Notice 2018-68 provides — Internal Revenue Bulletin 2020-3

occurs if a written binding contract in effect on November 2, 2017, is subsequently modified to defer the payment of compensation. Under those rules, which are adopted in these proposed regulations, if the contract is modified to defer the payment of compensation, any compensation paid or to be paid that is in excess of the amount that was originally payable to the employee under the contract will not be treated as resulting in a material modification if the additional amount is based on either a reasonable rate of interest or a predetermined actual investment (whether or not assets associated with the amount originally owed are actually invested therein) such that the amount payable by the employer at the later date will be based on the actual rate of return on the predetermined actual investment (includ

ing any decrease, as well as any increase, in the value of the investment). The proposed regulations provide that a predetermined actual investment means a predetermined actual investment as defined in §31.3121(v)(2)-1(d)(2)(i)(B), and also include examples illustrating these rules relating to the treatment of earnings.

However, even though the payment of earnings will not result in the contract being materially modified, this generally does not mean that the earnings are treated as grandfathered. For situations in which an employee defers an amount of grandfathered compensation after November 2, 2017, the earnings on the deferred amount are not grandfathered if, as of November 2, 2017, the corporation was not obligated under the terms of the contract to provide the deferral election and to pay the earnings on the deferred amount under applicable law. Pursuant to the definition of written binding contract in Notice 201868 and these proposed regulations, these earnings are not grandfathered because, as of November 2, 2017, the corporation was not obligated to pay them under applicable law.

Material Modification Prior to Payment of a Grandfathered Amount

Commenters asked whether a grandfathered amount of compensation is no longer considered grandfathered if the underlying compensation arrangement is materially modified after November 2, 2017, but before the payment of the grandfathered amount. Pursuant to the definition of material modification in Notice 2018-68 and these proposed regulations, if the contract is materially modified after November 2, 2017, but before the payment of a grandfathered amount of compensation, then the compensation is treated as paid pursuant to the new contract and is no longer grandfathered. For example, if, under applicable law, a corporation is obligated to pay $100,000 on December 31, 2020, under a written binding contract in effect on November 2, 2017, then the $100,000 is grandfathered. If, on January 1, 2019, the contract is materially modified, then the $100,000 is treated as paid pursuant to a new contract and is not grandfathered.

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Acceleration of Payment or Vesting

Under the definition of material modification in Notice 2018-68 and these proposed regulations, a modification of a written binding contract that accelerates the payment of compensation is a material modification unless the amount of compensation paid is discounted to reasonably reflect the time value of money. For example, if a corporation is obligated under applicable law to pay compensation on December 31, 2020, pursuant to a written binding contract in effect on November 2, 2017, then the compensation is grandfathered. If the corporation pays the entire amount of compensation on December 31, 2019 without a discount to reasonably reflect the time of value of money, then the entire amount of compensation is treated as paid pursuant to a new contract and is no longer grandfathered. Furthermore, any subsequent payment made pursuant to the contract is not grandfathered because the contract itself was materially modified when the prior payment was accelerated without a discount to reasonably reflect the time value of money.

Commenters asked whether accelerating the payment of compensation attributable to equity-based compensation is considered a material modification when the payment is subject to a substantial risk of forfeiture. For example, an option may be subject to a substantial risk of forfeiture if, on the date of grant, the terms of the option provide that an employee may exercise the option only after performing services for three years after the date of grant. In this example, if the terms of the option are subsequently modified to require performance of services for only two years, then the modification results in the lapse of a substantial risk of forfeiture. One might consider this a material modification because the employee may exercise the option and receive compensation attributable to the exercise earlier than provided in the terms of the option on the date of grant. However, commenters suggested that accelerating vesting of equity-based compensation should not be a material modification because the acceleration does not provide for an increase in the amount of compensation received. The commenters reasoned that the acceleration of vesting of an equity award for which the amount

of compensation is always variable is unlike the acceleration of the payment of a fixed cash award in which the acceleration may always be considered an increase in compensation due to the time value of money. To support their recommendation, commenters pointed out that, with respect to incentive stock options, section 424(h) (3)(C) and §1.424-1(e)(4)(ii) provide that acceleration of vesting of an incentive stock option is not a modification.

These proposed regulations adopt the commenters’ suggestion. Specifically, these proposed regulations provide that for compensation received pursuant to the substantial vesting of restricted property, or the exercise of a stock option or stock appreciation right that do not provide for a deferral of compensation (as defined in §1.409A-1(b)(5)(i) and (ii)), a modification of a written binding contract in effect on November 2, 2017, that results in a lapse of the substantial risk of forfeiture (as defined §1.83-3(c)) is not considered a material modification. Likewise, with respect to other compensation arrangements, if an amount of compensation payable under a written binding contract in effect on November 2, 2017, is subject to a substantial risk of forfeiture (as defined in §1.409A-1(d)), then a modification of the contract that results in a lapse of the substantial risk of forfeiture is not considered a material modification. Thus, for all forms of compensation, a modification to a written binding contract that accelerates vesting will not be considered a material modification.

The Treasury Department and the IRS considered alternatives to the commenters’ suggestion. For example, the Treasury Department and the IRS considered an approach based on the rules under section 280G. Under those rules, an acceleration of vesting can give rise to an excess parachute payment under section 280G even if the timing of the payment is not accelerated. See §1.280G-1, Q&A-24. In other words, the rules under section 280G are based on the principle that there is independent value attributable to the acceleration of vesting, even if the timing of the payment is unchanged. Given the limited scope of the section 162(m) grandfathering rule and its diminishing applicability over time, the Treasury Department and the IRS have determined that it is not nec

essary to apply that principle in this context.

G. Ordering Rule for Payments Consisting of Grandfathered and NonGrandfathered Amounts

Some NQDC arrangements provide for a series of payments instead of a lump sum. For a NQDC arrangement that is a written binding contract entered into prior to November 2, 2017, only a portion of the amounts payable under the arrangement might be grandfathered depending on the terms of the arrangement and applicable law. To identify the grandfathered amount when payment under the arrangement is made in a series of payments, the proposed regulations provide that the grandfathered amount is allocated to the first otherwise deductible payment paid under the arrangement. If the grandfathered amount exceeds the payment, then the excess is allocated to the next otherwise deductible payment paid under the arrangement. This process is repeated until the entire grandfathered amount has been paid. For example, assume that a NQDC arrangement provides for an annual payment of $100,000 for three years, and only $120,000 is grandfathered. Pursuant to the proposed regulations, the entire $100,000 paid in the first year is grandfathered. In the second year, only $20,000 of the $100,000 payment is grandfathered; the remaining $80,000 paid in the second year is not grandfathered. In the third year, none of the $100,000 payment is grandfathered.

VII. Coordination with Section 409A

Section 409A addresses NQDC arrangements and sets forth certain requirements that must be met to avoid current income inclusion and certain additional income tax. NQDC arrangements must designate a time and form of payment, among other requirements, to comply with section 409A. Pursuant to §1.409A-2(b) (7)(i), a payment may be delayed past the designated payment date to the extent that the service recipient reasonably anticipates that, if the payment were made as scheduled, the service recipient’s deduction with respect to such payment would not be permitted due to the application of

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section 162(m). ¹³ Generally, a payment delayed in accordance with §1.409A-2(b) (7)(i) must be paid no later than the service provider’s first taxable year in which the deduction of such payment will not be barred by the application of section 162(m). If any scheduled payment to a service provider in a service recipient’s taxable year is delayed in accordance with §1.409A-2(b)(7)(i), then the delay in payment is treated as a subsequent deferral election unless all scheduled payments to that service provider that could be delayed in accordance with §1.409A-2(b)(7)(i) are also delayed. ¹⁴ A subsequent deferral election will violate section 409A if the election fails to satisfy the requirements of section 409A(a)(4)(C). ¹⁵ A similar rule under §1.409A-1(b)(4)(ii) permits delayed payments of compensation that otherwise qualifies as a short-term deferral under §1.409A-1(b)(4)(i) (commonly referred to as the short-term deferral exception).

