-7. The amount of compensation used to identify the three most 
highly compensated executive officers for the taxable year is 
determined pursuant to the executive compensation disclosure rules 
under the Exchange Act (using the taxable year as the fiscal year for 
purposes of making the determination), regardless of whether the 
corporation's fiscal year and taxable year end on the same date.
    (C) Any individual who was a covered employee of the publicly held 
corporation (or any predecessor of a publicly held corporation, within 
the meaning of paragraph (c)(2)(ii) of this section) for any preceding 
taxable year beginning after December 31, 2016. For taxable years 
beginning prior to January 1, 2018, covered employees are identified in 
accordance with the rules in Sec.  1.162-27(c)(2).
    (ii) Predecessor of a publicly held corporation--(A) Publicly held 
corporations that become privately held. For purposes of this paragraph 
(c)(2)(ii), a predecessor of a publicly held corporation includes a 
publicly held corporation that, after becoming a privately held 
corporation, again becomes a publicly held corporation for a taxable 
year ending before the 36-month anniversary of the due date for the 
corporation's U.S. Federal income tax return (disregarding any 
extensions) for the last taxable year for which the corporation was 
previously publicly held.
    (B) Corporate reorganizations. A predecessor of a publicly held 
corporation includes a publicly held corporation the stock or assets of 
which are acquired in a corporate reorganization (as defined in section 
368(a)(1)).
    (C) Corporate divisions. A predecessor of a publicly held 
corporation includes a publicly held corporation that is a distributing 
corporation (within the meaning of section 355(a)(1)(A)) that 
distributes the stock of a controlled corporation (within the meaning 
of section 355(a)(1)(A)) to its shareholders in a distribution or 
exchange qualifying under section 355(a)(1) (corporate division). The 
rule of this paragraph (c)(2)(ii)(C) applies only with respect to 
covered employees of the distributing corporation who begin performing 
services for the controlled corporation (or for a corporation 
affiliated with the controlled corporation that receives stock of the 
controlled corporation in the corporate division) within the period 
beginning 12 months before and ending 12 months after the distribution.
    (D) Affiliated groups. A predecessor of a publicly held corporation 
includes any other publicly held corporation that becomes a member of 
its affiliated group (as defined in paragraph (c)(1)(ii) of this 
section).
    (E) Asset acquisitions. If a publicly held corporation, including 
one or more members of an affiliated group as defined in paragraph 
(c)(1)(ii) of this section (acquiror), acquires at least 80% of the 
gross operating assets (determined by fair market value on the date of 
acquisition) of another publicly held corporation (target), then the 
target is a predecessor of the acquiror. For an acquisition of assets 
that occurs over time, only assets acquired within a 12-month period 
are taken into account to determine whether at least 80% of the 
target's gross operating assets were acquired. However, this 12-month 
period is extended to include any continuous period that ends on, or 
begins on, any day during which the acquiror has an arrangement to 
purchase, directly or indirectly, assets of the target. A shareholder's 
additions to the assets of target made as part of a plan or arrangement 
to avoid the application of this subsection to acquiror's purchase of 
target's assets are disregarded in applying this paragraph 
(c)(2)(ii)(E). This paragraph (c)(2)(ii)(E) applies only with respect 
to the target's covered employees who begin performing services for the 
acquiror (or a corporation affiliated with the acquiror) within the 
period beginning 12 months before and ending 12 months after the date 
of the transaction as defined in paragraph (c)(2)(ii)(I) of this 
section (incorporating any extensions to the 12-month period made 
pursuant to this paragraph).
    (F) Predecessor of a predecessor. For purposes of this paragraph 
(c)(2)(ii), a predecessor of a corporation includes each predecessor of 
the corporation and the predecessor or predecessors of any prior 
predecessor or predecessors.
    (G) Corporations that are not publicly held at the time of the 
transaction and sequential transactions--(1) Predecessor corporation is 
not publicly held at the time of the transaction. This paragraph 
(c)(2)(ii)(G)(1) applies if a corporation that was previously publicly 
held (the first corporation) would be a predecessor to another 
corporation (the second corporation) under the rules of this paragraph 
(c)(2)(ii) but for the fact that the first corporation is not a 
publicly held corporation at the time of the relevant transaction (or 
transactions). If this paragraph (c)(2)(ii)(G)(1) applies, the first 
corporation is a predecessor of a publicly held corporation if the 
second corporation is a publicly held corporation at the time of the 
relevant transaction (or transactions) and the relevant transaction (or 
transactions) take place during a taxable year ending before the 36-
month anniversary of the due date for the first corporation's U.S. 
Federal income tax return (excluding any extensions) for the last 
taxable year for which the first corporation was previously publicly 
held.
    (2) Second corporation is not publicly held at the time of the 
transaction. This paragraph (c)(2)(ii)(G)(2) applies if a corporation 
that is publicly held (the first corporation) at the time of the 
relevant transaction (or transactions) would be a predecessor to 
another corporation (the second corporation) under the rules of this 
paragraph (c)(2)(ii) but for the fact that the second corporation is 
not a publicly held corporation at the time of the relevant transaction 
(or transactions). If this paragraph (c)(2)(ii)(G)(2) applies, the

[[Page 86498]]

first corporation is a predecessor of a publicly held corporation if 
the second corporation becomes a publicly held corporation for a 
taxable year ending before the 36-month anniversary of the due date for 
the first corporation's U.S. Federal income tax return (excluding any 
extensions) for the first corporation's last taxable year in which the 
transaction is taken into account.
    (3) Neither corporation is publicly held at the time of the 
transaction. This paragraph (c)(2)(ii)(G)(3) applies if a corporation 
that was previously publicly held (the first corporation) would be a 
predecessor to another corporation (the second corporation) under the 
rules of this paragraph (c)(2)(ii) but for the fact that neither the 
first corporation nor the second corporation is a publicly held 
corporation at the time of the relevant transaction (or transactions). 
If this paragraph (c)(2)(ii)(G)(3) applies, the first corporation is a 
predecessor of a publicly held corporation if the second corporation 
becomes a publicly held corporation for a taxable year ending before 
the 36-month anniversary of the due date for the first corporation's 
U.S. Federal income tax return (excluding any extensions) for the last 
taxable year for which the first corporation was previously publicly 
held.
    (4) Sequential transactions. If a corporation that was previously 
publicly held (the first corporation) would be a predecessor to another 
corporation (the second corporation) under the rules of this paragraph 
(c)(2)(ii) but for the fact that the first corporation is (or its 
assets are) transferred to one or more intervening corporations prior 
to being transferred to the second corporation, and if each intervening 
corporation would be a predecessor of a publicly held corporation with 
respect to the second corporation if the intervening corporation or 
corporations were publicly held corporations, then paragraphs 
(c)(2)(ii)(G)(1) through (3) of this section also apply without regard 
to the intervening corporations.
    (H) Elections under sections 336(e) and 338. For purposes of this 
paragraph (c)(2), if a corporation makes an election to treat as an 
asset purchase either the sale, exchange, or distribution of stock 
pursuant to regulations under section 336(e) (Sec. Sec.  1.336-1 
through 1.336-5) or the purchase of stock pursuant to regulations under 
section 338 (Sec. Sec.  1.338-1 through 1.338-11, 1.338(h)(10)-1, and 
1.338(i)-1), the corporation that issued the stock is treated as the 
same corporation both before and after such transaction.
    (I) Date of transaction. For purposes of this paragraph (c)(2)(ii), 
the date that a transaction is treated as having occurred is the date 
on which all events necessary for the transaction to be described in 
the relevant provision in this paragraph (c)(2)(ii) have occurred.
    (J) Publicly traded partnership. For purposes of applying this 
paragraph (c)(2)(ii), a publicly traded partnership is a predecessor of 
a publicly held corporation if under the same facts and circumstances a 
corporation substituted for the publicly traded partnership would be a 
predecessor of the publicly held corporation, and at the time of the 
transaction the publicly traded partnership is treated as a publicly 
held corporation as defined in paragraph (c)(1)(i) of this section. In 
making this determination, the rules in paragraphs (c)(2)(ii)(A) 
through (I) of this section apply by analogy to publicly traded 
partnerships.
    (iii) Disregarded entities. If a publicly held corporation under 
paragraph (c)(1) of this section owns an entity that is disregarded as 
an entity separate from its owner under Sec.  301.7701-2(c)(2)(i) of 
this chapter, then the covered employees of the publicly held 
corporation are determined pursuant to paragraphs (c)(2)(i) and (ii) of 
this section. The executive officers of the entity that is disregarded 
as an entity separate from its corporate owner under Sec.  301.7701-
2(c)(2)(i) of this chapter are neither covered employees of the entity 
nor of the publicly held corporation unless they meet the definition of 
covered employee in paragraphs (c)(2)(i) and (ii) of this section with 
respect to the publicly held corporation, in which case they are 
covered employees for its taxable year.
    (iv) Qualified subchapter S subsidiaries. If a publicly held 
corporation under paragraph (c)(1) of this section owns an entity that 
is a QSub under section 1361(b)(3)(B), then the covered employees of 
the publicly held corporation are determined pursuant to paragraphs 
(c)(2)(i) and (ii) of this section. The executive officers of the QSub 
are neither covered employees of the QSub nor of the publicly held 
corporation unless they meet the definition of covered employee in 
paragraphs (c)(2)(i) and (ii) of this section with respect to the 
publicly held corporation, in which case they are covered employees for 
the taxable year of the publicly held corporation.
    (v) Qualified real estate investment trust subsidiaries. If a 
publicly held corporation under paragraph (c)(1) of this section owns 
an entity that is a QRS under section 856(i)(2), then the covered 
employees of the publicly held corporation are determined pursuant to 
paragraphs (c)(2)(i) and (ii) of this section. The executive officers 
of the QRS are neither covered employees of the QRS nor of the publicly 
held corporation unless they meet the definition of covered employee in 
paragraphs (c)(2)(i) and (ii) of this section with respect to the 
publicly held corporation, in which case they are covered employees for 
the taxable year of the publicly held corporation.
    (vi) Covered employee of an affiliated group. A person who is 
identified as a covered employee in paragraphs (c)(2)(i) through (v) of 
this section for a publicly held corporation's taxable year is also a 
covered employee for the taxable year of an affiliated group treated as 
a publicly held corporation pursuant to paragraph (c)(1)(ii) of this 
section (treatment of an affiliated group).
    (vii) Examples. The following examples illustrate the provisions of 
this paragraph (c)(2). For each example, assume that the corporation 
has a taxable year that is a calendar year and has a fiscal year ending 
December 31 for reporting purposes under the Exchange Act. Also, for 
each example, unless provided otherwise, assume that none of the 
employees were covered employees for any taxable year preceding the 
first taxable year set forth in that example (since being a covered 
employee for a preceding taxable year would provide a separate, 
independent basis for classifying that employee as a covered employee 
for a subsequent taxable year).

    (A) Example 1 (Covered employees of members of an affiliated 
group)--(1) Facts. Corporations A, B, and C are direct wholly-owned 
subsidiaries of Corporation D. Corporations D and A are each 
publicly held corporations as of December 31, 2020. Corporations B 
and C are not publicly held corporations for their 2020 taxable 
years. Employee E served as the PEO of Corporation D from January 1, 
2020, to March 31, 2020. Employee F served as the PEO of Corporation 
D from April 1, 2020, to December 31, 2020. Employee G served as the 
PEO of Corporation A for its entire 2020 taxable year. Employee H 
served as the PEO of Corporation B for its entire 2020 taxable year. 
Employee I served as the PEO of Corporation C for its entire 2020 
taxable year. From April 1, 2020, through September 30, 2020, 
Employee E served as an advisor (not as a PEO) to Employee I and 
received compensation from Corporation C for these services. In 
2020, all four corporations paid compensation to their respective 
PEOs.
    (2) Conclusion (Employees E and F). Because both Employees E and 
F served as the PEO of Corporation D during its 2020 taxable year, 
both Employees E and F are covered employees of Corporation D for 
its 2020 and subsequent taxable years.
    (3) Conclusion (Employee G). Because Employee G served as the 
PEO of Corporation

[[Page 86499]]

