Limitation on Excessive Employee Compensation

Business Accounting

Written by Amanda Farley

March 26, 2018

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.


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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Amanda Farley
As a tax supervisor in the firm’s Green Bay, WI, office, I help to advise small businesses and assist with tax preparation and planning for a variety of different entities.

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