Before TCJA, an individual who was a covered employee for one taxable year would not necessarily remain a covered employee for subsequent taxable years, and would not be a covered employee after separation from service. Accordingly, parties to NQDC arrangements anticipated that in these cases, pursuant to §§1.409A‑1(b)(4)(ii) and 1.409A-2(b) (7)(i), the corporation would be able to make the payment when the individual separated from service (if not earlier), when the individual would no longer be a covered employee and the deduction for the payment would no longer be restricted due to the application of section 162(m). Because TCJA amendments to the definition of covered employee fundamentally alter the premise of §§1.409A-1(b)(4) (ii) and 1.409A-2(b)(7)(i), commenters asked whether a service recipient may delay the scheduled payment of grandfathered amounts in accordance with §§1.409A-1(b)(4)(ii) and 1.409A-2(b) (7)(i), without delaying the payment of

non-grandfathered amounts, in circumstances in which the service recipient has discretion to delay the payment. Commenters stated that the service provider may not want the non-grandfathered payments delayed and that the corporation would be willing to pay those payments under the original schedule since a delay in many cases would not result in the corporation being able to deduct the payment.

The Treasury Department and the IRS have concluded that the rules should be modified to accommodate this change. Consequently, in circumstances in which the service recipient has discretion to delay the payment, a service recipient may delay the scheduled payment of grandfathered amounts in accordance with §§1.409A-1(b) (4)(ii) and 1.409A-2(b)(7)(i), without delaying the payment of non-grandfathered amounts, and the delay of the grandfathered amounts will not be treated as a subsequent deferral election. As discussed in section VI of this preamble, the amendments made to section 162(m) by TCJA do not apply to grandfathered amounts. Therefore, the deduction for amounts grandfathered under the amended section 162(m) is not subject to section 162(m) when paid to a former covered employee who separated from service. Thus, the payment of these grandfathered amounts may be delayed consistent with §§1.409A-1(b)(4)(ii) and 1.409A-2(b) (7)(i). The Treasury Department and the IRS intend to incorporate these modifications into the regulations under section 409A, and taxpayers may rely on the guidance in this paragraph of the preamble for any taxable year beginning after December 31, 2017, until the issuance of proposed regulations under section 409A incorporating these modifications and permitting taxpayers to rely on such proposed regulations under section 409A.

Even though §§1.409A-1(b)(4)(ii) and 1.409A-2(b)(7)(i) provide that the service recipient has discretion to delay a payment, and that the discretion is not required to be set forth in the written plan, the Trea

sury Department and the IRS understand that compensation arrangements in effect on November 2, 2017, may explicitly require the service recipient to delay a payment if the service recipient reasonably believes the deduction with respect to the payment will not be permitted under section 162(m). Commenters pointed out that with respect to a service provider who is a covered employee, non-grandfathered amounts may require the passage of a significant period of time before a payment of the entire amount would be deductible, and may possibly never become deductible if the service provider dies and the payment (or remaining amount due) is payable at death. Commenters requested that relief be provided so that compensation arrangements may be amended to no longer require the service recipient to delay a payment that the service recipient reasonably believes will not be deductible under section 162(m) without resulting in a failure to meet the requirements of section 409A. The Treasury Department and the IRS have determined that this type of relief is appropriate given the impact of TCJA amendments on application of the rules in §§1.409A-1(b)(4)(ii) and 1.409A-2(b)(7) (i). Accordingly, if a NQDC arrangement is amended to remove the provision requiring the corporation to delay a payment if the corporation reasonably anticipates at the time of the scheduled payment that the deduction would not be permitted under section 162(m), then the amendment will not result in an impermissible acceleration of payment under §1.409A-3(j), and will not be considered a material modification for purposes of the grandfather rule under the amended section 162(m). The plan amendment must be made no later than December 31, 2020. If, pursuant to the amended plan, the corporation would have been required to make a payment (or payments) prior to December 31, 2020, then the payment (or payments) must be made no later than December 31, 2020. The Treasury Department and the IRS intend

13 In general, if a payment is delayed pursuant to §1.409A-2(b)(7)(i), then the payment must be made either during the service provider’s first taxable year in which the service recipient reasonably anticipates, or reasonably should anticipate, that the payment will not fail to be deductible because of section 162(m), if the payment is made during such year or, if later, during the period beginning on the day the service provider separates from service and ending on the later of the last day of the taxable year of the service recipient in which the separation from service occurs or the 15 ^th day of the third month following the separation from service.

14 See §1.409A-2(b)(7) for additional requirements for the service recipient to delay a payment so that the delay is not treated as a subsequent deferral election, such as treating all payments to similarly situated service providers on a reasonably consistent basis.

15 Pursuant to section 409A(a)(4)(C), a subsequent deferral election (i) must be made at least 12 months before the prior scheduled payment date, (ii) cannot be effective for at least 12 months after the date of the subsequent election, and (iii) must delay the payment at least 5 years from the original scheduled payment date.

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to incorporate these modifications into the regulations under section 409A, and taxpayers may rely on the guidance in this paragraph of the preamble for any taxable year beginning after December 31, 2017, until the issuance of proposed regulations under section 409A incorporating these modifications and permitting taxpayers to rely on such proposed regulations under section 409A.

Amounts payable under NQDC arrangements may consist of both grandfathered amounts and non-grandfathered amounts. With respect to these arrangements, employers may apply the guidance provided in the previous two paragraphs of this preamble. Accordingly, the plan may be amended to remove the provision requiring the corporation to delay the payment of non-grandfathered amounts if it is anticipated that the corporation’s deduction with respect to the payments will not be permitted under section 162(m); notwithstanding such an amendment, the corporation may continue to delay payment of the grandfathered amounts in accordance with §§1.409A-1(b)(4)(ii) and 1.409A-2(b)(7)(i).

VIII. Proposed Applicability Dates

A. General Applicability Date

Generally, these regulations are proposed to apply to compensation that is otherwise deductible for taxable years beginning on or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER] . Taxpayers may choose to rely on these proposed regulations until the applicability date of the final regulations, provided that taxpayers apply these proposed regulations consistently and in their entirety. Because these proposed regulations do not broaden the definition of “covered employee” as provided in Notice 2018-68 and do not restrict the application of the definition of “written binding contract” as provided in Notice 2018-68, except as provided by the special applicability dates described in section VIII.B of this preamble, taxpayers may no longer rely on Notice 2018-68 for taxable years ending on or after De- cember 20, 2019, but instead may rely on these proposed regulations for those taxable years.

B. Special Applicability Dates

These regulations are proposed to include special applicability dates covering certain aspects of the following provisions of the proposed regulations:

Definition of covered employee.
Definition of predecessor of a publicly held corporation.
Definition of compensation.
Application of section 162(m) to a deduction for compensation otherwise deductible for a taxable year ending on or after a privately held corporation becomes a publicly held corporation.
Definitions of written binding contract and material modification. First, the definition of covered employee is proposed to apply to taxable years ending on or after September 10, 2018, the publication date of Notice 2018-68, which provided guidance on the definition of covered employee. Notice 2018-68 also provided that the Treasury Department and the IRS anticipate that the guidance in the notice will be incorporated in future regulations that, with respect to the issues addressed in the notice, will apply to any taxable year ending on or after September 10, 2018. Because these proposed regulations adopt the definition of covered employee in Notice 2018-68, the guidance on the definition of covered employee in these proposed regulations is proposed to apply to taxable years ending on or after September 10, 2018. The Treasury Department and the IRS recognize, however, that the rules related to a corporation whose fiscal year and taxable year do not end on the same date were not discussed in Notice 2018-68. Accordingly, the proposed regulations provide that, for a corporation whose fiscal and taxable years do not end on the same date, the rule requiring the determination of the three most highly compensated executive officers to be made pursuant to the rules under the Exchange Act applies to taxable years beginning on or after December 20, 2019 .

Second, the provisions defining a predecessor corporation of a publicly held corporation are proposed to apply to corporate transactions for which all events necessary for the transaction occur on or after

[DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGIS

TER] . With respect to the rules that apply to corporations that change from publicly held to privately held status or visa-versa, the definition of the term predecessor corporation of a publicly held corporation applies to a privately held corporation that again becomes a publicly held corporation on or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER]. Accordingly, depending on the timing of any earlier transition from a publicly held corporation to a privately held corporation, the publicly held corporation that existed before the issuance of final regulations may be treated as a predecessor of a privately held corporation that becomes a publicly held corporation after the date of issuance of final regulations. Until the applicability date of the final regulations, taxpayers may rely on the definition of predecessor of a publicly held corporation in these proposed regulations or a reasonable good faith interpretation of the term “predecessor.” The Treasury Department and the IRS have determined, however, that excluding the following target corporations from the definition of the term “predecessor” in the following situations is not a reasonable good faith interpretation of the statute: (1) A publicly held target corporation the stock or assets of which are acquired by another publicly held corporation in a transaction to which section 381(a) applies, and (2) a publicly held target corporation, at least 80% of the total voting power, and at least 80% of the total value, of the stock of which is acquired by a publicly held acquiring corporation (including an affiliated group). No inference is intended regarding whether the treatment of a target corporation as other than a “predecessor” in any other situation is a reasonable good faith interpretation of the statute.