A, Employee G is a covered employee of Corporation A for its 2020 
and subsequent taxable years.
    (4) Conclusion (Employee H). Even though Employee H served as 
the PEO of Corporation B, Employee H is not a covered employee of 
Corporation B for its 2020 taxable year, because Corporation B is 
considered a publicly held corporation solely by reason of being a 
member of an affiliated group as defined in paragraph (c)(1)(ii) of 
this section.
    (5) Conclusion (Employee I). Even though Employee I served as 
the PEO of Corporation C, Employee I is not a covered employee of 
Corporation C for its 2020 taxable year, because Corporation C is 
considered a publicly held corporation solely by reason of being a 
member of an affiliated group as defined in paragraph (c)(1)(ii) of 
this section.
    (B) Example 2 (Covered employees of a publicly held 
corporation)--(1) Facts. Corporation J is a publicly held 
corporation. Corporation J is not a smaller reporting company or 
emerging growth company for purposes of reporting under the Exchange 
Act. For 2020, Employee K served as the sole PEO of Corporation J 
and Employees L and M both served as the PFO of Corporation J at 
separate times during the year. Employees N, O, and P were, 
respectively, the first, second, and third highest compensated 
executive officers of Corporation J for 2020 other than the PEO and 
PFO, and all three retired before December 31, 2020. Employees Q, R, 
and S were, respectively, Corporation J's fourth, fifth, and sixth 
highest compensated executive officers other than the PEO and PFO 
for 2020, and all three were serving as of December 31, 2020. On 
March 1, 2021, Corporation J filed its Form 10-K, Annual Report 
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 
1934 with the SEC. With respect to Item 11, Executive Compensation 
(as required by Part III of Form 10-K, or its successor), 
Corporation J disclosed the compensation of Employee K for serving 
as the PEO, Employees L and M for serving as the PFO, and Employees 
Q, R, and S pursuant to 17 CFR 229.402(a)(3)(iii) (Item 402 of 
Regulation S-K). Corporation J also disclosed the compensation of 
Employees N and O pursuant to 17 CFR 229.402(a)(3)(iv) (Item 402 of 
Regulation S-K).
    (2) Conclusion (Employee K). Because Employee K served as the 
PEO during 2020, Employee K is a covered employee for Corporation 
J's 2020 taxable year.
    (3) Conclusion (Employees L and M). Because Employees L and M 
served as the PFO during 2020, Employees L and M are covered 
employees for Corporation J's 2020 taxable year.
    (4) Conclusion (Employees N, O, P, Q, R, and S). Even though the 
executive compensation disclosure rules under the Exchange Act 
require Corporation J to disclose the compensation of Employees N, 
O, Q, R, and S for 2020, Corporation J's three highest compensated 
executive officers who are covered employees for its 2020 taxable 
year are Employees N, O, and P, because these are the three highest 
compensated executive officers other than the PEO and PFO for 2020.
    (C) Example 3 (Covered employees of a smaller reporting 
company)--(1) Facts. The facts are the same as in paragraph 
(c)(2)(vii)(B) of this section (Example 2), except that Corporation 
J is a smaller reporting company or emerging growth company for 
purposes of reporting under the Exchange Act. With respect to Item 
11, Executive Compensation, Corporation J disclosed the compensation 
of Employee K for serving as the PEO, Employees Q and R pursuant to 
17 CFR 229.402(m)(2)(ii) (Item 402(m) of Regulation S-K), and 
Employees N and O pursuant to 17 CFR 229.402(m)(2)(iii) (Item 402(m) 
of Regulation S-K).
    (2) Conclusion. The result is the same as in paragraph 
(c)(2)(vii)(L) of this section (Example 2). For purposes of 
identifying a corporation's covered employees, it is irrelevant 
whether the reporting obligation under the Exchange Act for smaller 
reporting companies and emerging growth companies apply to the 
corporation, and it is irrelevant whether the specific executive 
officers' compensation must be disclosed pursuant to the disclosure 
rules under the Exchange Act applicable to the corporation.
    (D) Example 4 (Covered employees of a publicly held corporation 
that is not required to file a Form 10-K)--(1) Facts. The facts are 
the same as in paragraph (c)(2)(vii)(B) of this section (Example 2), 
except that on February 4, 2021, Corporation J files Form 15, 
Certification and Notice of Termination of Registration under 
Section 12(g) of the Securities Exchange Act of 1934 or Suspension 
of Duty to File Reports under Sections 13 and 15(d) of the 
Securities Exchange Act of 1934, (or its successor) to terminate the 
registration of its securities. Corporation J's duty to file reports 
under Section 13(a) of the Exchange Act is suspended upon the filing 
of the Form 15 and, as a result, Corporation J is not required to 
file a Form 10-K and disclose the compensation of its executive 
officers for 2020.
    (2) Conclusion. The result is the same as in paragraph 
(c)(2)(vii)(B) of this section (Example 2). Covered employees 
include executive officers of a publicly held corporation even if 
the corporation is not required to disclose the compensation of its 
executive officers under the Exchange Act. Therefore, Employees K, 
L, M, N, O, and P are covered employees for 2020. The result would 
be different if Corporation J filed Form 15 to terminate the 
registration of its securities prior to December 31, 2020. In that 
case, Corporation J would not be a publicly held corporation for its 
2020 taxable year, and, therefore, Employees K, L, M, N, O, and P 
would not be covered employees for Corporation J's 2020 taxable 
year.
    (E) Example 5 (Covered employees of two publicly held 
corporations after a corporate transaction)--(1) Facts. Corporation 
T is a publicly held corporation for its 2019 taxable year. 
Corporation U is a privately held corporation for its 2019 and 2020 
taxable years. On July 31, 2020, Corporation U acquires for cash 80% 
of the only class of outstanding stock of Corporation T. The 
affiliated group (comprised of Corporations U and T) elects to file 
a consolidated Federal income tax return. As a result of this 
election, Corporation T has a short taxable year ending on July 31, 
2020. Corporation T does not change its fiscal year for reporting 
purposes under the Exchange Act to correspond to the short taxable 
year. Corporation T remains a publicly held corporation for its 
short taxable year ending on July 31, 2020, and its subsequent 
taxable year ending on December 31, 2020, for which it files a 
consolidated Federal income tax return with Corporation U. For 
Corporation T's taxable year ending July 31, 2020, Employee V serves 
as the only PEO, and Employee W serves as the only PFO. Employees X, 
Y, and Z are the three most highly compensated executive officers of 
Corporation T for the taxable year ending July 31, 2020, other than 
the PEO and PFO. As a result of the acquisition, effective July 31, 
2020, Employee V ceases to serve as the PEO of Corporation T. 
Instead, Employee AA starts serving as the PEO of Corporation T on 
August 1, 2020. Employee V continues to provide services for 
Corporation T but never serves as PEO again (or as an individual 
acting in such capacity). For Corporation T's taxable year ending 
December 31, 2020, Employee AA serves as the only PEO, and Employee 
W serves as the only PFO. Employees X, Y, and Z continue to serve as 
executive officers of Corporation T during the taxable year ending 
December 31, 2020. Employees BB, CC, and DD are the three most 
highly compensated executive officers of Corporation T, other than 
the PEO and PFO, for the taxable year ending December 31, 2020.
    (2) Conclusion (Employee V). Because Employee V served as the 
PEO during Corporation T's short taxable year ending July 31, 2020, 
Employee V is a covered employee for Corporation T's short taxable 
year ending July 31, 2020, even though Employee V's compensation is 
required to be disclosed pursuant to the executive compensation 
disclosure rules under the Exchange Act only for the fiscal year 
ending December 31, 2020. Because Employee V was a covered employee 
for Corporation T's short taxable year ending July 31, 2020, 
Employee V is also a covered employee for Corporation T's short 
taxable year ending December 31, 2020.
    (3) Conclusion (Employee W). Because Employee W served as the 
PFO during Corporation T's short taxable years ending July 31, 2020, 
and December 31, 2020, Employee W is a covered employee for both 
taxable years, even though Employee W's compensation is required to 
be disclosed pursuant to the executive compensation disclosure rules 
under the Exchange Act only for the fiscal year ending December 31, 
2020. Because Employee W was a covered employee for Corporation T's 
short taxable year ending July 31, 2020, Employee W would be a 
covered employee for Corporation T's short taxable year ending 
December 31, 2020, even if Employee W did not serve as the PFO 
during this taxable year.
    (4) Conclusion (Employee AA). Because Employee AA served as the 
PEO during Corporation T's short taxable year ending December 31, 
2020, Employee AA is a covered employee for that short taxable year.
    (5) Conclusion (Employees X, Y, and Z). Employees X, Y, and Z 
are covered

[[Page 86500]]

employees for Corporation T's short taxable years ending July 31, 
2020, and December 31, 2020. Employees X, Y, and Z are covered 
employees for Corporation T's short taxable year ending July 31, 
2020, because those employees are the three highest compensated 
executive officers for that short taxable year. Because they were 
covered employees for Corporation T's short taxable year ending July 
31, 2020, Employees X, Y, and Z are covered employees for 
Corporation T's short taxable year ending December 31, 2020 and 
would be covered employees for that later short taxable year even if 
their compensation would not be required to be disclosed pursuant to 
the executive compensation disclosure rules under the Exchange Act.
    (6) Conclusion (Employees BB, CC, and DD). Employees BB, CC, and 
DD are covered employees for Corporation T's short taxable year 
ending December 31, 2020, because those employees are the three 
highest compensated executive officers for that short taxable year.
    (F) Example 6 (Predecessor of a publicly held corporation)--(1) 
Facts. Corporation EE is a publicly held corporation for its 2021 
taxable year. Corporation EE is a privately held corporation for its 
2022 and 2023 taxable years. For its 2024 taxable year, Corporation 
EE is a publicly held corporation.
    (2) Conclusion. For its 2024 taxable year, Corporation EE is a 
predecessor of a publicly held corporation within the meaning of 
paragraph (c)(2)(ii)(A) of this section because, after ceasing to be 
a publicly held corporation, it again became a publicly held 
corporation for a taxable year ending prior to April 15, 2025. 
Therefore, for Corporation EE's 2024 taxable year, the covered 
employees of Corporation EE include the covered employees of 
Corporation EE for its 2021 taxable year and any additional covered 
employees determined pursuant to this paragraph (c)(2).
    (G) Example 7 (Predecessor of a publicly held corporation)--(1) 
Facts. The facts are the same as in paragraph (c)(2)(vii)(F) of this 
section (Example 6), except that Corporation EE remains a privately 
held corporation until it becomes a publicly held corporation for 
its 2027 taxable year.
    (2) Conclusion. Corporation EE is not a predecessor of a 
publicly held corporation within the meaning of paragraph 
(c)(2)(ii)(A) of this section because it became a publicly held 
corporation for a taxable year ending after April 15, 2025. 
Therefore, any covered employee of Corporation EE for its 2021 
taxable year is not a covered employee of Corporation EE for its 
2027 taxable year due to that individual's status as a covered 
employee of Corporation EE for a preceding taxable year (beginning 
after December 31, 2016) but may be a covered employee due to that 
individual's status during the 2027 taxable year.
    (H) Example 8 (Predecessor of a publicly held corporation that 
is party to a merger)--(1) Facts. On June 30, 2021, Corporation FF 
(a publicly held corporation) merged into Corporation GG (a publicly 
held corporation) in a transaction that qualifies as a 
reorganization under section 368(a)(1)(A), with Corporation GG as 
the surviving corporation. As a result of the merger, Corporation FF 
has a short taxable year ending June 30, 2021. Corporation FF is a 
publicly held corporation for this short taxable year. Corporation 
GG does not have a short taxable year and is a publicly held 
corporation for its 2021 taxable year.
    (2) Conclusion. Corporation FF is a predecessor of a publicly 
held corporation within the meaning of paragraph (c)(2)(ii)(B) of 
this section. Therefore, any covered employee of Corporation FF for 
its short taxable year ending June 30, 2021, is a covered employee 
of Corporation GG for its 2021 taxable year. For Corporation GG's 
2021 and subsequent taxable years, the covered employees of 
Corporation GG include the covered employees of Corporation FF (for 
a preceding taxable year beginning after December 31, 2016) and any 
additional covered employees determined pursuant to this paragraph 
(c)(2).
    (I) Example 9 (Predecessor of a publicly held corporation that 
is party to a merger)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vii)(H) of this section (Example 8), except that, 
after the merger, Corporation GG is a privately held corporation for 
its 2021 taxable year.
    (2) Conclusion. Because Corporation GG is a privately held 
corporation for its 2021 taxable year, it is not subject to section 
162(m)(1) for this taxable year.
    (J) Example 10 (Predecessor of a publicly held corporation that 
is party to a merger)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vii)(I) of this section (Example 9), except that 
Corporation GG, becomes a publicly held corporation (as defined in 
paragraph (c)(1)(i) of this section) on June 30, 2023, and is a 
publicly held corporation for its 2023 taxable year.
    (2) Conclusion. Because Corporation GG became a publicly held 
corporation for a taxable year ending prior to April 15, 2025, 
Corporation FF is a predecessor of a publicly held corporation 
within the meaning of paragraph (c)(2)(ii)(G) of this section. For 
Corporation GG's 2023 and subsequent taxable years, the covered 
employees of Corporation GG include the covered employees of 
Corporation FF (for a preceding taxable year beginning after 
December 31, 2016) and any additional covered employees determined 
pursuant to this paragraph (c)(2).
    (K) Example 11 (Predecessor of a publicly held corporation that 
is party to a merger)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vii)(J) of this section (Example 10), except that 
Corporation FF is a privately held corporation for its taxable year 
ending June 30, 2021, but was a publicly held corporation for its 
2020 taxable year.
    (2) Conclusion. Even though Corporation FF was a privately held 
corporation when it merged with Corporation GG on June 30, 2021, 
Corporation FF will be a predecessor corporation if Corporation GG 
becomes a publicly held corporation within a taxable year ending 
prior to April 15, 2024. Because Corporation GG became a publicly 
held corporation for its taxable year ending December 31, 2023, 
Corporation FF is a predecessor of a publicly held corporation 
within the meaning of paragraph (c)(2)(ii)(G) of this section. For 
Corporation GG's 2023 and subsequent taxable years, the covered 
employees of Corporation GG include the covered employees of 
Corporation FF (for a preceding taxable year beginning after 
December 31, 2016) and any additional covered employees determined 
pursuant to this paragraph (c)(2).
    (L) Example 12 (Predecessor of a publicly held corporation that 
is party to a merger and subsequently becomes member of an 
affiliated group)--(1) Facts. The facts are the same as in paragraph 
(c)(2)(vii)(J) of this section (Example 10), except that, on June 
30, 2022, Corporation GG becomes a publicly held corporation by 
becoming a member of an affiliated group (as defined in paragraph 
(c)(1)(ii) of this section). Corporation II is the parent 
corporation of the group and is a publicly held corporation. 
Employee HH was a covered employee of Corporation FF for its taxable 
year ending June 30, 2021. On July 1, 2022, Employee HH becomes an 
employee of Corporation II.
    (2) Conclusion. By becoming a member of an affiliated group (as 
defined in paragraph (c)(1)(ii) of this section) on June 30, 2022, 
Corporation GG became a publicly held corporation for a taxable year 
ending prior to April 15, 2025. Therefore, Corporation FF is a 
predecessor of a publicly held corporation (Corporation GG) within 
the meaning of paragraph (c)(2)(ii)(G) of this section. Furthermore, 
Corporation FF is also a predecessor of Corporation II, a publicly 
held corporation within the meaning of paragraph (c)(2)(ii)(G) of 
this section. For Corporation II's 2022 and subsequent taxable 
years, Employee HH is a covered employee of the affiliated group 
that includes Corporation II because Employee HH was a covered 
employee of Corporation FF for its taxable year ending June 30, 
2021.
    (M) Example 13 (Predecessor of a publicly held corporation that 
is party to a merger and subsequently becomes member of an 
affiliated group)--(1) Facts. The facts are the same as in paragraph 
(c)(2)(vii)(L) of this section (Example 12), except that Corporation 
FF was a privately held corporation for its taxable year ending June 
30, 2021, and Employee HH was a covered employee of Corporation FF 
for its taxable year ending December 31, 2020.
    (2) Conclusion. Even though Corporation FF was a privately held 
corporation when it merged with Corporation GG on June 30, 2021, 
Corporation FF will be a predecessor corporation if Corporation GG 
becomes a publicly held corporation for a taxable year ending prior 
to April 15, 2024. Because Corporation GG became a publicly held 
corporation for its 2022 taxable year by becoming a member of an 
affiliated group (as defined in paragraph (c)(1)(ii) of this 
section), Corporation FF is a predecessor of a publicly held 
corporation (Corporation GG) within the meaning of paragraph 
(c)(2)(ii)(G) of this section. Furthermore, Corporation FF is also a 
predecessor of Corporation II, a publicly held corporation within 
the meaning of paragraph (c)(2)(ii)(G) of this section. Therefore, 
any covered employee of Corporation FF for its 2020 taxable year is 
a covered employee of the affiliated group that includes Corporation 
II for its 2022 and subsequent taxable years. For Corporation II's

