INSIGHT

What to know about Section 162(m) 

Tsvetelina Petrova, Bob Houston • June 24, 2025

Services: Corporate Tax

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New IRS regulations expand executive compensation deduction limits 

The IRS has proposed significant new regulations that will expand the reach of Section 162(m)’s executive compensation deduction limitations starting in 2027. If your publicly held corporation hasn’t started planning for these changes, now is the time to act. 

On January 14, 2025, the IRS released proposed regulations (REG-118988-22) implementing amendments made by the American Rescue Plan Act of 2021 (ARPA) to Section 162(m). These changes will substantially increase the number of employees whose compensation above $1 million becomes non-deductible for tax purposes. 

Understanding the current landscape 

Section 162(m) has been limiting public companies’ tax deductions since 1993, but its scope has expanded significantly over time. Currently, the law disallows deductions for compensation exceeding $1 million paid to “covered employees” during the taxable year. 

The Tax Cuts and Jobs Act of 2017 introduced the “once covered, always covered” rule, meaning that anyone who was identified as a covered employee in 2017 or later remains a covered employee forever, even if they no longer hold their original position. This has already caused the number of covered employees at many companies to grow steadily over time. 

Who are covered employees today? 

Under current rules, covered employees include: 

• Chief executive officer (CEO) 
• Chief financial officer (CFO) 
• The three highest paid executive officers (other than the CEO and CFO) 
• Anyone who was previously identified as a covered employee since January 1, 2017 

The ARPA expansion: Five additional employees 

Starting with tax years beginning after December 31, 2026, ARPA adds a new category to the covered employee definition: the five highest compensated employees for each taxable year. 

This expansion represents a significant broadening of Section 162(m)’s reach, potentially affecting mid-level executives and high-earning employees who were previously outside the law’s scope. 

Key differences in the new category 

The proposed regulations clarify several important distinctions about these additional five employees: 

• Annual determination: Unlike the “once covered, always covered” rule that applies to traditional covered employees, the five highest compensated employees are determined fresh each year. An employee who qualifies one year doesn’t automatically remain a covered employee in subsequent years unless they continue to rank among the top five. 
• Broader definition of “employee”: The regulations define “employee” under Section 3401(c), which includes both common law employees and corporate officers. This means the five additional spots aren’t limited to executive officers—they can include any highly compensated employee. 
• Different compensation measurement: For identifying the five highest compensated employees, companies will use compensation that would be deductible for the tax year (generally Form W-2 box 1 wages). This differs from the current approach for identifying the three highest paid officers, which uses total compensation disclosed under Securities and Exchange Commission rules. 

Navigating affiliated group complexities 

The proposed regulations extend existing affiliated group rules to the new five highest compensated employee category. These rules prevent companies from circumventing the law’s intent by shifting highly paid employees to related entities. 

Single publicly held corporation in group 

If your affiliated group has one publicly held corporation, any employee of any group member can qualify as one of the five highest compensated employees, regardless of which entity employs them or pays their compensation. 

Multiple publicly held corporations 

When an affiliated group includes multiple public corporations, each determines its own set of five highest compensated employees separately. The regulations provide specific guidance on which group members each public corporation should consider in making these determinations. 

Planning considerations for your organization 

These changes will have meaningful implications for tax planning, financial reporting, and compensation design. Consider these key areas: 

Immediate assessment needs 

• Identify potential new covered employees: Review your current compensation structure to determine which employees might fall into the new five highest compensated category 
• Evaluate deferred tax positions: Existing deferred tax assets related to employee compensation may need adjustment, potentially affecting interim financial statements 
• Review compensation arrangements: Analyze current and planned compensation structures for employees who may become covered employees 

Strategic planning opportunities 

• Compensation restructuring: Consider whether modifications to compensation arrangements could minimize the impact of the new rules 
• Timing considerations: Evaluate whether accelerating or deferring certain compensation payments before the 2027 effective date makes sense
• Documentation review: Assess existing employment agreements and compensation plans for potential modifications 

Implementation timeline and next steps with BPM 

The proposed regulations generally apply to compensation that is otherwise deductible for tax years beginning after the later of December 31, 2026, or the date final regulations are published. 

Moving forward with confidence 

The expansion of Section 162(m) represents a significant change in the tax treatment of executive compensation. While the rules don’t take effect until 2027, the time to start planning is now. 

Understanding these new requirements and their potential impact on your organization will help you make informed decisions about compensation planning and tax strategy. Early preparation can help minimize surprises and position your company to adapt effectively to the new regulatory environment. 

Ready to assess how these changes might affect your organization? Contact BPM’s tax professionals to discuss your specific situation and develop a strategic approach to the new Section 162(m) requirements. Our team can help you navigate these complex regulations and identify planning opportunities tailored to your company’s needs.