Third, as discussed in section IV.C. of this preamble, the rule that the definition of compensation in proposed §1.162-33(c) (3) includes an amount equal to the publicly held corporation’s distributive share of a partnership’s deduction for compensation expense attributable to the compensation paid by the partnership is proposed to apply to any deduction for compensation that is otherwise allowable for a taxable year ending on or after December 20, 2019. The Treasury Department and the IRS are aware that arrangements cur

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rently exist that reflect an understanding that the allocated deduction would not be limited by section 162(m). Accordingly, this aspect of the definition of compensation would not apply to compensation paid pursuant to a written binding contract in effect on December 20, 2019 that is not materially modified after that date.

Fourth, the guidance on the applicability of section 162(m)(1) to the deduction for any compensation otherwise deductible for a taxable year ending on or after the date when a corporation becomes a publicly held corporation is proposed to apply to corporations that become publicly held after December 20, 2019 . A corporation that was not a publicly held corporation and then becomes a publicly held corporation on or before December 20, 2019 may rely on the transition relief as provided in §1.162-27(f)(1) until the earliest of the events provided in §1.16227(f)(2). Fifth, the definitions of written binding contract and material modification are proposed to apply to taxable years ending on or after September 10, 2018, the publication date of Notice 2018-68, which provided guidance defining these terms. Notice 2018-68 also provided that the Treasury Department and IRS anticipated that the guidance in the notice would be incorporated in future regulations that, with respect to the issues addressed in the notice, would apply to any taxable year ending on or after September 10, 2018. Because these proposed regulations adopt the definitions of the terms “written binding contract” and “material modification” that were included in Notice 2018-68, the guidance on these definitions in these proposed regulations is proposed to apply to taxable years ending on or after September 10, 2018.

Special Analyses

This regulation is not subject to review under section 6(b) of Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Department of the Treasury and the Office of Management and Budget regarding review of tax regulations. Pursuant to the Regulatory Flexibility Act (RFA) (5 U.S.C. chapter 6), it is hereby certified that these proposed regulations would not

have a significant economic impact on a substantial number of small entities. This certification is based on the fact that section 162(m)(1) applies only to publicly held corporations (for example, corporations that list securities on a national securities exchange and are rarely small entities) and only impacts those publicly held corporations that compensate certain executive officers in excess of $1 million in a taxable year. Notwithstanding this certification that the proposed regulations would not have a significant economic impact on a substantial number of small entities, the Treasury Department and the IRS invite comments on the impacts these proposed regulations may have on small entities. Pursuant to section 7805(f) of the Code, this proposed rule has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small entities.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in this preamble under the “ ADDRESS- ES ” heading. Treasury and the IRS request comments on all aspects of the proposed rules. All comments will be available at www.regulations.gov or upon request.

A public hearing has been scheduled for March 9, 2020, beginning at 10 a.m. in the Auditorium of the Internal Revenue Building, 1111 Constitution Avenue, NW., Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For more information about having your name placed on the building access list to attend the hearing, see the “FOR FUR- THER INFORMATION CONTACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit an outline of the topics to be discussed and the time to be devoted to each topic by February 18, 2020 . Submit a

signed paper or electronic copy of the outline as prescribed in this preamble under the “ ADDRESSES ” heading. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Drafting Information

The principal author of these regulations is Ilya Enkishev, Office of Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Taxes). However, other personnel from the Treasury Department and the IRS participated in the development of these regulations.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.162-27 is amended by revising paragraphs (a) and (j)(1) to read as follows:

§1.162-27 Certain employee remuner- ation in excess of $1,000,000 not deduct- ible for taxable years beginning on or af- ter January 1, 1994, and for taxable years beginning prior to January 1, 2018.

(a) Scope . This section provides rules for the application of the $1 million deduction limitation under section 162(m) (1) for taxable years beginning on or after January 1, 1994, and beginning prior to January 1, 2018, and, as provided in paragraph (j) of this section, for taxable years beginning after December 31, 2017. For rules concerning the applicability of section 162(m)(1) to taxable years beginning after December 31, 2017, see

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§1.162-33. Paragraph (b) of this section provides the general rule limiting deductions under section 162(m)(1). Paragraph (c) of this section provides definitions of generally applicable terms. Paragraph (d) of this section provides an exception from the deduction limitation for compensation payable on a commission basis. Paragraph (e) of this section provides an exception for qualified performance-based compensation. Paragraphs (f) and (g) of this section provide special rules for corporations that become publicly held corporations and payments that are subject to section 280G, respectively. Paragraph (h) of this section provides transition rules, including the rules for contracts that are grandfathered and not subject to section 162(m) (1). Paragraph (j) of this section contains the effective date provisions, which also specify when these rules apply to the deduction for compensation otherwise deductible in a taxable year beginning after December 31, 2017. For rules concerning the deductibility of compensation for services that are not covered by section 162(m)(1) and this section, see section 162(a)(1) and §1.162-7. This section is not determinative as to whether compensation meets the requirements of section 162(a) (1). For rules concerning the deduction limitation under section 162(m)(6) applicable to certain health insurance providers, see §1.162-31.

(j) Effective date —(1) In general . Section 162(m) and this section apply to the deduction for compensation that is otherwise deductible by the corporation in taxable years beginning on or after January 1, 1994, and beginning prior to January 1, 2018. Section 162(m) and this section also apply to compensation that is a grandfathered amount (as defined in §1.16233(g)) at the time it is paid to the covered employee. For examples of the application of the rules of this section to grandfathered amounts paid during taxable years beginning after December 31, 2017, see §1.162-33(g).

Par. 3. Section 1.162-33 is added to read as follows:

§1.162-33 Certain employee remuner- ation in excess of $1,000,000 not deduct- ible for taxable years beginning after De- cember 31, 2017.

(a) Scope . This section provides rules for the application of the $1 million deduction limitation under section 162(m) (1) for taxable years beginning after December 31, 2017. For rules concerning the applicability of section 162(m)(1) to taxable years beginning on or after January 1, 1994, and prior to January 1, 2018, see §1.162-27. Paragraph (b) of this section provides the general rule limiting deductions under section 162(m)(1). Paragraph (c) of this section provides definitions of generally applicable terms. Paragraph (d) of this section provides rules for determining when a corporation becomes a publicly held corporation. Paragraph (e) of this section provides rules for payments that are subject to section 280G. Paragraph (f) of this section provides a special rule for coordination with section 4985. Paragraph (g) of this section provides transition rules, including the rules for contracts that are grandfathered. Paragraph (h) of this section sets forth the effective date provisions. For rules concerning the deductibility of compensation for services that are not covered by section 162(m)(1) and this section, see section 162(a)(1) and §1.1627. This section is not determinative as to whether compensation meets the requirements of section 162(a)(1). For rules concerning the deduction limitation under section 162(m)(6) applicable to certain health insurance providers, see §1.162-31.

(b) Limitation on deduction . Section 162(m)(1) precludes a deduction under chapter 1 of the Internal Revenue Code by any publicly held corporation for compensation paid to any covered employee to the extent that the compensation for the taxable year exceeds $1,000,000.

(c) Definitions —(1) Publicly held cor- poration —(i) General rule . A publicly held corporation means any corporation that issues securities required to be registered under section 12 of the Exchange Act or that is required to file reports under section 15(d) of the Exchange Act. In addition, a publicly held corporation means any S corporation (as defined in section 1361(a)(1)) that issues securities that are required to be registered under section 12(b) of the Exchange Act, or that is required to file reports under section 15(d) of the Exchange Act. For purposes of this section, whether a corporation is publicly held is determined based solely on wheth

er, as of the last day of its taxable year, the securities issued by the corporation are required to be registered under section 12 of the Exchange Act or the corporation is required to file reports under section 15(d) of the Exchange Act. Whether registration under the Exchange Act is required by rules other than those of the Exchange Act is irrelevant to this determination. A publicly traded partnership that is treated as a corporation under section 7704 (or otherwise) is a publicly held corporation if, as of the last day of its taxable year, its securities are required to be registered under section 12 of the Exchange Act or it is required to file reports under section 15(d) of the Exchange Act.