[[Page 86501]]

2022 taxable year, Employee HH is a covered employee of the 
affiliated group that includes Corporation II because Employee HH 
was a covered employee of Corporation FF for its 2020 taxable year.
    (N) Example 14 (Predecessor of a publicly held corporation that 
is a party to a merger)--(1) Facts. Corporation JJ is a publicly 
held corporation for its 2019 taxable year and is incorporated in 
State KK. On June 1, 2019, Corporation JJ formed a wholly-owned 
subsidiary, Corporation LL. Corporation LL is a publicly held 
corporation incorporated in State MM. On June 30, 2021, Corporation 
JJ merged into Corporation LL under State MM law in a transaction 
that qualifies as a reorganization under section 368(a)(1)(A), with 
Corporation LL as the surviving corporation. As a result of the 
merger, Corporation JJ has a short taxable year ending June 30, 
2021. Corporation JJ is a publicly held corporation for this short 
taxable year.
    (2) Conclusion. Corporation JJ is a predecessor of a publicly 
held corporation within the meaning of paragraph (c)(2)(ii)(B) of 
this section. For Corporation LL's taxable years ending after June 
30, 2021, the covered employees of Corporation LL include the 
covered employees of Corporation JJ for its short taxable year 
ending June 30, 2021 (as well as preceding taxable years beginning 
after December 31, 2016) and any additional covered employees 
determined pursuant to this paragraph (c)(2).
    (O) Example 15 (Predecessor of a publicly held corporation 
becomes member of an affiliated group)--(1) Facts. On June 30, 2021, 
Corporation OO acquires for cash 100% of the only class of 
outstanding stock of Corporation NN. The affiliated group (comprised 
of Corporations NN and OO) elects to file a consolidated Federal 
income tax return. As a result of this election, Corporation NN has 
a short taxable year ending on June 30, 2021. Corporation NN is a 
publicly held corporation for its taxable year ending June 30, 2021, 
and a privately held corporation for subsequent taxable years. On 
June 30, 2022, Corporation OO completely liquidates Corporation NN. 
Corporation OO is a publicly held corporation for its 2021 and 2022 
taxable years.
    (2) Conclusion. After Corporation OO acquired Corporation NN, 
Corporations NN and OO comprise an affiliated group as defined in 
paragraph (c)(1)(ii) of this section. Thus, Corporation NN is a 
predecessor of a publicly held corporation within the meaning of 
paragraph (c)(2)(ii)(D) of this section. For Corporation OO's 
taxable years ending after June 30, 2021, the covered employees of 
Corporation OO include the covered employees of Corporation NN for 
its short taxable year ending June 30, 2021 (as well as preceding 
taxable years beginning after December 31, 2016) and any additional 
covered employees determined pursuant to this paragraph (c)(2).
    (P) Example 16 (Predecessor of a publicly held corporation 
becomes member of an affiliated group)--(1) Facts. The facts are the 
same as in paragraph (c)(2)(vii)(O) of this section (Example 15), 
except that Corporation OO is a privately held corporation on June 
30, 2021, and for its 2021 and 2022 taxable years.
    (2) Conclusion. Because Corporation OO is a privately held 
corporation for its 2021 and 2022 taxable years, it is not subject 
to section 162(m)(1) for these taxable years.
    (Q) Example 17 (Predecessor of a publicly held corporation 
becomes member of an affiliated group)--(1) Facts. The facts are the 
same as in paragraph (c)(2)(vii)(P) of this section (Example 16), 
except that, on October 1, 2022, the SEC declares effective 
Corporation OO's Securities Act registration statement in connection 
with its initial public offering, and Corporation OO is a publicly 
held corporation for its 2022 taxable year.
    (2) Conclusion (Taxable Year Ending December 31, 2021). Because 
Corporation OO is a privately held corporation for its 2021 taxable 
year, it is not subject to section 162(m)(1) for this taxable year.
    (3) Conclusion (Taxable Year Ending December 31, 2022). For the 
2022 taxable year, Corporations NN and OO comprise an affiliated 
group as defined in paragraph (c)(1)(ii) of this section. 
Corporation NN is a predecessor of a publicly held corporation 
within the meaning of paragraph (c)(2)(ii)(D) and (G) of this 
section because Corporation OO became a publicly held corporation 
for a taxable year ending prior to April 15, 2025. For Corporation 
OO's 2022 and subsequent taxable years, the covered employees of 
Corporation OO include the covered employees of Corporation NN for 
its short taxable year ending June 30, 2021 (as well as preceding 
taxable years beginning after December 31, 2016) and any additional 
covered employees determined pursuant to this paragraph (c)(2).
    (R) Example 18 (Predecessor of a publicly held corporation and 
asset acquisition)--(1) Facts. Corporations VV, WW, and XX are 
publicly held corporations for their 2020 and 2021 taxable years. 
Corporations VV and WW are members of an affiliated group. 
Corporation WW is a direct subsidiary of Corporation VV. On June 30, 
2021, Corporation VV acquires for cash 40% of the gross operating 
assets (determined by fair market value as of January 31, 2022) of 
Corporation XX. On January 31, 2022, Corporation WW acquires an 
additional 40% of the gross operating assets (determined by fair 
market value as of January 31, 2022) of Corporation XX. Employees 
EB, EC, and EA are covered employees for Corporation XX's 2020 
taxable year. Employees ED and EF are also covered employees for 
Corporation XX's 2021 taxable year. On January 15, 2021, Employee EA 
started performing services as an employee of Corporation WW. On 
July 1, 2021, Employee EB started performing services as an employee 
of Corporation WW. On February 1, 2022, Employees EC and ED started 
performing services as employees of Corporation WW. On June 30, 
2023, Employee EF started performing services as an employee of 
Corporation WW.
    (2) Conclusion. Because an affiliated group, comprised of 
Corporations VV and WW, acquired 80% of Corporation XX's gross 
operating assets (determined by fair market value) within a twelve-
month period, Corporation XX is a predecessor of a publicly held 
corporation within the meaning of paragraph (c)(2)(ii)(E) of this 
section. Therefore, any covered employee of Corporation XX for its 
2020 and 2021 taxable years (who started performing services as an 
employee of Corporation WW within the period beginning 12 months 
before and ending 12 months after the date of the January 31, 2022, 
acquisition (determined under paragraph (c)(2)(ii)(I) of this 
section) is a covered employee of Corporation WW for its 2021, 2022, 
and subsequent taxable years. For Corporation WW's 2021 and 
subsequent taxable years, the covered employees of Corporation WW 
include Employee EB and any additional covered employees determined 
pursuant to paragraph (c)(2)(i) of this section. For Corporation 
WW's 2022 and subsequent taxable years, the covered employees of 
Corporation WW include Employees EB, EC, and ED, and any additional 
covered employees determined pursuant to this paragraph (c)(2). 
Because Employee EA started performing services as an employee of 
Corporation WW before January 31, 2021, Employee EA is not a covered 
employee of Corporation WW for its 2021 taxable year and subsequent 
taxable years by reason of paragraph (c)(2)(ii)(E) of this section, 
but may be a covered employee of Corporation WW by application of 
other rules in this paragraph (c)(2). Because Employee EF started 
performing services as an employee of Corporation WW after January 
31, 2023, Employee EF is not a covered employee of Corporation WW 
for its 2023 taxable year by reason of paragraph (c)(2)(ii)(E) of 
this section, but may be a covered employee of Corporation WW by 
application of other rules in this paragraph (c)(2).
    (S) Example 19 (Predecessor of a publicly held corporation and 
asset acquisition)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vii)(R) of this section (Example 18), except that 
Corporations VV and WW are not publicly held corporations on June 
30, 2021, or for their 2021 taxable years.
    (2) Conclusion. Because Corporations VV and WW are not publicly 
held corporations for their 2021 taxable years, they are not subject 
to section 162(m)(1) for their 2021 taxable years.
    (T) Example 20 (Predecessor of a publicly held corporation and 
asset acquisition)--(1) Facts. The facts are the same as in 
paragraph (c)(2)(vii)(R) of this section (Example 18), except that, 
on October 1, 2022, the SEC declares effective Corporation VV's 
Securities Act registration statement in connection with its initial 
public offering, and Corporation VV is a publicly held corporation 
for its 2022 taxable year.
    (2) Conclusion (2021 taxable year). Because Corporations VV and 
WW are not publicly held corporations for their 2021 taxable years, 
they are not subject to section 162(m)(1) for their 2021 taxable 
years.
    (3) Conclusion (2022 taxable year). Corporation XX is a 
predecessor of a publicly held corporation within the meaning of 
paragraphs (c)(2)(ii)(E) and (G) of this section because a member of 
the affiliated group comprised of Corporations VV and WW acquired 
80% of Corporation XX's gross operating assets (determined by fair 
market

[[Page 86502]]

