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.
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.