(ii) Affiliated groups —(A) In gener- al . A publicly held corporation includes an affiliated group of corporations, as defined in section 1504 (determined without regard to section 1504(b)) that includes one or more publicly held corporations (as defined in paragraph (c)(1)(i) of this section). In the case of an affiliated group that includes two or more publicly held corporations as defined in paragraph (c) (1)(i) of this section, each member of the affiliated group that is a publicly held corporation as defined in paragraph (c)(1) (i) of this section is separately subject to this section, and the affiliated group as a whole is subject to this section. Thus, for example, assume that a publicly held corporation (as defined in paragraph (c)(1)(i) of this section) is a wholly-owned subsidiary of another publicly held corporation (as defined in paragraph (c)(1)(i) of this section), which is a wholly-owned subsidiary of a privately held corporation. In this case, the two subsidiaries are separately subject to this section, and all three corporations are members of an affiliated group that is subject to this section. Furthermore, each subsidiary has its own set of covered employees as defined in paragraphs (c)(2) (i) through (iv) of this section (although it is possible that the same individual may be a covered employee of both subsidiaries).

(B) Proration of amount disallowed as a deduction . If, in a taxable year, a covered employee (as defined in paragraphs (c)(2)(i) through (iv) of this section) of one member of an affiliated group is paid compensation by more than one member of the affiliated group, compensation

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paid by each member of the affiliated group is aggregated with compensation paid to the covered employee by all other members of the affiliated group (excluding compensation paid by any other publicly held corporation in the affiliated group, as defined in paragraph (c)(1)(i) of this section, of which the individual is also a covered employee as defined in paragraphs (c)(2)(i) through (iv) of this section). In the event that, in a taxable year, a covered employee (as defined in paragraphs (c)(2)(i) through (iv) of this section) is paid compensation by more than one publicly held corporation in an affiliated group and is also a covered employee of more than one publicly held payor corporation (as defined in paragraph (c)(1)(i) of this section) in the affiliated group, the amount disallowed as a deduction is determined separately with respect to each publicly held corporation of which the individual is a covered employee. Any amount disallowed as a deduction by this section must be prorated among the payor corporations (excluding any other publicly held payor corporation of which the individual is also a covered employee) in proportion to the amount of compensation paid to the covered employee (as defined in paragraphs (c)(2) (i) through (iv) of this section) by each such corporation in the taxable year. This process is repeated for each publicly held payor corporation of which the individual is a covered employee.

(iii) Disregarded entities . For purposes of paragraph (c)(1) of this section, a publicly held corporation includes a corporation that owns an entity that is disregarded as an entity separate from its owner within the meaning of §301.7701-2(c)(2)(i) of this chapter if the disregarded entity issues securities required to be registered under section 12(b) of the Exchange Act, or is required to file reports under section 15(d) of the Exchange Act.

(iv) Qualified subchapter S subsidiar- ies . For purposes of paragraph (c)(1) of this section, a publicly held corporation includes an S corporation that owns a qualified subchapter S subsidiary as defined in section 1361(b)(3)(B) (QSub) if the QSub issues securities required to be registered under section 12(b) of the Exchange Act, or is required to file reports under section 15(d) of the Exchange Act.

(v) Examples . The following examples illustrate the provisions of this paragraph (c)(1). For each example, assume that no corporation is a predecessor of a publicly held corporation within the meaning of this paragraph (c)(2)(ii). Furthermore, for each example, unless provided otherwise, a reference to a publicly held corporation means a publicly held corporation as defined in paragraph (c)(1) (i) of this section. Additionally, for each example, assume that the corporation is a calendar year taxpayer and has a fiscal year ending December 31 for reporting purposes under the Exchange Act. These examples are not intended to provide guidance on the legal requirements of the Securities Act and Exchange Act and the rules thereunder (17 CFR Part 240).

(A) Example 1 (Corporation required to file re- ports under section 15(d) of the Exchange Act) —( 1 ) Facts . Corporation Z plans to issue debt securities in a public offering registered under the Securities Act. Corporation Z is not required to file reports under section 15(d) of the Exchange Act with respect to any other class of securities and does not have another class of securities required to be registered under section 12 of the Exchange Act. On April 1, 2021, the Securities Act registration statement for Corporation Z’s debt securities is declared effective by the SEC. As a result, Corporation Z is required to file reports under section 15(d) of the Exchange Act. Accordingly, as of December 31, 2021, the last day of its taxable year, Corporation Z is required to file reports under section 15(d) of the Exchange Act.

( 2 ) Conclusion . Corporation Z is a publicly held corporation for its 2021 taxable year because it is required to file reports under section 15(d) of the Exchange Act as of the last day of its taxable year.

(B) Example 2 (Corporation not required to file reports under section 15(d) of the Exchange Act) ( 1 ) Facts . The facts are the same as in paragraph (c) (1)(v)(A) of this section ( Example 1 ), except that, on January 1, 2022, pursuant to section 15(d) of the Exchange Act, Corporation Z’s obligation to file reports under section 15(d) is automatically suspended for the fiscal year ending December 31, 2022, because Corporation Z meets the statutory requirements for an automatic suspension to file reports under section 15(d). Accordingly, as of December 31, 2022, Corporation Z is not required to file reports under section 15(d) of the Exchange Act. ( 2 ) Conclusion . Corporation Z is not a publicly held corporation for its 2022 taxable year because it is not required to file reports under section 15(d) of the Exchange Act as of as of the last day of its taxable year.

(C) Example 3 (Corporation not required to file reports under section 15(d) of the Exchange Act) ( 1 ) Facts . The facts are the same as in paragraph (c) (1)(v)(B) of this section ( Example 2 ), except that, on January 1, 2022, pursuant to section 15(d) of the Exchange Act, Corporation Z’s obligation to file reports under section 15(d) is not automatically suspended for the fiscal year ending December 31, 2022

because Corporation Z does not meet the statutory requirements for automatic suspension. Instead, on May 2, 2022, Corporation Z is eligible to suspend its section 15(d) reporting obligation under Rule 12h-3 of the Exchange Act (17 CFR 240.12h-3) and files Form 15, Certification and Notice of Termination of Registration under Section 12(g) of the Securities Exchange Act of 1934 or Suspension of Duty to File Reports under Sections 13 and 15(d) of the Securities Exchange Act of 1934 (or its successor), to suspend its section 15(d) reporting obligation for its fiscal year ending December 31, 2022. Accordingly, as of December 31, 2022, Corporation Z is not required to file reports under section 15(d) of the Exchange Act.

( 2 ) Conclusion . Corporation Z is not a publicly held corporation for its 2022 taxable year because it is not required to file reports under section 15(d) of the Exchange Act as of the last day of its taxable year.

(D) Example 4 (Corporation required to file re- ports under section 15(d) of the Exchange Act) —( 1 ) Facts . The facts are the same as in paragraph (c)(1) (v)(C) of this section ( Example 3 ), except that, Corporation Z does not utilize Rule 12h-3 under the Exchange Act (17 CFR 240.12h-3) to file a Form 15, Certification and Notice of Termination of Registration under Section 12(g) of the Securities Exchange Act of 1934 or Suspension of Duty to File Reports under Sections 13 and 15(d) of the Securities Exchange Act of 1934 (or its successor), to suspend its section 15(d) reporting obligation during its fiscal year ending December 31, 2022. Accordingly, Corporation Z’s reporting obligation under section 15(d) of the Exchange Act is not suspended for its fiscal year ending December 31, 2022.

( 2 ) Conclusion . Corporation Z is a publicly held corporation for its 2022 taxable year because it is required to file reports under section 15(d) of the Exchange Act as of the last day of its taxable year.

(E) Example 5 (Corporation required to file re- ports under section 15(d) of the Exchange Act) —( 1 ) Facts . Corporation Y is a wholly-owned subsidiary of Corporation X, which is required to file reports under the Exchange Act. Corporation Y issued a class of debt securities in a public offering registered under the Securities Act, and therefore is required to file reports under Exchange Act Section 15(d), including for its fiscal year ending December 31, 2020. Corporation Y has no other class of securities registered under the Exchange Act. In its Form 10K, Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (or its successor), for the 2020 fiscal year, Corporation Y may omit Item 11 Executive Compensation (required by Part III of Form 10-K), which requires disclosure of compensation of certain executive officers because it is wholly-owned by Corporation X and the other conditions of General Instruction I to Form 10-K are satisfied.

( 2 ) Conclusion . Corporation Y is a publicly held corporation for its 2020 taxable year because it is required to file reports under section 15(d) of the Exchange Act as of the last day of its taxable year.