value) within a twelve-month period ending on January 31, 2022, and 
the parent of the affiliated group, Corporation VV, subsequently 
became a publicly held corporation for a taxable year ending prior 
to April 15, 2024. Therefore, any covered employee of Corporation XX 
for its 2020 and 2021 taxable years (who started performing services 
as an employee of Corporation WW within the period beginning 12 
months before and ending 12 months after the acquisition) is a 
covered employee of the affiliated group comprised of Corporations 
VV and WW for its 2022 and subsequent taxable years. For Corporation 
WW's 2022 and subsequent taxable years, the covered employees of 
Corporation WW include Employees EB, EC, and ED, and any additional 
covered employees determined pursuant to this paragraph (c)(2).
    (U) Example 21 (Predecessor of a publicly held corporation and a 
division)--(1) Facts. Corporation CA is a publicly held corporation 
for its 2021 and 2022 taxable years. On March 2, 2021, Corporation 
DDD forms a wholly-owned subsidiary, Corporation CB, and transfers 
assets to it. On April 1, 2022, Corporation CA distributes all 
shares of Corporation CB to its shareholders in a transaction 
described in section 355(a)(1). On April 1, 2022, the SEC declares 
effective Corporation CB's Securities Act registration statement in 
connection with its initial public offering. Corporation CB is a 
publicly held corporation for its 2022 taxable year. Employee EG 
serves as the PFO of Corporation CA from January 1, 2022, to March 
31, 2022. On April 2, 2022, Employee EG starts performing services 
as an employee of Corporation CB advising the PFO of Corporation CB. 
After March 31, 2022, Employee EG ceases to provide services for 
Corporation CA.
    (2) Conclusion. Because the distribution of the stock of 
Corporation CB is a transaction described under section 355(a)(1), 
Corporation CA is a predecessor of Corporation CB within the meaning 
of paragraph (c)(2)(ii)(C) of this section. Because Employee EG was 
a covered employee of Corporation CA for its 2022 taxable year, 
Employee ED is a covered employee of Corporation CB for its 2022 
taxable year. The result is the same whether Employee EG performs 
services as an advisor for Corporation CB as an employee or an 
independent contractor.
    (V) Example 22 (Predecessor of a publicly held corporation and a 
division)--(1) Facts. The facts are the same as in paragraph 
(c)(2)(vii)(U) of this section (Example 21), except that Corporation 
CA distributes 100% of the shares of Corporation CB to Corporation 
CD in exchange for all of Corporation CD's stock in Corporation CA 
in a transaction described in section 355(a)(1) and Corporation CB 
does not register any class of securities with the SEC. Also, 
Employee EG performs services as an employee of Corporation CD 
instead of as an employee of Corporation CB. Corporation CD is a 
privately held corporation for its 2022 taxable year. On October 1, 
2023, the SEC declares effective Corporation CD's Securities Act 
registration statement in connection with its initial public 
offering. Corporation CD is a publicly held corporation for its 2023 
taxable year. On January 1, 2028, Employee EG starts performing 
services as an employee of Corporation CA. Corporation CA is a 
publicly held corporation for its 2028 taxable year.
    (2) Conclusion (2022 taxable year). Because Corporation CD is a 
privately held corporation for its 2022 taxable year, it is not 
subject to section 162(m)(1) for this taxable year.
    (3) Conclusion (2023 taxable year). Because the exchange of the 
stock of Corporation CB for the stock of Corporation CA is a 
transaction described in section 355(a)(1), Corporations CB and CD 
are an affiliated group, and Corporation CD became a publicly held 
corporation for a taxable year ending prior to April 15, 2026, 
Corporation CA is a predecessor of Corporation CD within the meaning 
of paragraphs (c)(2)(ii)(D) and (G) of this section. Employee EG was 
a covered employee of Corporation CA for its 2022 taxable year, and 
started performing services as an employee of Corporation CD 
following April 1, 2021, and before April 1, 2023. Therefore, 
Employee ED is a covered employee of Corporation CD for its 2023 
taxable year.
    (4) Conclusion (2028 taxable year). Because Employee EG served 
as the PFO of Corporation CA from January 1, 2022, to March 31, 
2022, Employee EG was a covered employee of Corporation CA for its 
2022 taxable year. Because an individual who is a covered employee 
for a taxable year remains a covered employee for all subsequent 
taxable years (even after the individual has separated from 
service), Employee EG is a covered employee of Corporation CA for 
its 2028 taxable year.
    (W) Example 23 (Predecessor of a publicly held corporation and a 
division)--(1) Facts. The facts are the same as in paragraph 
(c)(2)(vii)(V) of this section (Example 22), except that Employee EG 
starts performing services as an employee of Corporation CD on June 
30, 2023, instead of on April 2, 2022, and never performs services 
for Corporation CA after June 30, 2023. Furthermore, on June 30, 
2023, Employee EH, a covered employee of Corporation CB for all of 
its taxable years, starts performing services for Corporation EF as 
an independent contractor advising its PEO but not serving as a PEO.
    (2) Conclusion (2023 taxable year). Because the exchange of the 
stock of Corporation CB for the stock of Corporation CA is a 
transaction described in section 355(a)(1) and Corporation CD became 
a publicly held corporation for a taxable year ending before April 
15, 2026, Corporation CA is a predecessor of Corporation CD within 
the meaning of paragraphs (c)(2)(ii)(D) and (G) of this section. 
Even though Employee EG was a covered employee of Corporation CA for 
its 2022 taxable year, because Employee EG started performing 
services as an employee of Corporation CD after April 1, 2023, 
Employee EG is not a covered employee of Corporation CD for its 2023 
taxable year under paragraph (c)(2)(ii)(C) of this section. However, 
Employee EG may be a covered employee of Corporation CD by 
application of other rules in this paragraph (c)(2). Because 
Employee EH was a covered employee of Corporation CB for its 2022 
taxable year, Employee EH is a covered employee of Corporation CD 
for its 2023 taxable year.
    (X) Example 24 (Predecessor of a publicly held corporation and 
election under section 338(h)(10))--(1) Facts. Corporation CE is the 
common parent of a group of corporations filing consolidated returns 
that includes Corporation CF as a member. Corporation CE wholly-owns 
Corporation CF, a publicly held corporation within the meaning of 
paragraph (c)(1)(i) of this section. On June 30, 2021, Corporation 
CG purchases Corporation CF from Corporation CE. Corporation CE and 
Corporation CG make a timely election under section 338(h)(10) with 
respect to the purchase of Corporation CF stock. For its taxable 
year ending December 31, 2021, Corporation CF continues to be a 
publicly held corporation within the meaning of paragraph (c)(1)(i) 
of this section.
    (2) Conclusion. As provided in paragraph (c)(2)(ii)(H) of this 
section, Corporation CF is treated as the same corporation after the 
section 338(h)(10) transaction as before the transaction for 
purposes for purposes of this paragraph (c)(2). Any covered employee 
of Corporation CF for its short taxable year ending June 30, 2021, 
is a covered employee of Corporation CF for its short taxable year 
ending on December 31, 2021, and subsequent taxable years.
    (Y) Example 25 (Disregarded entity)--(1) Facts. Corporation CH 
is a privately held corporation for its 2020 taxable year. Entity CI 
is a wholly-owned limited liability company and is disregarded as an 
entity separate from its owner, Corporation CH, under Sec.  
301.7701-2(c)(2)(i) of this chapter. As of December 31, 2020, Entity 
CI is required to file reports under section 15(d) of the Exchange 
Act. For the 2020 taxable year, Employee EI is the PEO and Employee 
EJ is the PFO of Corporation CH. Employees EK, EL, and EM, are the 
three most highly compensated executive officers of Corporation CH 
(other than Employees EI and EJ). Employee EN is the PFO of Entity 
CI and does not perform any policy making functions for Corporation 
CH. Entity CI has no other executive officers.
    (2) Conclusion. Because Entity CI is disregarded as an entity 
separate from its owner, Corporation CH, and is required to file 
reports under section 15(d) of the Exchange Act, Corporation CH is a 
publicly held corporation under paragraph (c)(1)(iii) of this 
section for its 2020 taxable year. Even though Employee EN is a PFO 
of Entity CI, Employee EN is not considered a PFO of Corporation CH 
under paragraph (c)(2)(iii) of this section. As PEO and PFO, 
Employees EI and EJ are covered employees of Corporation CH under 
paragraph (c)(2)(i) of this section. Additionally, as the three most 
highly compensated executive officers of Corporation CH (other than 
Employees EI and EJ), Employees EK, EL, and EM also are covered 
employees of Corporation CH under paragraph (c)(2)(i) of this 
section for Corporation CH's 2020 taxable year. The result would be 
the same if Entity CI was not required to file reports under section 
15(d) of the Exchange Act and Corporation CH was a publicly held 
corporation pursuant to paragraph (c)(1)(i) instead of paragraph 
(c)(1)(iii) of this section.

[[Page 86503]]

    (Z) Example 26 (Disregarded entity)--(1) Facts. The facts are 
the same as in paragraph (c)(2)(vii)(Y) of this section (Example 
25), except that Employee EN performs a policy making function for 
Corporation CH. If Corporation CH were subject to the SEC executive 
compensation disclosure rules, then Employee EN would be treated as 
an executive officer of Corporation CH pursuant to 17 CFR 240.3b-7 
for purposes of determining the three highest compensated executive 
officers for Corporation CH's 2020 taxable year. Employee EN is 
compensated more than Employee EK, but less than Employees EL and 
EM.
    (2) Conclusion. Because Entity CI is disregarded as an entity 
separate from its owner, Corporation CH, and is required to file 
reports under section 15(d) of the Exchange Act, Corporation CH is a 
publicly held corporation under paragraph (c)(1)(iii) of this 
section for its 2020 taxable year. As PEO and PFO, Employees EI and 
EJ are covered employees of Corporation CH under paragraph (c)(2)(i) 
of this section. Employee EN is one of the three highest compensated 
executive officers for Corporation CH's taxable year. Because 
Employees EN, EL, and EM are the three most highly compensated 
executive officers of Corporation CH (other than Employees EI and 
EJ), they are covered employees of Corporation CH under paragraph 
(c)(2)(i) of this section for Corporation CH's 2020 taxable year. 
The result would be the same if Entity CI was not required to file 
reports under section 15(d) of the Exchange Act and Corporation CH 
was a publicly held corporation pursuant to paragraph (c)(1)(i) 
instead of paragraph (c)(1)(iii) of this section.
    (AA) Example 27 (Individual as covered employee of a publicly 
held corporation that includes the affiliated group)--(1) Facts. 
Corporations CJ and CK are publicly held corporations for their 
2020, 2021, and 2022 taxable years. Corporation CK is a direct 
subsidiary of Corporation CJ. Employee EO is an employee, but not a 
covered employee (as defined in paragraph (c)(2)(i) of this 
section), of Corporation CJ for its 2020, 2021, and 2022 taxable 
years. From April 1, 2020, to September 30, 2020, Employee EO serves 
as the PFO of Corporation CK. Employee EO does not perform any 
services for Corporation CK for its 2021 and 2022 taxable years, 
however, employee EO is a covered employee (as defined in paragraph 
(c)(2)(i) of this section) of Corporation CK for its 2020, 2021, and 
2022 taxable years. For the 2020 taxable year, Employee EO receives 
compensation of $1,500,000 for services provided to Corporations CJ 
and CK. Employee EO receives $2,000,000 from Corporation CJ for 
performing services for Corporation CJ during each of its 2021 and 
2022 taxable years. On June 30, 2022, Corporation CK pays $500,000 
to Employee EO from a nonqualified deferred compensation plan that 
complies with section 409A.
    (2) Conclusion (2020 taxable year). Because Employee EO is a 
covered employee of Corporation CK and because the affiliated group 
(comprised of Corporations CJ and CK) is a publicly held 
corporation, Employee EO is a covered employee of the publicly held 
corporation that is the affiliated group pursuant to paragraph 
(c)(2)(vi) of this section. Compensation paid by Corporations CJ and 
CK is aggregated for purposes of section 162(m)(1) and, as a result, 
$500,000 of the aggregate compensation paid is nondeductible. The 
result would be the same if Corporation CJ was a privately held 
corporation for its 2020 taxable year.
    (3) Conclusion (2021 taxable year). Because Employee EO is a 
covered employee of Corporation CK pursuant to paragraph 
(c)(2)(i)(C) of this section and because the affiliated group 
(comprised of Corporations CJ and CK) is a publicly held 
corporation, Employee EO is a covered employee of the publicly held 
corporation that is the affiliated group pursuant to paragraph 
(c)(2)(vi) of this section. Compensation paid by Corporations CJ and 
CK is aggregated for purposes of section 162(m)(1) and, as a result, 
$1,000,000 of the aggregate compensation paid is nondeductible. The 
result would be the same if Corporation CJ was a privately held 
corporation for its 2021 taxable year.
    (4) Conclusion (2022 taxable year). Because Employee EO is a 
covered employee of Corporation CK pursuant to paragraph 
(c)(2)(i)(C) of this section and because the affiliated group 
(comprised of Corporations CJ and CK) is a publicly held 
corporation, Employee EO is a covered employee of the publicly held 
corporation that is the affiliated group pursuant to paragraph 
(c)(2)(vi) of this section. Compensation paid by Corporations CJ and 
CK is aggregated for purposes of section 162(m)(1) and, as a result, 
$1,500,000 of the aggregate compensation paid is nondeductible. The 
result would be the same if Corporation CJ was a privately held 
corporation for its 2022 taxable year.
    (BB) Example 28 (Individual as covered employee of a publicly 
held corporation that includes the affiliated group)--(1) Facts. 
Corporation CL is a publicly held corporation for its 2020 through 
2023 taxable years. Corporations CM and CN are direct subsidiaries 
of Corporation CL and are privately held corporations for their 2020 
through 2022 taxable years. Employee EP serves as the PFO of 
Corporation CL from January 1, 2020 to December 31, 2020, when 
Employee EP terminates employment from Corporation CL. On January 1, 
2021, Employee EP starts performing services as an employee of 
Corporation CM. In 2021, Employee EP receives compensation from 
Corporation CM in excess of $1,000,000. On April 1, 2022, Employee 
EP starts performing services as an employee of Corporation CN. On 
September 30, 2022, Employee EP terminates employment from 
Corporations CM and CN. In 2022, Employee EP receives compensation 
from Corporations CM and CN in excess of $1,000,000. For the 2021 
and 2022 taxable years, Employee EP does not serve as either the PEO 
or PFO of Corporations CM and CN, and is not one of the three 
highest compensated executive officers (other than the PEO or PFO) 
of Corporations CM and CN. On April 1, 2023, Corporation CL 
distributes all the shares of Corporation CM to its shareholders in 
a transaction described in section 355(a)(1). On April 1, 2023, the 
SEC declares effective Corporation CM's Securities Act registration 
statement in connection with its initial public offering. 
Corporation CM is a publicly held corporation for its 2023 taxable 
year. On April 2, 2023, Employee EP starts performing services as an 
employee of Corporation CM but is not an executive officer of 
Corporation CM.
    (2) Conclusion (2021 taxable year). Employee EP is a covered 
employee of Corporation CL for the 2020 and subsequent taxable 
years. Because Employee EP is a covered employee of Corporation CL 
and because the affiliated group (comprised of Corporations CL, CM, 
and CN) is a publicly held corporation, Employee EP is a covered 
employee of the publicly held corporation that is the affiliated 
group pursuant to paragraph (c)(2)(vi) of this section for the 2020 
and subsequent taxable years. Therefore, Corporation CM's deduction 
for compensation paid to Employee EP for the 2021 taxable year is 
subject to section 162(m)(1). The result would be the same if 
Corporation CM was a publicly held corporation as defined in 
paragraph (c)(1)(i) of this section.
    (3) Conclusion (2022 taxable year). Because Employee EP is a 
covered employee of Corporation CL and because the affiliated group 
(comprised of Corporations CL, CM, and CN) is a publicly held 
corporation, Employee EP is a covered employee of the publicly held 
corporation that is the affiliated group pursuant to paragraph 
(c)(2)(vi) of this section. Therefore, Corporation CM's and CN's 
deduction for compensation paid to Employee EP for the 2022 taxable 
year is subject to section 162(m)(1). Because the compensation paid 
by all affiliated group members is aggregated for purposes of 
section 162(m)(1), $1,000,000 of the aggregate compensation paid is 
nondeductible. Corporations CM and CN are each treated as paying a 
ratable portion of the nondeductible compensation. The result would 
be the same if either Corporation CM or CN (or both) was a publicly 
held corporation as defined in paragraph (c)(1)(i) of this section.
    (4) Conclusion (2023 taxable year). Because the distribution of 
the stock of Corporation CM is a transaction described in section 
355(a)(1), Corporation CL is a predecessor of Corporation CM within 
the meaning of paragraph (c)(2)(ii)(C) of this section. However, 
because Employee EP started performing services as an employee of 
Corporation CM on January 1, 2021, and the distribution of stock of 
Corporation CM did not occur until April 1, 2023, Employee EP is not 
a covered employee of Corporation CM for its 2023 taxable year.

