Prior Law

Through December 31, 2017

An employer generally may deduct reasonable compensation for personal services as an ordinary and necessary business expense. But a publicly held corporation cannot deduct applicable employee remuneration in excess of $1 million per year paid to a covered employee.

Under pre-Tax Cuts and Jobs Act law, performance-based compensation was exempt from the $1 million deduction limit, i.e., it wasn’t applicable employee remuneration.

Compensation qualified for this exception if:

  • it was payable solely on account of performance goals having been reached;
  • the performance goals were pre-established and objective;
  • the performance goals stated the method of computing compensation in an objective formula;
  • the objective compensation formula precluded discretion to increase the amount payable upon reaching the goal;
  • the performance goals were set by a compensation committee consisting solely of two or more outside directors;
  • the performance goals were approved by shareholders; and
  • before any remuneration was paid, the company’s compensation committee certified that the performance goals had been reached.

In addition, under pre-Tax Cuts and Jobs Act law, commission payments that were based solely on income that was generated directly by the employee’s individual performance were exempt from the $1 million deduction limit.

New Law

Effective for tax years beginning after December 31, 2017 and before January 1, 2026

The Tax Cuts and Jobs Act eliminates the exceptions for performance-based compensation and commissions from the definition of “applicable employee remuneration” that is subject to the $1 million deduction limit.

Commentary

As a result of the law change, bonuses, stock options and other performance-based compensation, are taken into account when determining the amount of compensation for a tax year that exceeds $1 million and which will not be deductible for tax purposes.

This law only applies to employees of publically traded companies. Also, under a transition rule, if the covered employee has a binding written contract dated before November 2, 2017, the provisions of the Tax Cuts and Jobs Act will not apply.

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David Howell
Tax Manager
As a Tax Manager, I provide tax planning and preparation services to businesses in varying industries, individuals, estates and trusts.

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