(F) Example 6 (Corporation not required to file reports under section 15(d) of the Exchange Act and not required to register securities under section 12 of the Exchange Act) —( 1 ) Facts . Corporation A has a class of securities registered un

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der section 12(g) of the Exchange Act. For its 2020 taxable year, Corporation A is a publicly held corporation. On September 30, 2021, Corporation A is eligible to terminate the registration of its securities under section 12(g) of the Exchange Act pursuant to Rule 12g-4(a)(2) of the Exchange Act (17 CFR 240.12g-4(a)(2)), but does not terminate the registration of its securities prior to December 31, 2021. Because Corporation A did not issue securities in a public offering registered under the Securities Act, Corporation A is not required to file reports under section 15(d) of the Exchange Act.

( 2 ) Conclusion . Corporation A is not a publicly held corporation for its 2021 taxable year because, as of the last day of its taxable year, the securities issued by Corporation A are not required to be registered under section 12 of the Exchange Act and Corporation A is not required to file reports under section 15(d) of the Exchange Act. (G) Example 7 (Corporation required to file re- ports under section 15(d) of the Exchange Act) —( 1 ) Facts . The facts are the same as in paragraph (c)(1) (v)(F) of this section ( Example 6 ), except that Corporation A previously issued a class of securities in a public offering registered under the Securities Act. Furthermore, on October 1, 2021, Corporation A terminates the registration of its securities under section 12(g) of the Exchange Act. Because Corporation A issued a class of securities in a public offering registered under the Securities Act and is not eligible to suspend its reporting obligation under section 15(d) of the Exchange Act, as of December 31, 2021, Corporation A is required to file reports under section 15(d) of the Exchange Act.

( 2 ) Conclusion . Corporation A is a publicly held corporation for its 2021 taxable year because it is required to file reports under section 15(d) of the Exchange Act as of the last day of its taxable year.

(H) Example 8 (Corporation not required to file reports under section 15(d) of the Exchange Act and not required to register securities under section 12 of the Exchange Act) —( 1 ) Facts . On November 1, 2021, Corporation B is an issuer with only one class of equity securities. On November 5, 2021, Corporation B files a registration statement for its equity securities under section 12(g) of the Exchange Act. Corporation B’s filing of its registration statement is voluntary because the Exchange Act does not require Corporation B to register its class of securities under section 12(g) of the Exchange Act based on the number and composition of its record holders. On December 1, 2021, the Exchange Act registration statement for Corporation B’s securities is declared effective by the SEC. As of December 31, 2021, the last day of its taxable year, Corporation B continues to have its class of equity securities registered voluntarily under section 12 of the Exchange Act. Furthermore, Corporation B is not required to file reports under section 15(d) of the Exchange Act because it did not register any class of securities in a public offering under the Securities Act.

( 2 ) Conclusion . Corporation B is not a publicly held corporation for its 2021 taxable year because, as of the last day of that taxable year, the securities issued by Corporation B are not required to be registered under section 12 of the Exchange Act and Corporation B is not required to file reports under section 15(d) of the Exchange Act.

(I) Example 9 (Corporation not required to file reports under section 15(d) of the Exchange Act and not required to register securities under section 12 of the Exchange Act) —( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(H) of this section ( Exam- ple 8 ), except that, on December 31, 2022, because of a change in circumstances, under the Exchange Act, Corporation B must register its class of equity securities under section 12(g) of the Exchange Act within 120 days of December 31, 2022. On February 1, 2023, the Exchange Act registration statement for Corporation B’s securities is declared effective by the SEC.

( 2 ) Conclusion . Corporation B is not a publicly held corporation for its 2022 taxable year because, as of the last day of that taxable year, Corporation B is not required to file reports under section 15(d) of the Exchange Act, and the class of equity securities issued by Corporation B is not yet required to be registered under section 12 of the Exchange Act. Corporation B has 120 days following December 31, 2022, to file a registration statement to register its class of equity securities under section 12(g) of the Exchange Act.

(J) Example 10 (Securities of foreign private issuer in the form of ADRs traded in the over-the- counter market) —( 1 ) Facts . For its fiscal and taxable years ending December 31, 2021, Corporation W is a foreign private issuer. Because Corporation W has not registered an offer or sale of securities under the Securities Act, it is not required to file reports under section 15(d) of the Exchange Act. Corporation W qualifies for an exemption from registration of its securities under section 12(g) of the Exchange Act pursuant to Rule 12g3-2(b) under the Exchange Act (17 CFR 240.12g3-2(b)). Corporation W wishes to have its securities traded in the U.S. in the over-the-counter market in the form of ADRs. Because Corporation W qualifies for an exemption pursuant to Rule 12g32(b) under the Exchange Act (17 CFR 240.12g32(b)), Corporation W is not required to register its securities underlying the ADRs under section 12 of the Exchange Act. However, the depositary bank is required to register the ADRs under the Securities Act. Even though the depositary bank is required to register the ADRs under the Securities Act, such registration of the ADRs does not create a requirement for either the depositary bank or Corporation W to file reports under section 15(d) of the Exchange Act. On February 3, 2021, the Securities Act registration statement for the ADRs is declared effective by the SEC. On February 4, 2021, Corporation W’s ADRs begin trading in the over-the-counter market. On December 31, 2021, the securities of Corporation W are not required to be registered under Section 12 of the Exchange Act because Corporation W qualifies for an exemption pursuant to Rule 240.12g3-2(b) of the Exchange Act. Furthermore, on December 31, 2021, Corporation W is not required to file reports under section 15(d) of the Exchange Act.

( 2 ) Conclusion . Corporation W is not a publicly held corporation for its 2021 taxable year because, as of the last day of that taxable year, the securities underlying the ADRs are not required to be registered under section 12 of the Exchange Act and Corporation W is not required to file reports under section 15(d) of the Exchange Act. The conclusion would be the same if Corporation W had its securities traded

in the over-the-counter market other than in the form of ADRs.

(K) Example 11 (Securities of foreign private is- suer in the form of ADRs quoted on Over the Counter Bulletin Board) —( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(J) of this section ( Exam- ple 10 ), except that Corporation W has its securities quoted on the Over the Counter Bulletin Board (OTCBB) in the form of ADRs. Because Corporation W qualifies for an exemption pursuant to Rule 12g3-2(b) of the Exchange Act (17 CFR 240.12g32(b)), Corporation W is not required to register its securities underlying the ADRs under section 12 of the Exchange Act. However, the depositary bank is required to register the ADRs under the Securities Act. Section 6530(b)(1) of the OTCBB Rules requires that a foreign equity security may be quoted on the OTCBB only if the security is registered with the SEC pursuant to section 12 of the Exchange Act and the issuer of the security is current in its reporting obligations. To comply with section 6530(b)(1) of the OTCBB Rules, on February 5, 2021, Corporation W files a registration statement for its class of securities underlying the ADRs under section 12(g) of the Exchange Act. On February 26, 2021, the Exchange Act registration statement for Corporation W’s securities is declared effective by the SEC. As of December 31, 2021, Corporation W is subject to the reporting obligations under the section 12 of the Exchange Act as a result of section 12 registration.

( 2 ) Conclusion . Corporation W is not a publicly held corporation for its 2021 taxable year because, as of the last day of that taxable year, its ADRs and the securities underlying the ADRs are not required by the Exchange Act to be registered under section 12, and Corporation W is not required to file reports under section 15(d) of the Exchange Act. The conclusion would be the same if Corporation W had its securities traded on the OTCBB other than in the form of ADRs.

(L) Example 12 (Securities of foreign private issuer in the form of ADRs listed on a national se- curities exchange without a capital raising trans- action) —( 1 ) Facts . For its fiscal and taxable years ending December 31, 2021, Corporation V is a foreign private issuer. Corporation V wishes to list its securities on the New York Stock Exchange (NYSE) in the form of ADRs without a capital raising transaction. Under the Exchange Act, Corporation V is required to register its securities underlying the ADRs under section 12(b) of the Exchange Act. Because the ADRs and the deposited securities are separate securities, the depositary bank is required to register the ADRs under the Securities Act. On February 2, 2021, Corporation V’s registration statement under section 12(b) of the Exchange Act in connection with the underlying securities, and the depositary bank’s registration statement under the Securities Act in connection with the ADRs, are declared effective by the SEC. On March 1, 2021, Corporation V’s securities begin trading on the NYSE in the form of ADRs. As of December 31, 2021, Corporation V is not required to file reports under section 15(d) of the Exchange Act; however, the securities underlying the ADRs are required to be registered under section 12(b) of the Exchange Act. ( 2 ) Conclusion . Corporation V is a publicly held corporation for its 2021 taxable year because, as of

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the last day of that taxable year, the securities underlying the ADRs are required to be registered under section 12 of the Exchange Act. The conclusion would be the same if Corporation V had its securities listed on the NYSE other than in the form of ADRs.