    (3) Compensation--(i) In general. For purposes of the deduction 
limitation described in paragraph (b) of this section, compensation 
means the aggregate amount allowable as a deduction to the publicly 
held corporation under chapter 1 of the Internal Revenue Code for the 
taxable year (determined without regard to section 162(m)(1)) for 
remuneration for services performed by a covered employee in any 
capacity, whether or not the services were performed during

[[Page 86504]]

the taxable year. Compensation includes an amount that is includible in 
the income of, or paid to, a person other than the covered employee 
(including a beneficiary after the death of the covered employee) for 
services performed by the covered employee.
    (ii) Compensation paid by a partnership. For purposes of paragraph 
(c)(3)(i) of this section, compensation includes an amount equal to a 
publicly held corporation's distributive share of a partnership's 
deduction for compensation expense attributable to the remuneration 
paid by the partnership to a covered employee of the publicly held 
corporation for services performed by the covered employee, including a 
payment for services under section 707(a) or under section 707(c).
    (iii) Exceptions. Compensation does not include--
    (A) Remuneration covered in section 3121(a)(5)(A) through (D) 
(concerning remuneration that is not treated as wages for purposes of 
the Federal Insurance Contributions Act);
    (B) Remuneration consisting of any benefit provided to or on behalf 
of an employee if, at the time the benefit is provided, it is 
reasonable to believe that the employee will be able to exclude it from 
gross income; or
    (C) Salary reduction contributions described in section 3121(v)(1).
    (iv) Examples. The following examples illustrate the provisions of 
this paragraph (c)(3). For each example, assume that the corporation is 
a calendar year taxpayer.

    (A) Example 1--(1) Facts. Corporation Z is a publicly held 
corporation for its 2020 taxable year, during which Employee A 
serves as the PEO of Corporation Z and also serves on the board of 
directors of Corporation Z. In 2020, Corporation Z paid $1,200,000 
to Employee A plus a $50,000 fee for serving as a director of 
Corporation Z. These amounts are otherwise deductible for 
Corporation Z's 2020 taxable year.
    (2) Conclusion. The $1,200,000 paid to Employee A in 2020 plus 
the $50,000 director's fee paid to Employee A in 2020 are 
compensation within the meaning of this paragraph (c)(3). Therefore, 
Corporation Z's $1,250,000 deduction for the 2020 taxable year is 
subject to the section 162(m)(1) limit.
    (B) Example 2--(1) Facts. Corporation X is a publicly held 
corporation for its 2020 and all subsequent taxable years. Employee 
B serves as the PEO of Corporation X for its 2020 taxable year and 
is a participant in the Corporation X nonqualified retirement plan 
that meets the requirements of section 409A. The plan provides for 
the distribution of benefits over a three-year period beginning 
after a participant separates from service. Employee B terminates 
employment in 2021. In 2022, Employee B receives a $75,000 fee for 
services as a director and $1,500,000 as the first payment under the 
retirement plan. Employee B continues to serve on the board of 
directors until 2023 when Employee B dies before receiving the 
retirement benefit for 2023 and before becoming entitled to any 
director's fees for 2023. In 2023 and 2024, Corporation X pays the 
$1,500,000 annual retirement benefits to Person C, a beneficiary of 
Employee B.
    (2) Conclusion (2022 Taxable Year). In 2022, Corporation X paid 
Employee B $1,575,000, including $1,500,000 under the retirement 
plan and $75,000 in director's fees. The retirement benefit and the 
director's fees are compensation within the meaning of this 
paragraph (c)(3). Therefore, Corporation X's $1,575,000 deduction 
for the 2022 taxable year is subject to the section 162(m)(1) limit.
    (3) Conclusion (2023 and 2024 Taxable Years). In 2023 and 2024, 
Corporation X made payments to Person C of $1,500,000 under the 
retirement plan. The retirement benefits are compensation within the 
meaning of this paragraph (c)(3). Therefore, Corporation X's 
deduction for each annual payment of $1,500,000 for the 2023 and 
2024 taxable years is subject to the section 162(m)(1) limit.
    (C) Example 3--(1) Facts. Corporation T is a publicly held 
corporation for its 2021 taxable year. Corporation S is a privately 
held corporation for its 2021 taxable year. On January 2, 2021, 
Corporations S and T form a general partnership. Under the 
partnership agreement, Corporations S and T each have a 50% 
distributive share of the partnership's income, gain, loss, and 
deductions. For the taxable year ending December 31, 2021, Employee 
D, a covered employee of Corporation T, performs services for the 
partnership, and the partnership pays $800,000 to Employee D for 
these services, the deduction of $400,000 of which is allocated to 
Corporation T. Corporation T's $400,000 distributive share of the 
partnership's deduction is reported separately to Corporation T 
pursuant to Sec.  1.702-1(a)(8)(iii).
    (2) Conclusion. Because Corporation T's $400,000 distributive 
share of the partnership's deduction is attributable to the 
compensation paid by the partnership for services performed by 
Employee D, a covered employee of Corporation T, the $400,000 is 
compensation within the meaning of this paragraph (c)(3) and 
Corporation T's deduction for this expense for its 2021 taxable year 
is subject to the section 162(m)(1) limit. Corporation T's $400,000 
allocation of the partnership's deduction is aggregated with 
Corporation T's deduction for compensation paid to Employee D, if 
any, in determining the amount allowable as a deduction to 
Corporation T for compensation paid to Employee D for Corporation 
T's 2021 taxable year. The result is the same whether Employee D 
performs services for the partnership as a common law employee, an 
independent contractor, or a partner, and whether the payment to 
Employee D is a payment under section 707(a) or section 707(c).

    (4) Securities Act. The Securities Act means the Securities Act of 
1933.
    (5) Exchange Act. The Exchange Act means the Securities Exchange 
Act of 1934.
    (6) SEC. The SEC means the United States Securities and Exchange 
Commission.
    (7) Foreign Private Issuer. A foreign private issuer means an 
issuer as defined in 17 CFR 240.3b-4(c).
    (8) American Depositary Receipt (ADR). An American Depositary 
Receipt or ADR means a negotiable certificate that evidences ownership 
of a specified number (or fraction) of a foreign private issuer's 
securities held by a depositary (typically, a U.S. bank).
    (9) Privately held corporation. A privately held corporation is a 
corporation that is not a publicly held corporation as defined in 
paragraph (c)(1) of this section (without regard to paragraph 
(c)(1)(ii) of this section).
    (d) Corporations that become publicly held--(1) In general. In the 
case of a corporation that was a privately held corporation and then 
becomes a publicly held corporation, the deduction limitation of 
paragraph (b) of this section applies to any compensation that is 
otherwise deductible for the taxable year ending on or after the date 
that the corporation becomes a publicly held corporation. A corporation 
is considered to become publicly held on the date that its registration 
statement becomes effective either under the Securities Act or the 
Exchange Act. The rules in this section apply to a partnership that 
becomes a publicly traded partnership that is a publicly held 
corporation within the meaning of paragraph (c)(1)(i) of this section.
    (2) Example. The following example illustrates the provision of 
this paragraph (d).

    (i) Facts. In 2021, Corporation E plans to issue debt securities 
in a public offering registered under the Securities Act. 
Corporation E is not required to file reports under section 15(d) of 
the Exchange Act with respect to any other class of securities and 
does not have another class of securities required to be registered 
under section 12 of the Exchange Act. On December 18, 2021, the SEC 
declares effective the Securities Act registration statement for 
Corporation E's debt securities.
    (ii) Conclusion. Corporation E becomes a publicly held 
corporation on December 18, 2021 because it is then required to file 
reports under section 15(d) of the Exchange Act. The deduction 
limitation of paragraph (b) of this section applies to any 
compensation that is otherwise deductible for Corporation E's 
taxable year ending on or after December 18, 2021.

    (e) Coordination with disallowed excess parachute payments under 
section 280G. The $1,000,000 limitation

[[Page 86505]]

in paragraph (b) of this section is reduced (but not below zero) by the 
amount (if any) that would have been included in the compensation of 
the covered employee for the taxable year but for being disallowed by 
reason of section 280G. For example, assume that during a taxable year 
a corporation pays $1,500,000 to a covered employee, of which $600,000 
is an excess parachute payment, as defined in section 280G(b)(1), and a 
deduction for that excess parachute payment is disallowed by reason of 
section 280G(a). Because the $1,000,000 limitation in paragraph (b) of 
this section is reduced by the amount of the excess parachute payment, 
the corporation may deduct $400,000 ($1,000,000-$600,000), and $500,000 
of the otherwise deductible amount is nondeductible by reason of 
section 162(m)(1). Thus $1,100,000 (of the total $1,500,000 payment) is 
non-deductible, reflecting the disallowance related to the excess 
parachute payment under section 280G and the application of section 
162(m)(1).
    (f) Coordination with excise tax on specified stock compensation. 
The $1,000,000 limitation in paragraph (b) of this section is reduced 
(but not below zero) by the amount (if any) of any payment (with 
respect to such employee) of the tax imposed by section 4985 directly 
or indirectly by the expatriated corporation (as defined in section 
4985(e)(2)) or by any member of the expanded affiliated group (as 
defined in section 4985(e)(4)) that includes such corporation.
    (g) Transition rules--(1) Amount of compensation payable under a 
written binding contract that was in effect on November 2, 2017--(i) 
General rule. This section does not apply to the deduction for 
compensation payable under a written binding contract that was in 
effect on November 2, 2017, and that is not modified in any material 
respect on or after that date (a grandfathered amount). Instead, 
section 162(m), as in effect prior to its amendment by Public Law 115-
97, applies to limit the deduction for that compensation. Because Sec.  
1.162-27 implemented section 162(m) as in effect prior to its amendment 
by Public Law 115-97, the rules of Sec.  1.162-27 determine the 
applicability of the deduction limitation under section 162(m) with 
respect to the payment of a grandfathered amount (including the 
potential application of the separate grandfathering rules contained in 
Sec.  1.162-27(h)). Compensation is a grandfathered amount only to the 
extent that as of November 2, 2017, the corporation was and remains 
obligated under applicable law (for example, state contract law) to pay 
the compensation under the contract if the employee performs services 
or satisfies the applicable vesting conditions. This section applies to 
the deduction for any amount of compensation that exceeds the 
grandfathered amount. If a grandfathered amount and non-grandfathered 
amount are otherwise deductible for the same taxable year and, under 
the rules of Sec.  1.162-27, the deduction of some or all of the 
grandfathered amount may be limited (for example, the grandfathered 
amount does not satisfy the requirements of Sec.  1.162-27(e)(2) 
through (5) as qualified performance-based compensation), then the 
grandfathered amount is aggregated with the non-grandfathered amount to 
determine the deduction disallowance for the taxable year under section 
162(m)(1) (so that the deduction limit applies to the excess of the 
aggregated amount over $1 million).
    (ii) Contracts that are terminable or cancelable. If a written 
binding contract is renewed after November 2, 2017, this section (and 
not Sec.  1.162-27) applies to any payments made after the renewal. A 
written binding contract that is terminable or cancelable by the 
corporation without the employee's consent after November 2, 2017, is 
treated as renewed as of the earliest date that any such termination or 
cancellation, if made, would be effective. Thus, for example, if the 
terms of a contract provide that it will be automatically renewed or 
extended as of a certain date unless either the corporation or the 
employee provides notice of termination of the contract at least 30 
days before that date, the contract is treated as renewed as of the 
date that termination would be effective if that notice were given. 
Similarly, for example, if the terms of a contract provide that the 
contract will be terminated or canceled as of a certain date unless 
either the corporation or the employee elects to renew within 30 days 
of that date, the contract is treated as renewed by the corporation as 
of that date (unless the contract is renewed before that date, in which 
case, it is treated as renewed on the earlier date). Alternatively, if 
the corporation will remain legally obligated by the terms of a 
contract beyond a certain date at the sole discretion of the employee, 
the contract will not be treated as renewed as of that date if the 
employee exercises the discretion to keep the corporation bound to the 
contract. A contract is not treated as terminable or cancelable if it 
can be terminated or canceled only by terminating the employment 
relationship of the employee. A contract is not treated as renewed if 
upon termination or cancellation of the contract the employment 
relationship continues but would no longer be covered by the contract. 
However, if the employment continues after the termination or 
cancellation, payments with respect to the post-termination or post-
cancellation employment are not made pursuant to the contract (and, 
therefore, are not grandfathered amounts).
    (iii) Compensation payable under a plan or arrangement. If a 
compensation plan or arrangement is a written binding contract in 
effect on November 2, 2017, the deduction for the amount that the 
corporation is obligated to pay to an employee pursuant to the plan or 
arrangement is not subject to this section solely because the employee 
was not eligible to participate in the plan or arrangement as of 
November 2, 2017, provided the employee was employed on November 2, 
2017, by the corporation that maintained the plan or arrangement, or 
the employee had the right to participate in the plan or arrangement 
under a written binding contract as of that date.
    (iv) Compensation subject to recovery by corporation. If the 
corporation is obligated or has discretion to recover compensation paid 
in a taxable year only upon the future occurrence of a condition that 
is objectively outside of the corporation's control, then the 
corporation's right to recovery is disregarded for purposes of 
determining the grandfathered amount for the taxable year. Whether or 
not the corporation exercises its discretion to recover any 
compensation does not affect the amount of compensation that the 
corporation remains obligated to pay under applicable law.
    (v) Compensation payable from an account balance plan--(A) In 
general. Except as otherwise provided in this paragraph (g), the 
grandfathered amount of payments from an account balance plan (as 
defined in Sec.  1.409A-1(c)(2)(i)(A)) that is a written binding 
contract in effect as of November 2, 2017, is the amount that the 
corporation is obligated to pay pursuant to the terms of the account 
balance plan in effect as of that date, as determined under applicable 
law. If under the terms of the plan, the corporation is obligated to 
pay the employee the account balance that is credited with earnings and 
losses and has no right to terminate or materially amend the plan, then 
the grandfathered amount would be the account balance as of November 2, 
2017, plus any additional contributions and earnings and losses that 
the corporation is obligated to credit to the account

