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IRS releases memorandum on definition of ‘covered employee’ under Section 162(m)

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Tax Hot Topics: definition of covered employeeIn a recently released Chief Counsel Advice memorandum (CCA 201543003), the IRS addressed the definition of “covered employee” for purposes of Section 162(m). Under Section 162(m), a public company’s compensation deduction is limited to $1 million per year for each covered employee and a covered employee is defined in part by referring to the SEC’s disclosure rules for executive compensation.  

The SEC revised the rules for most public companies in 2006. In response to the new rules, the IRS issued Notice 2007-49 to clarify the definition of a covered employee. The term “covered employee” generally now includes the CEO as of the end of the taxable year and the three highest-paid officers, other than the CEO and the CFO.  

Accordingly, under the general definition of Notice 2007-49, a CFO isn’t a covered employee.  

In CCA 201543003, the IRS addressed how the definition of a covered employee applies to a small public company that is eligible to comply with the executive compensation disclosure requirements under the Securities Exchange Act of 1943 by satisfying the disclosure rules required of a smaller reporting company under Item 402(m) of Regulation S-K.  

Under Item 402(m) of Regulation S-K, the named executive officers required to be reported on the company’s proxy statement include all individuals who served as the CEO during the last fiscal year and the two highest-paid officers other than the CEO who served as officers on the last day of the last fiscal year.  

The IRS noted that the disclosure rules for smaller reporting companies don’t require disclosure of the compensation of an officer by virtue of the individual serving as the CFO. Instead, CFO compensation is disclosed only if the CFO is among the highest-paid two executives. Thus, the IRS explained in the memorandum that while the CFO is generally not included as a covered employee, the CFO of a smaller reporting company is a covered employee if he or she is one of the two ighest- paid officers other than the CEO who were serving as an officer at the end of the year.  


Please contact Eddie Adkins or Jeffrey Martin for more information.

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