(M) Example 13 (Securities of foreign private issuer in the form of ADRs listed on a national secu- rities exchange with a capital raising transaction) ( 1 ) Facts . The facts are the same as in paragraph (c) (1)(v)(L) of this section ( Example 12 ), except that Corporation V wishes to raise capital and have its securities listed on the NYSE in the form of ADRs. Corporation V is required to register the offer of securities underlying the ADRs under the Securities Act and to register the class of those securities under section 12(b) of the Exchange Act. The depositary bank is required to register the ADRs under the Securities Act. On February 2, 2021, Corporation V’s registration statements under the Securities Act and section 12(b) of the Exchange Act, and the registration statement for the ADRs under the Securities Act, are declared effective by the SEC. As of December 31, 2021, Corporation V is not required to file reports under section 15(d) of the Exchange Act; however, the securities underlying the ADRs are required to be registered under section 12(b) of the Exchange Act.

( 2 ) Conclusion . Corporation V is a publicly held corporation for its 2021 taxable year because, as of the last day of that taxable year, its securities underlying the ADRs are required to be registered under section 12 of the Exchange Act. The conclusion would be the same if Corporation V had its securities listed on the NYSE other than in the form of ADRs.

(N) Example 14 (Foreign private issuer incor- porates subsidiary in the United States to issue debt securities and subsequently issues a guarantee) —( 1 ) Facts . Corporation T is a corporation incorporated in Country S (which is not the United States). For its fiscal and taxable years ending December 31, 2021, Corporation T is a foreign private issuer. Corporation T wishes to access the U.S. capital markets. Corporation T incorporates Corporation U in the United States to issue debt securities. On January 15, 2021, the SEC declares Corporation U’s Securities Act registration statement effective. Corporation U is a wholly-owned subsidiary of Corporation T. To enhance the credit of Corporation U and the marketability of Corporation U’s debt securities, Corporation T issues a guarantee of Corporation U’s securities and, as required, registers the guarantee under the Securities Act on the registration statement that the SEC declares effective on January 15, 2021. On December 31, 2021, Corporations T and U are required to file reports under section 15(d) of the Exchange Act.

( 2 ) Conclusion . Corporations T and U are publicly held corporations for their 2021 taxable years because they are required to file reports under section 15(d) of the Exchange Act as of the last day of their taxable years.

(O) Example 15 (Affiliated group composed of two corporations, one of which is a publicly held corporation) —( 1 ) Facts . Employee D, a covered employee of Corporation N, performs services and receives compensation from Corporations N and O, members of an affiliated group of corporations. Corporation N, the parent corporation, is a publicly held corporation. Corporation O is a direct subsidiary of

Corporation N and is a privately held corporation. The total compensation paid to Employee D from all affiliated group members is $3,000,000 for the taxable year, of which Corporation N pays $2,100,000 and Corporation O pays $900,000.

( 2 ) Conclusion . Because the compensation paid by all affiliated group members is aggregated for purposes of section 162(m)(1), $2,000,000 of the aggregate compensation paid is nondeductible. Corporations N and O each are treated as paying a ratable portion of the nondeductible compensation. Thus, two thirds of each corporation’s payment will be nondeductible. Corporation N has a nondeductible compensation expense of $1,400,000 ($2,100,000 x $2,000,000/$3,000,000). Corporation O has a nondeductible compensation expense of $600,000 ($900,000 x $2,000,000/$3,000,000).

(P) Example 16 (Affiliated group composed of two corporations, one of which is a publicly held corporation) —( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(O) of this section ( Example 15 ), except that, Corporation O is a publicly held corporation and Corporation N is a privately held corporation, and Employee D is a covered employee of Corporation O (instead of Corporation N).

( 2 ) Conclusion . The result is the same as in paragraph (c)(1)(v)(O) of this section ( Example 15 ). Even though Corporation O is a subsidiary that is a publicly held corporation, it is still a member of the affiliated group comprised of Corporations N and O. Accordingly, $2,000,000 of the aggregate compensation paid is nondeductible. Thus, Corporations N and O each are treated as paying a ratable portion of the nondeductible compensation.

(Q) Example 17 (Affiliated group composed of two publicly held corporations) —( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(O) of this section ( Example 15 ), except that Corporation O is also a publicly held corporation. As in paragraph (c) (1)(v)(O) of this section ( Example 15 ), Employee D is not a covered employee of Corporation O.

( 2 ) Conclusion . The result is the same as in paragraph (c)(1)(v)(O) of this section ( Example 15 ). Even though Corporation O is a subsidiary that is a publicly held corporation, it is still a member of the affiliated group comprised of Corporations N and O. Corporations N and O are payor corporations that are members of an affiliated group for purposes of prorating the amount disallowed as a deduction. Accordingly, $2,000,000 of the aggregate compensation paid is nondeductible. Thus, Corporations N and O each are treated as paying a ratable portion of the nondeductible compensation.

(R) Example 18 (Affiliated group composed of two publicly held corporations) —( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(Q) of this section ( Example 17 ), except that Employee D is also a covered employee of Corporation O.

( 2 ) Conclusion . Even though Corporations N and O are each publicly held corporations and separately subject to this section, they are still members of the affiliated group comprised of Corporations N and O. Because Employee D is a covered employee of both Corporations N and O, which are each a separate publicly held corporation, the determination of the amount disallowed as a deduction is made separately for each publicly held corporation. Accordingly, Corporation N has a nondeductible compensation

expense of $1,100,000 (the excess of $2,100,000 over $1,000,000), and Corporation O has no nondeductible compensation expense because the amount it paid to Employee D was below $1,000,000.

(S) Example 19 (Affiliated group composed of three corporations, one of which is a publicly held corporation) —( 1 ) Facts . Employee C, a covered employee of Corporation P, performs services for, and receives compensation from, Corporations P, Q, and R, members of an affiliated group of corporations. Corporation P, the parent corporation, is a publicly held corporation. Corporation Q is a direct subsidiary of Corporation P, and Corporation R is a direct subsidiary of Corporation Q. Corporations Q and R are both privately held corporations. The total compensation paid to Employee C from all affiliated group members is $3,000,000 for the taxable year, of which Corporation P pays $1,500,000, Corporation Q pays $900,000, and Corporation R pays $600,000.

( 2 ) Conclusion . Because the compensation paid by all affiliated group members is aggregated for purposes of section 162(m)(1), $2,000,000 of the aggregate compensation paid is nondeductible. Corporations P, Q, and R are each treated as paying a ratable portion of the nondeductible compensation. Thus, two thirds of each corporation’s payment will be nondeductible. Corporation P has a nondeductible compensation expense of $1,000,000 ($1,500,000 x $2,000,000/$3,000,000). Corporation Q has a nondeductible compensation expense of $600,000 ($900,000 x $2,000,000/$3,000,000). Corporation R has a nondeductible compensation expense of $400,000 ($600,000 x $2,000,000/$3,000,000).

(T) Example 20 (Affiliated group composed of three corporations, one of which is a publicly held corporation) —( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(S) of this section ( Example 19 ), except that Corporation Q is a publicly held corporation and Corporation P is a privately held corporation, and Employee C is a covered employee of Corporation Q (instead of Corporation P).

( 2 ) Conclusion . The result is the same as in paragraph (c)(1)(v)(S) of this section ( Example 19 ). Even though Corporation Q is a subsidiary that is a publicly held corporation, it is still a member of the affiliated group comprised of Corporations P, Q, and R. Accordingly, $2,000,000 of the aggregate compensation paid is nondeductible. Thus, Corporations P, Q, and R are each treated as paying a ratable portion of the nondeductible compensation.

(U) Example 21 (Affiliated group composed of three corporations, two of which are publicly held corporations) —( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(T) of this section ( Exam- ple 20 ), except that Corporation R is also a publicly held corporation. As in paragraph (c)(1)(v)(T) of this section ( Example 20 ), Corporation Q is a publicly held corporation, Corporation P is a privately held corporation, and Employee C is a covered employee of Corporation Q but not a covered employee of Corporation R.