[[Page 86506]]

balance in accordance with the terms of the plan as of November 2, 
2017, through the date of payment.
    (B) Account balance plan providing right to terminate. If under the 
terms of the account balance plan in effect as of November 2, 2017, the 
corporation may terminate the contract and distribute the account 
balance to the employee, then the grandfathered amount would be the 
account balance determined as if the corporation had terminated the 
plan on November 2, 2017 or, if later, the earliest possible date the 
plan could be terminated in accordance with the terms of the plan 
(termination date). Whether additional contributions and earnings and 
losses credited to the account balance after the termination date, 
through the earliest possible date the account balance could have been 
distributed to the employee in accordance with the terms of the plan, 
are grandfathered depends on whether the terms of the plan require the 
corporation to make those contributions or credit those earnings and 
losses through that distribution date. Notwithstanding the foregoing, 
the corporation may treat the account balance as of the termination 
date as the grandfathered amount regardless of when the amount is paid 
and regardless of whether it has been credited with additional 
contributions or earnings or losses prior to payment.
    (C) Account balance plan providing right to discontinue future 
contributions. If under the terms of the account balance plan in effect 
as of November 2, 2017, the corporation has no right to terminate the 
plan, but may discontinue future contributions and distribute the 
account balance in accordance with the terms of the plan, then the 
grandfathered amount would be the account balance determined as if the 
corporation had exercised the right to discontinue contributions on 
November 2, 2017, or, if later, the earliest permissible date the 
corporation could exercise that right in accordance with the terms of 
the plan (the freeze date). If, after the freeze date, the plan 
requires the crediting of earnings and losses on the account balance 
through the payment date, then the earnings and losses credited to the 
grandfathered account balance would also be grandfathered. 
Notwithstanding the foregoing, the corporation may treat the account 
balance as of the freeze date as the grandfathered amount regardless of 
when the amount is paid and regardless of whether it has been credited 
with earnings or losses prior to payment.
    (vi) Compensation payable from a nonaccount balance plan--(A) In 
general. Except as otherwise provided in this paragraph (g), the 
grandfathered amount of payments from a nonaccount balance plan (as 
defined in Sec.  1.409A-1(c)(2)(i)(C)) that is a written binding 
contract in effect as of November 2, 2017, is the amount that the 
corporation is obligated to pay pursuant to the terms of the nonaccount 
balance plan in effect as of that date, as determined under applicable 
law. If under the terms of the plan, the corporation is obligated to 
pay the employee the benefit under the plan and has no right to 
terminate or materially amend the plan, then the grandfathered amount 
would be the benefit under the plan as of November 2, 2017, plus any 
additional accrued benefits that the corporation is obligated to pay in 
accordance with the terms of the plan as of November 2, 2017, through 
the date of payment.
    (B) Nonaccount balance plan providing right to terminate. If under 
the terms of the nonaccount balance plan in effect as of November 2, 
2017, the corporation may terminate the plan and distribute the total 
benefit to the employee, then the grandfathered amount would be the 
present value of the total benefit (lump sum value) determined as if 
the corporation had terminated the plan on November 2, 2017 or, if 
later, the earliest possible date the plan could be terminated in 
accordance with the terms of the plan (termination date). Whether an 
increase or decrease in the lump sum value after the termination date, 
through the earliest possible date the lump sum value could have been 
distributed to the employee, is grandfathered depends on whether the 
terms of the plan require the corporation to increase or decrease the 
lump sum value through the distribution date. For example, if the plan 
did not require the corporation to make further service or compensation 
credits, then any increase in the lump sum value for these credits 
after the termination date is not grandfathered. Notwithstanding the 
foregoing, the corporation may treat the lump sum value as of the 
termination date as the grandfathered amount regardless of when the 
amount is paid and regardless of whether it has increased or decreased 
prior to payment. For purposes of this paragraph (g)(1)(vi)(B), the 
lump sum value is determined based on the actuarial methods and 
assumptions provided in the plan in effect on November 2, 2017, if the 
assumptions are reasonable, or any reasonable actuarial assumptions if 
the plan does not provide for applicable actuarial methods and 
assumptions or the terms of the plan were not reasonable. The 
determination of the lump sum value may not take into account the 
likelihood that payments will not be made (or will be reduced) because 
of the unfunded status of the plan, the risk that the employer, the 
trustee, or another party will be unwilling or unable to pay, the 
possibility of future plan amendments, the possibility of a future 
change in the law, or similar risks or contingencies. If the benefit 
provided under the plan in effect on November 2, 2017, is paid as a 
life annuity or other form of benefit that is not a single lump sum 
payment, the application of the grandfathered amount to the payments of 
the benefit is determined in accordance with the ordering rule of 
paragraph (g)(1)(viii) of this section.
    (C) Nonaccount balance plan providing right to discontinue future 
accrual of benefits. If under the terms of the nonaccount balance plan 
in effect as of November 2, 2017, the corporation has no right to 
terminate the plan, but may discontinue future accruals of benefits and 
distribute the benefit in accordance with the terms of the plan, then 
the grandfathered amount would be the lump sum value of the total 
benefit (lump sum value) determined as if the corporation had exercised 
the right to discontinue the future accrual of benefits on November 2, 
2017, or, if later, the earliest permissible date the corporation could 
exercise such right in accordance with the terms of the plan (the 
freeze date). If, after the freeze date, the plan required the 
corporation to increase or decrease the lump sum value through the 
payment date, then any increase to the grandfathered lump sum would 
also be grandfathered. Notwithstanding the foregoing, the corporation 
may treat the lump sum value determined as of the freeze date as the 
grandfathered amount regardless of when the amount is paid and 
regardless of whether it has been increased or decreased prior to 
payment. For purposes of this paragraph (g)(1)(vi)(C), the lump sum 
value is determined based on the actuarial methods and assumptions 
provided in the plan in effect on November 2, 2017, if the assumptions 
are reasonable, or any reasonable actuarial assumptions if the plan 
does not provide for applicable actuarial methods and assumptions or 
the terms of the plan were not reasonable. The determination of the 
lump sum value may not take into account the likelihood that payments 
will not be made (or will be reduced) because of the unfunded status of 
the plan, the risk that the employer, the trustee, or another party 
will be unwilling or unable to pay, the possibility of future plan 
amendments,

[[Page 86507]]

the possibility of a future change in the law, or similar risks or 
contingencies. If the benefit paid under the plan in effect on November 
2, 2017, is paid as a life annuity or other form of benefit that is not 
a single lump sum payment, the application of the grandfathered amount 
to the payments of the benefit is determined in accordance with the 
ordering rule of paragraph (g)(1)(viii) of this section.
    (vii) Grandfathered amount limited to a particular plan or 
arrangement. The grandfathered amount under a plan or arrangement 
applies solely to the amounts paid under that plan or arrangement, so 
that regardless of whether all of the grandfathered amount is paid to 
the participant (for example, regardless of whether some or all of the 
grandfathered amount under the plan is forfeited under the terms of the 
plan), no portion of that grandfathered amount may be treated as a 
grandfathered amount under any other separate plan or arrangement in 
which the employee is a participant.
    (viii) Ordering rule. If a portion of the amount payable under a 
plan or arrangement is a grandfathered amount and a portion is subject 
to this section, and payment under the plan or arrangement is made in a 
series of payments (including payments as a life annuity), the 
grandfathered amount is allocated to the first payment of an amount 
under the plan or arrangement that is otherwise deductible. If the 
grandfathered amount exceeds the initial payment, the excess is 
allocated to the next payment of an amount under the plan or 
arrangement that is otherwise deductible, and this process is repeated 
until the entire grandfathered amount has been paid. Notwithstanding 
the foregoing, for amounts otherwise deductible for taxable years 
ending before December 20, 2019, the grandfathered amount may be 
allocated to each payment on a pro rata basis or to the last otherwise 
deductible payment. If one of these two methods was used for taxable 
years ending before December 20, 2019, then, for taxable years ending 
on or after December 20, 2019, the method must be changed to allocate 
any remaining grandfathered amount to the first payment for the 
remaining payments (treating as the first payment the first otherwise 
deductible amount for taxable years ending on or after December 20, 
2019).
    (2) Material modifications. (i) If a written binding contract is 
modified on or after November 2, 2017, this section (and not Sec.  
1.162-27) applies to any payments made after the modification. A 
material modification occurs when the contract is amended to increase 
the amount of compensation payable to the employee. If a written 
binding contract is materially modified, it is treated as a new 
contract entered into as of the date of the material modification. 
Thus, amounts received by an employee under the contract before a 
material modification are not affected, but amounts received subsequent 
to the material modification are treated as paid pursuant to a new 
contract, rather than as paid pursuant to a written binding contract in 
effect on November 2, 2017.
    (ii) A modification of the contract that accelerates the payment of 
compensation is a material modification unless the amount of 
compensation paid is discounted to reasonably reflect the time value of 
money. If the contract is modified to defer the payment of 
compensation, any compensation paid or to be paid that is in excess of 
the amount that was originally payable to the employee under the 
contract will not be treated as resulting in a material modification if 
the additional amount is based on applying to the amount originally 
payable either a reasonable rate of interest or the rate of return on a 
predetermined actual investment as defined in Sec.  31.3121(v)(2)-
1(d)(2)(i)(B) of this chapter (whether or not assets associated with 
the amount originally owed are actually invested therein) such that the 
amount payable by the employer at the later date will be based on the 
reasonable rate of interest or the actual rate of return on the 
predetermined actual investment (including any decrease, as well as any 
increase, in the value of the investment). For an arrangement under 
which the grandfathered amounts are subject to increase or decrease 
based on the performance of a predetermined actual investment, the 
addition or substitution of a predetermined actual investment or 
reasonable interest rate as an investment alternative for amounts 
deferred is not treated as a material modification. However, a 
modification of a contract to defer payment of a grandfathered amount 
that results in payment of additional amounts (such as additional 
earnings) does not necessarily mean that the additional amounts are 
grandfathered amounts; for rules concerning the determination of 
grandfathered amounts see paragraph (g) of this section. 
Notwithstanding the foregoing, if compensation attributable to an 
option to purchase stock (other than an incentive stock option 
described in section 422 or a stock option granted under an employee 
stock purchase plan described in section 423) or a stock appreciation 
right is grandfathered, an extension of the exercise period that is 
extended in compliance with Sec.  1.409A-1(b)(5)(v)(C)(1) will not be 
treated as a material modification and the amount of compensation paid 
upon the exercise of the stock option or stock appreciation right will 
be grandfathered.
    (iii) The adoption of a supplemental contract or agreement that 
provides for increased compensation, or the payment of additional 
compensation, is a material modification of a written binding contract 
if the facts and circumstances demonstrate that the additional 
compensation to be paid is based on substantially the same elements or 
conditions as the compensation that is otherwise paid pursuant to the 
written binding contract. However, a material modification of a written 
binding contract does not include a supplemental payment that is equal 
to or less than a reasonable cost-of-living increase over the payment 
made in the preceding year under that written binding contract. In 
addition, the failure, in whole or in part, to exercise negative 
discretion under a contract does not result in the material 
modification of that contract (although the existence of the negative 
discretion under the contract may impact the initial determination of 
whether amounts under the contract are grandfathered amounts).
    (iv) If a grandfathered amount is subject to a substantial risk of 
forfeiture (as defined in Sec.  1.409A-1(d)), then a modification of 
the contract that results in a lapse of the substantial risk of 
forfeiture is not considered a material modification. Furthermore, for 
compensation received pursuant to the substantial vesting of restricted 
property, or the exercise of a stock option or stock appreciation right 
that does not provide for a deferral of compensation (as defined in 
Sec.  1.409A-1(b)(5)(i) and (ii)), a modification of a written binding 
contract in effect on November 2, 2017, that results in a lapse of the 
substantial risk of forfeiture (as defined Sec.  1.83-3(c)) is not 
considered a material modification.
    (3) Examples. The following examples illustrate the provisions of 
this paragraph (g). For each example, assume for all relevant years 
that the corporation is a publicly held corporation within the meaning 
of paragraph (c)(1) of this section and is a calendar year taxpayer, 
and is not a ``smaller reporting company'' or ``emerging growth 
company'' for purposes of reporting under the Exchange Act. 
Furthermore, assume that, for each example, if any arrangement is 
subject to section 409A,

[[Page 86508]]

then the arrangement complies with section 409A, and that no 
arrangement is subject to section 457A.

