While the performance-based compensation exception to the $1 million compensation limit under Internal Revenue Code Section 162(m) for “covered employees” is a thing of the past (absent grandfathered contracts) for federal income tax purposes, practitioners are realizing that Section 162(m) may continue to be a consideration for state taxes.
For administrative ease, the great majority of states conform many elements of their state tax codes to the federal tax code. However, it is rare for any state to conform to the federal code in all respects.
States conform on either a static or rolling basis, and are roughly split between the two approaches. Static conformity means conforming to the Internal Revenue Code as of a specific date (and among the states with static conformity, the dates of conformity vary widely). Rolling conformity means adopting changes as they occur, so for a state that automatically tracks federal law, this issue does not exist. Some large states, such as California and Florida, have static conformity. Others, such as New York, have rolling conformity.
So, what does this mean in the world of executive compensation? It means that many states have corporate income tax laws that reflect an older version of the Internal Revenue Code, including the older version of Section 162(m), so that, while complying with the performance-based compensation limit of Section 162(m) no longer has a federal tax benefit, it may have a state income tax benefit, at least under current state law. While one would think that all states will eventually conform to the new Section 162(m), whether that change will be effective at the same time as the new federal law is uncertain. It’s hard to see why a state would not eventually conform to the new Section 162(m). However, conforming to the new rules may get tied up into the broader issue of conforming to all of the new federal income tax rules, and we can imagine state legislators taking some time to decide the extent to which they want to adopt all of the federal changes.
This is a complicated topic. We advise that companies consult with their tax and accounting specialists to determine if the Section 162(m) repeal has flowed through to their state tax jurisdictions, and then to determine what, if any, compensation program planning implications may result.
Dave Gordon’s practice as an executive compensation consultant stretches back over a decade. He has covered a variety of industries, including extensive experience with financial institutions and utilities. In addition to engagements for his own clients, based on his years of experience as an executive compensation lawyer, he acts as the senior resource on numerous technical issues for the Firm. He frequently acts as an expert witness, where his prior background as a lawyer litigating executive compensation cases gives him a unique perspective when called upon to perform services as an executive compensation expert witness.
Samantha Nussbaum has consulted on behalf of public and private companies, compensation committees, and senior management on all aspects of executive compensation. Samantha’s consulting and legal background includes advising on executive compensation in the context of mergers and acquisitions, spin-offs, and initial public offerings; executive employment, severance, and change in control agreements; equity incentive plans; deferred compensation; and securities laws, including reporting and disclosure implications.