( 2 ) Conclusion . The result is the same as in paragraph (c)(1)(v)(T) of this section ( Example 20 ). Even though Corporation R is a subsidiary that is a publicly held corporation, it is still a member of the affiliated group comprised of Corporations P, Q, and R. Accordingly, $2,000,000 of the aggregate compensation paid is nondeductible. Thus, Corporations P, Q,

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and R are each treated as paying a ratable portion of the nondeductible compensation.

(V) Example 22 (Affiliated group composed of three publicly held corporations) —( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(S) of this section ( Example 19 ), except that, Corporations Q and R are also publicly held corporations, and Employee C is a covered employee of both Corporations P and Q, but is not a covered employee of Corporation R.

( 2 ) Conclusion . Even though Corporations Q and R are subsidiaries that are publicly held corporations and separately subject to this section, they are still members of the affiliated group comprised of Corporations P, Q, and R. Because Employee C is a covered employee of both Corporations P and Q, the determination of the amount disallowed as a deduction is prorated among Corporation P and R, and separately prorated among Corporations Q and R. With respect to Corporations P and R, $1,100,000 of the aggregate compensation is nondeductible (the difference between the total compensation of $2,100,000 paid by Corporations P and R and the $1,000,000 deduction limitation). Corporations P and R are each treated as paying a ratable portion of the nondeductible compensation. Accordingly, Corporation P has a nondeductible compensation expense of $785,714 ($1,500,000 x $1,100,000/$2,100,000), and Corporation R has a nondeductible compensation expense of $314,285 ($600,000 x $1,100,000/$2,100,000). With respect to Corporations Q and R, $500,000 of the aggregate compensation is nondeductible (the difference between the total compensation of $1,500,000 paid by Corporations Q and R and the $1,000,000 deduction limitation). Accordingly, Corporation Q has a nondeductible compensation expense of $300,000 ($900,000 x $500,000/$1,500,000), and Corporation R has a nondeductible compensation expense of $200,000 ($600,000 x $500,000/$1,500,000). The total amount of nondeductible compensation expense with respect to Corporation R is $514,285.

(W) Example 23 (Affiliated group composed of three publicly held corporations )—( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(V) of this section ( Example 22 ), except that Employee C does not perform any services for Corporation R and does not receive any compensation from Corporation R.

(X) Example 24 (Affiliated group composed of three corporations, one of which is a publicly held corporation —( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(S) of this section ( Example 19 ), except that Corporation R is a direct subsidiary of

Corporation P instead of being a direct subsidiary of Corporation Q.

( 2 ) Conclusion . The result is the same as in paragraph (c)(1)(v)(S) of this section ( Example 19 ). Corporations P, Q, and R are members of an affiliated group. Accordingly, $2,000,000 of the aggregate compensation paid is nondeductible. Thus, Corporations P, Q, and R are each treated as paying a ratable portion of the nondeductible compensation.

(Y) Example 25 (Affiliated group composed of three publicly held corporations )—( 1 ) Facts . The facts are the same as in paragraph (c)(1)(v)(X) of this section ( Example 24 ), except that Corporations Q and R are also publicly held corporations, and Employee C is a covered employee of both Corporations P and Q.

( 2 ) Conclusion . The result is the same as in paragraph (c)(1)(v)(V) of this section ( Example 22 ). Even though Corporations Q and R are subsidiaries that are publicly held corporations and separately subject to this section, they are still members of the affiliated group comprised of Corporations P, Q, and R. Because Employee C is a covered employee of both Corporations P and Q, the determination of the amount disallowed as a deduction is prorated among Corporation P and R, and separately among Corporations Q and R.

(Z) Example 26 (Disregarded entity) —( 1 ) Facts . Corporation G is a privately held corporation for its 2020 taxable year. Entity H, a limited liability company, is wholly-owned by Corporation G and is disregarded as an entity separate from its owner under §301.7701-2(c)(2)(i). As of December 31, 2020, Entity H is required to file reports under section 15(d) of the Exchange Act.

(2) Conclusion. Because Entity H is required to file reports under section 15(d) of the Exchange Act and is disregarded as an entity separate from its owner Corporation G, Corporation G is a publicly held corporation under paragraph (c)(1)(iii) of this section for its 2020 taxable year.

(2) Covered employee —(i) Gener- al rule . Except as provided in paragraph (c)(2)(v) of this section, with respect to a publicly held corporation as defined in paragraph (c)(1) of this section (without regard to paragraph (c)(1)(ii) of this section), for the publicly held corporation’s taxable year, a covered employee means any of the following—

(A) The principal executive officer (PEO) or principal financial officer (PFO) of the publicly held corporation serving at any time during the taxable year, including individuals acting in either such capacity.

(B) The three highest compensated executive officers of the publicly held corporation for the taxable year (other than the principal executive officer or principal financial officer, or an individual acting in such capacity), regardless of whether the executive officer is serving at the end of the publicly held corporation’s taxable year, and regardless of whether the ex

ecutive officer’s compensation is subject to disclosure for the last completed fiscal year under the executive compensation disclosure rules under the Exchange Act. The amount of compensation used to identify the three most highly compensated executive officers for the taxable year is determined pursuant to the executive compensation disclosure rules under the Exchange Act (using the taxable year as the fiscal year for purposes of making the determination), regardless of whether the corporation’s fiscal year and taxable year end on the same date.

(C) Any individual who was a covered employee of the publicly held corporation (or any predecessor of a publicly held corporation, as defined in paragraph (c)(2) (ii) of this section) for any preceding taxable year beginning after December 31, 2016. For taxable years beginning prior to January 1, 2018, covered employees are identified in accordance with the rules in §1.162-27(c)(2).

(ii) Predecessor of a publicly held cor- poration —(A) Publicly held corporations that become privately held . For purposes of this paragraph (c)(2)(ii), a predecessor of a publicly held corporation includes a publicly held corporation that, after becoming a privately held corporation, again becomes a publicly held corporation for a taxable year ending before the 36-month anniversary of the due date for the corporation’s U.S. Federal income tax return (disregarding any extensions) for the last taxable year for which the corporation was previously publicly held.

(B) Corporate reorganizations . A predecessor of a publicly held corporation includes a publicly held corporation the stock or assets of which are acquired in a corporate reorganization (as defined in section 368(a)(1)).

(C) Corporate divisions. A predecessor of a publicly held corporation includes a publicly held corporation that is a distributing corporation (within the meaning of section 355(a)(1)(A)) that distributes the stock of a controlled corporation (within the meaning of section 355(a)(1)(A)) to its shareholders in a distribution or exchange qualifying under section 355(a)(1) (corporate division). The rule of this paragraph (c)(2)(ii)(C) applies only with respect to covered employees of the distributing corporation who commence the performance

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of services for the controlled corporation (or for a corporation affiliated with the controlled corporation that receives stock of the controlled corporation in the corporate division) within the period beginning 12 months before and ending 12 months after the distribution.

(D) Affiliated groups . A predecessor of a publicly held corporation includes a publicly held corporation that becomes a member of an affiliated group (as defined in paragraph (c)(1)(ii) of this section).

(E) Asset acquisitions . If a publicly held corporation, including one or more members of an affiliated group as defined in paragraph (c)(1)(ii) of this section (acquiror), acquires at least 80% of the operating assets (determined by fair market value on the date of acquisition) of another publicly held corporation (target), then the target is a predecessor of the acquiror. For an acquisition of assets that occurs over time, only assets acquired within a 12-month period are taken into account to determine whether at least 80% of the target’s operating assets were acquired. However, this 12-month period is extended to include any continuous period that ends on, or begins on, any day during which the acquiror has an arrangement to purchase, directly or indirectly, assets of the target. Additions to the assets of target by a shareholder made as part of a plan or arrangement to avoid the application of this subsection to acquiror’s purchase of target’s assets are disregarded in applying this paragraph. This paragraph (c)(2)(ii) (E) applies only with respect to covered employees of the target who commence the performance of services for the acquiror (or a corporation affiliated with the acquiror) within the period beginning 12 months before and ending 12 months after the date of the transaction as defined in paragraph (c)(2)(ii)(I) of this section (incorporating any extensions to the 12-month period made pursuant to this paragraph).

(F) Predecessor of a predecessor . For purposes of this paragraph (c)(2)(ii), a reference to a predecessor of a corporation includes each predecessor of the corporation and the predecessor or predecessors of any prior predecessor or predecessors.