    (i) Example 1 (Multi-year agreement for annual salary)--(A) 
Facts. On October 2, 2017, Corporation X executed a three-year 
employment agreement with Employee A for an annual salary of 
$2,000,000 beginning on January 1, 2018. Employee A serves as the 
PFO of Corporation X for the 2017 through 2020 taxable years. The 
agreement provides for automatic extensions after the three-year 
term for additional one-year periods, unless the corporation 
exercises its option to terminate the agreement within 30 days 
before the end of the three-year term or, thereafter, within 30 days 
before each anniversary date. Termination of the employment 
agreement does not require the termination of Employee A's 
employment with Corporation X. Under applicable law, the agreement 
for annual salary constitutes a written binding contract in effect 
on November 2, 2017, to pay $2,000,000 of annual salary to Employee 
A for three years through December 31, 2020.
    (B) Conclusion. If this section applies, Employee A is a covered 
employee for Corporation X's 2018 through 2020 taxable years. 
Because the October 2, 2017, employment agreement is a written 
binding contract to pay Employee A an annual salary of $2,000,000, 
this section does not apply (and Sec.  1.162-27 does apply) to the 
deduction for Employee A's annual salary. Pursuant to Sec.  1.162-
27(c)(2), Employee A is not a covered employee for Corporation X's 
2018 through 2020 taxable years. The deduction for Employee A's 
annual salary for the 2018 through 2020 taxable years is not subject 
to section 162(m)(1). However, the employment agreement is treated 
as renewed on January 1, 2021, unless it is previously terminated, 
and the deduction limit of this Sec.  1.162-33 (and not Sec.  1.162-
27) will apply to the deduction for any payments made under the 
employment agreement on or after that date.
    (ii) Example 2 (Agreement for severance based on annual salary 
and discretionary bonus)--(A) Facts. The facts are the same as in 
paragraph (g)(3)(i) of this section (Example 1), except that the 
employment agreement also requires Corporation X to pay Employee A 
severance if Corporation X terminates the employment relationship 
without cause during the term of the agreement. The amount of 
severance is equal to the sum of two times Employee A's annual 
salary plus two times Employee A's discretionary bonus (if any) paid 
within 24 months preceding termination. Under applicable law, the 
agreement for severance constitutes a written binding contract in 
effect on November 2, 2017, to pay $4,000,000 (two times Employee 
A's $2,000,000 annual salary) if Corporation X terminates Employee 
A's employment without cause during the term of the agreement.
    (B) Conclusion. If this section applies, Employee A is a covered 
employee for Corporation X's 2018 through 2020 taxable years. 
Because the October 2, 2017, employment agreement is a written 
binding contract to pay Employee A $4,000,000 if Employee A is 
terminated without cause prior to December 31, 2020, this section 
does not apply (and Sec.  1.162-27 does apply) to the deduction for 
$4,000,000 of Employee A's severance. Pursuant to Sec.  1.162-
27(c)(2), Employee A is not a covered employee for Corporation X's 
2018 through 2020 taxable years. The deduction for $4,000,000 of 
Employee A's severance is not subject to section 162(m)(1). However, 
the employment agreement is treated as renewed on January 1, 2021, 
unless it is previously terminated, and this Sec.  1.162-33 (and not 
Sec.  1.162-27) will apply to the deduction for any payments made 
under the employment agreement, including for severance, on or after 
that date.
    (iii) Example 3 (Effect of discretionary bonus payment on 
agreement for severance based on annual salary and discretionary 
bonus)--(A) Facts. The facts are the same as in paragraph (g)(3)(ii) 
of this section (Example 2), except that, on October 31, 2017, 
Corporation X paid Employee A a discretionary bonus of $100,000, on 
May 14, 2018, Corporation X paid Employee A a discretionary bonus of 
$600,000, and on April 30, 2019, terminated Employee A's employment 
without cause. Pursuant to the terms of the employment agreement for 
severance, on May 1, 2019, Corporation X paid to Employee A a 
$5,400,000 severance payment (the sum of two times the $2,000,000 
annual salary, two times the $100,000 discretionary bonus, and two 
times the $600,000 discretionary bonus).
    (B) Conclusion. If this section applies, Employee A is a covered 
employee for Corporation X's 2019 taxable year. Because the October 
2, 2017, agreement is a written binding contract to pay Employee A 
$4,000,000 if Employee A is terminated without cause prior to 
December 31, 2020, and $200,000 if Corporation X terminates Employee 
A's employment without cause prior to October 31, 2019, this section 
does not apply (and Sec.  1.162-27 does apply) to the deduction for 
$4,200,000 of Employee A's severance payment. The deduction for 
$4,200,000 of Employee A's severance payment is not subject to 
section 162(m)(1). Because the October 2, 2017, agreement is not a 
written binding contract to pay Employee A's $600,000 discretionary 
bonus (since, as of November 2, 2017, Corporation X was not 
obligated under applicable law to make the bonus payment), the 
deduction for $1,200,000 of the $5,400,000 payment is subject to 
this section (and not Sec.  1.162-27).
    (iv) Example 4 (Effect of adjustment to annual salary on 
severance)--(A) Facts. The facts are the same as in paragraph 
(g)(3)(ii) of this section (Example 2), except that the employment 
agreement provides for discretionary increases in salary and, on 
January 1, 2019, Corporation X increased Employee A's annual salary 
from $2,000,000 to $2,050,000, an increase that was less than a 
reasonable, cost-of-living adjustment.
    (B) Conclusion (Annual salary). If this section applies, 
Employee A is a covered employee for Corporation X's 2018 through 
2020 taxable years. Because the October 2, 2017, agreement is a 
written binding contract to pay Employee A an annual salary of 
$2,000,000, this section does not apply (and Sec.  1.162-27 does 
apply) to the deduction for Employee A's annual salary unless the 
change in the salary is a material modification. Even though the 
$50,000 increase is paid on the basis of substantially the same 
elements or conditions as the salary that is otherwise paid under 
the contract, the $50,000 increase does not constitute a material 
modification because it is less than or equal to a reasonable cost-
of-living increase to the $2,000,000 annual salary Corporation X is 
required to pay under applicable law as of November 2, 2017. 
However, the deduction for the $50,000 increase is subject to this 
section (and not Sec.  1.162-27).
    (C) Conclusion (Severance payment). Because the October 2, 2017, 
agreement is a written binding contract to pay Employee A severance 
of $4,000,000, this section would not apply (and Sec.  1.162-27 
would apply) to the deduction for this amount of severance unless 
the change in the employment agreement is a material modification. 
Even though the $100,000 increase in severance (two times the 
$50,000 increase in salary) would be paid on the basis of 
substantially the same elements or conditions as the severance that 
would otherwise be paid pursuant to the written binding contract, 
the $50,000 increase in salary on which it is based does not 
constitute a material modification of the written binding contract 
since it is less than or equal to a reasonable cost-of-living 
increase. However, the deduction for the $100,000 increase in 
severance is subject to this section (and not Sec.  1.162-27).
    (v) Example 5 (Effect of adjustment to annual salary on 
severance)--(A) Facts. The facts are the same as in paragraph 
(g)(3)(iv) of this section (Example 4), except that, on January 1, 
2019, Corporation X increased Employee A's annual salary from 
$2,000,000 to $3,000,000, an increase that exceeds a reasonable, 
cost-of-living adjustment.
    (B) Conclusion (Annual salary). If this section applies, 
Employee A is a covered employee for Corporation X's 2018 through 
2020 taxable years. Because the October 2, 2017, agreement is a 
written binding contract to pay Employee A an annual salary of 
$2,000,000, this section does not apply (and Sec.  1.162-27 does 
apply) to the deduction for Employee A's annual salary unless the 
change in the employment agreement is a material modification. The 
$1,000,000 increase 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 exceeds a reasonable, annual cost-of-living 
increase from the $2,000,000 annual salary for 2018 that Corporation 
X is required to pay under applicable law as of November 2, 2017. 
Because the written binding contract is materially modified as of 
January 1, 2019, the deduction for all annual salary paid to 
Employee A in 2019 and thereafter is subject to this section (and 
not Sec.  1.162-27).
    (C) Conclusion (Severance payment). Because the October 2, 2017, 
agreement is a written binding contract to pay Employee A severance 
of $4,000,000, this section would not apply (and Sec.  1.162-27 
would apply) to

[[Page 86509]]

the deduction for this amount of severance unless the change in the 
employment agreement is a material modification. The additional 
$2,000,000 severance payment (two times the $1,000,000 increase in 
annual salary) constitutes a material modification of the written 
binding contract because the $1,000,000 increase in salary on which 
it is based constitutes a material modification of the written 
binding contract since it exceeds a reasonable cost-of-living 
increase from the $2,000,000 annual salary for 2018 that Corporation 
X is required to pay under applicable law as of November 2, 2017. 
Because the agreement is materially modified as of January 1, 2019, 
the deduction for any amount of severance paid to Employee A under 
the agreement is subject to this section (and not Sec.  1.162-27).
    (vi) Example 6 (Elective deferral of an amount that corporation 
was obligated to pay under applicable law)--(A) Facts. The facts are 
the same as in paragraph (g)(3)(i) of this section (Example 1), 
except that, on December 15, 2018, Employee A makes a deferral 
election under a nonqualified deferred compensation (NQDC) plan to 
defer $200,000 of annual salary earned and payable in 2019. Pursuant 
to the NQDC plan, the $200,000, including earnings, is to be paid in 
a lump sum on the date six months following Employee A's separation 
from service. The earnings are based on the Standard & Poor's 500 
Index. Under applicable law, pursuant to the written binding 
contract in effect on November 2, 2017, (and absent the deferral 
agreement) Corporation X would have been obligated to pay $200,000 
to Employee A in 2019, but is not obligated to pay any earnings on 
the $200,000 deferred pursuant to the deferral election Employee A 
makes on December 15, 2018. Employee A separates from service on 
December 15, 2020. On June 15, 2021, Corporation X pays $250,000 
(the deferred $200,000 of salary plus $50,000 in earnings).
    (B) Conclusion. If this section applies, Employee A is a covered 
employee for Corporation X's 2021 taxable year. Employee A's NQDC 
plan is not a material modification of the written binding contract 
in effect on November 2, 2017, because the earnings to be paid under 
the NQDC plan are based on a predetermined actual investment (as 
defined in Sec.  31.3121(v)(2)-1(d)(2)(i)(B) of this chapter). The 
deduction for the $50,000 of earnings to be paid that exceed the 
amount originally payable to Employee A under the written binding 
contract ($200,000 of salary) are subject to this section (and not 
Sec.  1.162-27). This section does not apply (and Sec.  1.162-27 
does apply) to the deduction for the $200,000 portion of the 
$250,000 payment that Corporation X was obligated under applicable 
law to pay as of November 2, 2017. Pursuant to Sec.  1.162-27(c)(2), 
Employee A is not a covered employee for Corporation X's 2021 
taxable year; thus, the deduction for the $200,000 payment is not 
subject to section 162(m)(1).
    (vii) Example 7 (Compensation subject to discretionary recovery 
by corporation)--(A) Facts. Employee B serves as the PFO of 
Corporation Z for its 2017 through 2019 taxable years. On October 2, 
2017, Corporation Z executed a bonus agreement with Employee B that 
requires Corporation Z to pay Employee B a performance bonus of 
$3,000,000 on May 1, 2019, if Corporation Z's net earnings increase 
by at least 10% for its 2018 taxable year based on the financial 
statements filed with the SEC. The agreement does not permit 
Corporation Z to reduce the amount of the bonus payment for any 
reason if the Corporation Z attains the net earnings performance 
target. However, the agreement provides that, if the bonus is paid 
and subsequently the financial statements are restated to show that 
the net earnings did not increase by at least 10%, then Corporation 
Z may, in its discretion, recover the $3,000,000 from Employee B 
within six months of the restatement. Under applicable law, the 
agreement for the performance bonus constitutes a written binding 
contract in effect on November 2, 2017, to pay $3,000,000 to 
Employee B if Corporation Z's net earnings increase by at least 10% 
for its 2018 taxable year based on the financial statements filed 
with the SEC. On May 1, 2019, Corporation Z pays $3,000,000 to 
Employee B because its net earnings increased by at least 10% of its 
2018 taxable year.
    (B) Conclusion. If this section applies, Employee B is a covered 
employee for Corporation Z's 2019 taxable year. Because the October 
2, 2017, agreement is a written binding contract to pay Employee B 
$3,000,000 if the applicable conditions are met, this section does 
not apply (and Sec.  1.162-27 does apply) to the deduction for the 
$3,000,000 regardless of whether Corporation Z's financial 
statements are restated to show that its net earnings did not 
increase by at least 10%, and regardless of whether Corporation Z 
exercises its discretion to recover the bonus if Corporation Z's 
financial statements are restated to show that its net earnings did 
not increase by at least 10%.
    (viii) Example 8 (Performance bonus plan with negative 
discretion)--(A) Facts. Employee E serves as the PEO of Corporation 
V for the 2017 and 2018 taxable years. On February 1, 2017, 
Corporation V establishes a bonus plan, under which Employee E will 
receive a cash bonus of $1,500,000 if a specified performance goal 
is satisfied. The compensation committee retains the right, if the 
performance goal is met, to reduce the bonus payment to no less than 
$400,000 if, in its judgment, other subjective factors warrant a 
reduction. On November 2, 2017, under applicable law, which takes 
into account the employer's ability to exercise negative discretion, 
the bonus plan established on February 1, 2017, constitutes a 
written binding contract to pay $400,000. On March 1, 2018, the 
compensation committee certifies that the performance goal was 
satisfied, but exercises its discretion to reduce the award to 
$500,000. On April 1, 2018, Corporation V pays $500,000 to Employee 
E. The payment satisfies the requirements of Sec.  1.162-27(e)(2) 
through (5) as qualified performance-based compensation.
    (B) Conclusion. If this section applies, Employee E is a covered 
employee for Corporation V's 2018 taxable year. Because the February 
1, 2017, plan is a written binding contract to pay Employee E 
$400,000 if the performance goal is satisfied, this section does not 
apply (and Sec.  1.162-27 does apply) to the deduction for the 
$400,000 portion of the $500,000 payment. Furthermore, pursuant to 
paragraph (g)(2)(iii) of this section, the failure of the 
compensation committee to exercise its discretion to reduce the 
award further to $400,000, instead of $500,000, does not result in a 
material modification of the contract. Pursuant to Sec.  1.162-
27(e)(1), the deduction for the $400,000 payment is not subject to 
section 162(m)(1) because the payment satisfies the requirements of 
Sec.  1.162-27(e)(2) through (5) as qualified performance-based 
compensation. The deduction for the remaining $100,000 of the 
$500,000 payment is subject to this section (and not Sec.  1.162-27) 
and therefore the status as qualified performance-based compensation 
is irrelevant to the application of section 162(m)(1) to this 
remaining amount.
    (ix) Example 9 (Equity-based compensation with underlying grants 
made prior to November 2, 2017)--(A) Facts. On January 2, 2017, 
Corporation T executed a 4-year employment agreement with Employee G 
to serve as its PEO, and Employee G serves as the PEO for the four-
year term. Pursuant to the employment agreement, on January 2, 2017, 
Corporation T executed a grant agreement and granted to Employee G 
nonqualified stock options to purchase 1,000 shares of Corporation T 
stock, stock appreciation rights (SARs) on 1,000 shares, and 1,000 
shares of Corporation T restricted stock. On the date of grant, the 
stock options had no readily ascertainable fair market value as 
defined in Sec.  1.83-7(b), and neither the stock options nor the 
SARs provided for a deferral of compensation under Sec.  1.409A-
1(b)(5)(i)(A) and (B). The stock options, SARs, and shares of 
restricted stock are subject to a substantial risk of forfeiture and 
all substantially vest on January 2, 2020. Employee G may exercise 
the stock options and the SARs at any time from January 2, 2020, 
through January 2, 2027. On January 2, 2020, Employee G exercises 
the stock options and the SARs, and the 1,000 shares of restricted 
stock become substantially vested (as defined in Sec.  1.83-3(b)). 
The grant agreement pursuant to which grants of the stock options, 
SARs, and shares of restricted stock are made constitutes a written 
binding contract under applicable law. The compensation attributable 
to the stock options and the SARs satisfy the requirements of Sec.  
1.162-27(e)(2) through (5) as qualified performance-based 
compensation.
    (B) Conclusion. If this section applies, Employee G is a covered 
employee for Corporation T's 2020 taxable year. Because the January 
2, 2017, grant agreement constitutes a written binding contract, 
this section does not apply (and Sec.  1.162-27 does apply) to the 
deduction for compensation received pursuant to the exercise of the 
stock options and the SARs, or the restricted stock becoming 
substantially vested (as defined in Sec.  1.83-3(b)). Pursuant to 
Sec.  1.162-27(e)(1), the deduction attributable to the stock 
options and the SARs is not subject to section 162(m)(1) because the 
compensation satisfies the requirements of Sec.  1.162-27(e)(2) 
through

[[Page 86510]]

(5) as qualified performance-based compensation. However, the 
deduction attributable to the restricted stock is subject to section 
162(m)(1) because the compensation does not satisfy the requirements 
of Sec.  1.162-27(e)(2) through (5) as qualified performance-based 
compensation.
    (x) Example 10 (Plan in which an employee is not a participant 
on November 2, 2017)--(A) Facts. On October 2, 2017, Employee H 
executes an employment agreement with Corporation Y to serve as its 
PFO, and begins employment with Corporation Y. The employment 
agreement, which is a written binding contract under applicable law, 
provides that if Employee H continues in his position through April 
1, 2018, Employee H will become a participant in the NQDC plan of 
Corporation Y and that Employee H's benefit accumulated on that date 
will be $3,000,000. On April 1, 2021, Employee H receives a payment 
of $4,500,000 (the increase from $3,000,000 to $4,500,000 is not a 
result of a material modification as defined in paragraph (g)(2) of 
this section), which is the entire benefit accumulated under the 
plan through the date of payment.
    (B) Conclusion. If this section applies, Employee H is a covered 
employee for Corporation Y's 2021 taxable year. Even though Employee 
H was not eligible to participate in the NQDC plan on November 2, 
2017, Employee H had the right to participate in the plan under a 
written binding contract as of that date. Because the amount 
required to be paid pursuant to the written binding contract is 
$3,000,000, this section does not apply (and Sec.  1.162-27 does 
apply) to the deduction for the $3,000,000 portion of the 
$4,500,000. Pursuant to Sec.  1.162-27(c)(2), Employee H is not a 
covered employee of Corporation Y for the 2021 taxable year. The 
deduction for the $3,000,000 portion of the $4,500,000 is not 
subject to section 162(m)(1). The deduction for the remaining 
$1,500,000 portion of the payment is subject to this section (and 
not Sec.  1.162-27).
    (xi) Example 11 (Material modification of annual salary)--(A) 
Facts. On January 2, 2017, Corporation R executed a 5-year 
employment agreement with Employee I to serve as Corporation R's 
PFO, providing for an annual salary of $1,800,000. The agreement 
constitutes a written binding contract under applicable law. In 2017 
and 2018, Employee I receives the salary of $1,800,000 per year. In 
2019, Corporation R increases Employee I's salary by $40,000, which 
is less than a reasonable cost-of-living increase from $1,800,000. 
On January 1, 2020, Corporation R increases Employee I's salary to 
$2,400,000. The $560,000 increase exceeds a reasonable, annual cost-
of-living increase from $1,840,000.
    (B) Conclusion ($1,840,000 Payment in 2019). If this section 
applies, Employee I is a covered employee for Corporation R's 2018 
through 2020 taxable years. Because the January 1, 2017, agreement 
is a written binding contract to pay Employee I an annual salary of 
$1,800,000, this section does not apply (and Sec.  1.162-27 does 
apply) to the deduction for Employee I's annual salary unless the 
change in the employment agreement is a material modification. 
Pursuant to Sec.  1.162-27(c)(2), Employee I is not a covered 
employee of Corporation R for the 2019 taxable year, so the 
deduction for the $1,800,000 salary is not subject to section 
162(m)(1). Even though the $40,000 increase is made on the basis of 
substantially the same elements or conditions as the salary, the 
$40,000 increase does not constitute a material modification of the 
written binding contract because the $40,000 is less than or equal 
to a reasonable cost-of-living increase. However, the deduction for 
the $40,000 increase is subject to this section (and not Sec.  
1.162-27).
    (C) Conclusion (Salary increase to $2,400,000 in 2020). The 
$560,000 increase in salary 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 salary, and it exceeds a reasonable, annual cost-of-living 
increase from $1,840,000. Because the written binding contract is 
materially modified as of January 1, 2020, the deduction for all 
salary paid to Employee I on and after January 1, 2020, is subject 
is subject to this section (and not Sec.  1.162-27).
    (xii) Example 12 (Additional payment not considered a material 
modification)--(A) Facts. The facts are the same as in paragraph 
(g)(3)(xi) of this section (Example 11), except that instead of an 
increase in salary, in 2020 Employee I receives a restricted stock 
grant subject to Employee I's continued employment for the balance 
of the contract.
    (B) Conclusion. The restricted stock grant is not a material 
modification of the written binding contract because any additional 
compensation paid to Employee I under the grant is not paid on the 
basis of substantially the same elements and conditions as Employee 
I's salary. However, the deduction attributable to the restricted 
stock grant is subject to this section (and not Sec.  1.162-27).

    (h) Effective/Applicability dates--(1) Effective date. This section 
is effective on December 30, 2020.
    (2) Applicability dates--(i) General applicability date. Except as 
otherwise provided in paragraph (h)(2)(ii) of this section, this 
section applies to taxable years beginning on or after December 30, 
2020. Taxpayers may choose to apply this section for taxable years 
beginning after December 31, 2017, and before December 30, 2020 
provided the taxpayer applies this section in its entirety and in a 
consistent manner.
    (ii) Special applicability dates--(A) Definition of covered 
employee. The definition of covered employee in paragraph (c)(2)(i) of 
this section applies to taxable years ending on or after September 10, 
2018. However, for a corporation whose fiscal year and taxable year do 
not end on the same date, the rule in paragraph (c)(2)(i)(B) of this 
section requiring the determination of the three most highly 
compensated executive officers to be made pursuant to the rules under 
the Exchange Act applies to taxable years ending on or after December 
20, 2019.
    (B) Definition of predecessor of a publicly held corporation--(1) 
Publicly held corporations that become privately held. The definition 
of predecessor of a publicly held corporation in paragraph 
(c)(2)(ii)(A) of this section applies to any publicly held corporation 
that becomes a privately held corporation for a taxable year beginning 
after December 31, 2017, and, subsequently, again becomes a publicly 
held corporation on or after December 30, 2020. The definition of 
predecessor of a publicly held corporation in paragraph (c)(2)(ii)(A) 
of this section does not apply to any publicly held corporation that 
became a privately held corporation for a taxable year beginning before 
January 1, 2018, with respect to the earlier period as a publicly held 
corporation; or a publicly held corporation that becomes a privately 
held corporation for a taxable year beginning after December 31, 2017, 
and, subsequently, again becomes a publicly held corporation before 
December 30, 2020.
    (2) Corporate transactions. The definition of predecessor of a 
publicly held corporation in paragraphs (c)(2)(ii)(B) through (H) of 
this section applies to corporate transactions that occur (as provided 
in the transaction timing rule of paragraph (c)(2)(ii)(I) of this 
section) on or after December 30, 2020. With respect to any of the 
following corporate transactions occurring after December 20, 2019, and 
before December 30, 2020, excluding target corporations from the 
definition of the term ``predecessor'' is not a reasonable good faith 
interpretation of the statute:
    (i) A publicly held target corporation the stock or assets of which 
are acquired by another publicly held corporation in a transaction to 
which section 381(a) applies.
    (ii) A publicly held target corporation, at least 80% of the total 
voting power of the stock of which, and at least 80% of the total value 
of the stock of which, are acquired by a publicly held acquiring 
corporation (including an affiliated group).
    (C) Definition of compensation. The definition of compensation 
provided in paragraph (c)(3)(ii) of this section (relating to 
distributive share of partnership deductions for compensation paid) 
applies to any deduction for compensation that is paid after December 
18, 2020. The definition of compensation in paragraph (c)(3)(ii) does 
not apply to compensation paid pursuant to a written binding contract 
that is in effect on December 20, 2019,

[[Page 86511]]

and that is not materially modified after that date. For purposes of 
this paragraph (h)(3), written binding contract and material 
modification have the same meanings as provided in paragraphs (g)(1) 
and (2) of this section.
    (D) Corporations that become publicly held. The rule in paragraph 
(d) of this section (providing that the deduction limitation of 
paragraph (b) of this section applies to a deduction for any 
compensation that is otherwise deductible for the taxable year ending 
on or after the date that a privately held corporation becomes a 
publicly held corporation) applies to corporations that become publicly 
held after December 20, 2019. A privately held corporation that becomes 
a publicly held corporation on or before December 20, 2019, may rely on 
the transition rules provided in Sec.  1.162-27(f)(1) until the 
earliest of the events provided in Sec.  1.162-27(f)(2). A subsidiary 
that is a member of an affiliated group (as defined in Sec.  1.162-
27(c)(1)(ii)) may rely on transition relief provided in Sec.  1.162-
27(f)(4) if it becomes a separate publicly held corporation (whether in 
a spin-off transaction or otherwise) on or before December 20, 2019.
    (E) Transition rules. Except for the transition rules in paragraphs 
(g)(1)(v) through (vii) of this section, the transition rules in 
paragraphs (g)(1) and (2) of this section (providing that this section 
does not apply to compensation payable under a written binding contract 
which was in effect on November 2, 2017, and which is not modified in 
any material respect on or after such date) apply to taxable years 
ending on or after September 10, 2018.

0
Par. 4. Section 1.338-1 is amended by revising paragraph (b)(2)(i) to 
read as follows:


Sec.  1.338-1  General principles; status of old target and new target.

* * * * *
    (b) * * *
    (2) * * *
    (i) The rules applicable to employee benefit plans (including those 
plans described in sections 79, 104, 105, 106, 125, 127, 129, 132, 137, 
and 220), qualified pension, profit-sharing, stock bonus and annuity 
plans (sections 401(a) and 403(a)), simplified employee pensions 
(section 408(k)), tax qualified stock option plans (sections 422 and 
423), welfare benefit funds (sections 419, 419A, 512(a)(3), and 4976), 
voluntary employee benefit associations (section 501(c)(9) and the 
regulations thereunder (Sec. Sec.  1.501(c)(9)-1 through 1.501(c)(9)-
8)) and certain excessive employee remuneration (section 162(m) and the 
regulations thereunder (Sec. Sec.  1.162-27, 1.162-31, and 1.162-33));
* * * * *

Sunita Lough,
Deputy Commissioner for Services and Enforcement.

    Approved: December 11, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-28484 Filed 12-28-20; 8:45 am]
BILLING CODE 4830-01-P