(G) Corporations that are not public- ly held at the time of the transaction and sequential transactions –( 1 ) Predecessor

corporation is not publicly held at the time of the transaction . If a corporation that was previously publicly held (the first corporation) would be a predecessor to another corporation (the second corporation) under the rules of this paragraph (c)(2) (ii) but for the fact that it is not a publicly held corporation at the time of the relevant transaction (or transactions), the first corporation is a predecessor of a publicly held corporation if the second corporation is a publicly held corporation at the time of the relevant transaction (or transactions) and the relevant transaction (or transactions) take place during a taxable year ending before the 36-month anniversary of the due date for the first corporation’s U.S. Federal income tax return (excluding any extensions) for the last taxable year for which the first corporation was previously publicly held.

( 2 ) Second corporation is not public- ly held at the time of the transaction . If a corporation that is publicly held (the first corporation) at the time of the relevant transaction (or transactions) would be a predecessor to another corporation (the second corporation) under the rules of this paragraph (c)(2)(ii) but for the fact that the second corporation is not a publicly held corporation at the time of the relevant transaction (or transactions), the first corporation is a predecessor of a publicly held corporation if the second corporation becomes a publicly held corporation for a taxable year ending before the 36-month anniversary of the due date for the first corporation’s U.S. Federal income tax return (excluding any extensions) for the first corporation’s last taxable year in which the transaction is taken into account.

( 3 ) Neither corporation is publicly held at the time of the transaction . If a corporation that was previously publicly held (the first corporation) would be a predecessor to another corporation (the second corporation) under the rules of this paragraph (c)(2)(ii) but for the fact that neither it nor the second corporation is a publicly held corporation at the time of the relevant transaction (or transactions), the first corporation is a predecessor of a publicly held corporation if the second corporation becomes a publicly held corporation for a taxable year ending before the 36-month anniversary of the due date for the first

corporation’s U.S. Federal income tax return (excluding any extensions) for the last taxable year for which the first corporation was previously publicly held.

( 4 ) Sequential transactions. If a corporation that was previously publicly held (the first corporation) would be a predecessor to another corporation (the second corporation) under the rules of this paragraph (c)(2)(ii) but for the fact that the first corporation is (or its assets are) transferred to one or more intervening corporations prior to being transferred to the second corporation, and if each intervening corporation would be a predecessor of a publicly held corporation with respect to the second corporation if the intervening corporation or corporations were publicly held corporations, then paragraphs (c)(2) (ii)(G)( 1 ) through ( 3 ) of this section also apply without regard to the intervening corporations.

(H) Elections under sections 336(e) and 338 . For purposes of this paragraph (c)(2), when a corporation makes an election to treat as an asset purchase either the sale, exchange, or distribution of stock pursuant to regulations under section 336(e) or the purchase of stock pursuant to regulations under section 338, the corporation that issued the stock is treated as the same corporation both before and after such transaction.

(I) Date of transaction . For purposes of this paragraph (c)(2)(ii), the date that a transaction is treated as having occurred is the date on which all events necessary for the transaction to be described in the relevant provision have occurred.

(J) Publicly traded partnership . For purposes of applying this paragraph (c) (2)(ii), a publicly traded partnership is a predecessor of a publicly held corporation if under the same facts and circumstances a corporation substituted for the publicly traded partnership would be a predecessor of the publicly held corporation, and at the time of the transaction the publicly traded partnership is treated as a publicly held corporation as defined in paragraph (c)(1)(i) of this section. In making this determination, the rules in paragraphs (c)(2) (ii)(A) through (I) of this section apply to publicly traded partnerships by analogy.

(iii) Disregarded entities . If a publicly held corporation under paragraph (c) (1) of this section owns an entity that is

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disregarded as an entity separate from its owner under §301.7701-2(c)(2)(i) of this chapter, then the covered employees of the publicly held corporation are determined pursuant to paragraphs (c)(2)(i) and (ii) of this section. The executive officers of the entity that is disregarded as an entity separate from its corporate owner under §301.7701-2(c)(2)(i) of this chapter are neither covered employees of the entity nor of the publicly held corporation unless they meet the definition of covered employee in paragraphs (c)(2)(i) and (ii) of this section with respect to the publicly held corporation, in which case they are covered employees for its taxable year.

(iv) Qualified subchapter S subsidiar- ies . If a publicly held corporation under paragraph (c)(1) of this section owns an entity that is a QSub under section 1361(b) (3)(B), then the covered employees of the publicly held corporation are determined pursuant to paragraphs (c)(2)(i) and (ii) of this section. The executive officers of the QSub are neither covered employees of the QSub nor of the publicly held corporation unless they meet the definition of covered employee in paragraphs (c)(2)(i) and (ii) of this section with respect to the publicly held corporation, in which case they are covered employees for its taxable year.

(v) Covered employee of an affiliated group . A person who is identified as a covered employee in paragraphs (c)(2)(i) through (iv) of this section for a publicly held corporation’s taxable year is also a covered employee for the taxable year of a publicly held corporation as defined in paragraph (c)(1)(ii) of this section.

(vi) Examples . The following examples illustrate the provisions of this paragraph (c)(2). For each example, assume that the corporation has a taxable year that is a calendar year and has a fiscal year ending December 31 for reporting purposes under the Exchange Act. Additionally, for each example, unless explicitly provided, assume that none of the employees were covered employees for any taxable year preceding the first taxable year set forth in that example (since being a covered employee for a preceding taxable year would provide a separate and independent basis for classifying that employee as a covered employee for a subsequent taxable year).

(A) Example 1 (Covered employees of members of an affiliated group) —( 1 ) Facts . Corporations A, B, and C are direct wholly-owned subsidiaries of Corporation D. Corporation D is a publicly held corporation as defined in paragraph (c)(1)(i) of this section because its class of securities is required to be registered under section 12 of the Exchange Act as of December 31, 2020. Corporation A is a publicly held corporation as defined in paragraph (c)(1)(i) of this section because it is required to file reports under section 15(d) of the Exchange Act as of December 31, 2020. Corporations B and C are not publicly held corporations for their 2020 taxable years. Employee E served as the PEO of Corporation D from January 1, 2020, to March 31, 2020. Employee F served as the PEO of Corporation D from April 1, 2020, to December 31, 2020. Employee G served as the PEO of Corporation A for its entire 2020 taxable year. Employee H served as the PEO of Corporation B for its entire 2020 taxable year. Employee I served as the PEO of Corporation C for its entire 2020 taxable year. From April 1, 2020, through September 30, 2020, Employee E served as an advisor (not as a PEO) to Employee I and received compensation from Corporation C for these services. In 2020, all four corporations paid compensation to their respective PEOs.

( 2 ) Conclusion (Employees F and E) . Because both Employees E and F served as the PEO during Corporation D’s 2020 taxable year, both Employees E and F are covered employees for Corporation D’s 2020 and subsequent taxable years. Corporations D and C are members of an affiliated group as defined in paragraph (c)(1)(ii) of this section. Because Employee E received compensation from Corporations D and C, the compensation paid by both corporations is aggregated. Any amount disallowed as a deduction by this section is prorated between Corporations D and C in proportion to the amount of compensation paid to Employee E by each corporation in 2020.

( 3 ) Conclusion (Employee G) . Because Employee G served as a PEO of Corporation A, a publicly held corporation, Employee G is a covered employee of Corporation A for its 2020 and subsequent taxable years.

( 4 ) Conclusion (Employee H) . Even though Employee H served as the PEO of Corporation B, Employee H is not a covered employee of Corporation B for its 2020 taxable year, because Corporation B is considered a publicly held corporation solely by reason of being a member of an affiliated group as defined in paragraph (c)(1)(ii) of this section.

( 5 ) Conclusion (Employee I) . Even though Employee I served as the PEO of Corporation C, Employee I is not a covered employee of Corporation C for its 2020 taxable year, because Corporation C is considered a publicly held corporation solely by reason of being a member of an affiliated group as defined in paragraph (c)(1)(ii) of this section. The aggregation of the compensation paid to Employee E by Corporations D and C (for purposes of determining the amount of deduction disallowed by this section) is immaterial to determining whether Employee I is a covered employee of Corporation C.

(B) Example 2 (Covered employees of a publicly held corporation) —( 1 ) Facts . Corporation J is a publicly held corporation. Corporation J is not a smaller reporting company or emerging growth company for

purposes of reporting under the Exchange Act. For 2020, Employee K served as the sole PEO of Corporation J and Employees L and M both served as the PFO of Corporation J at different times during the year. Employees N, O, and P were, respectively, the first, second, and third highest compensated executive officers of Corporation J for 2020 other than the PEO and PFO, and all three retired before the end of 2020. Employees Q, R, and S were, respectively, Corporation J’s fourth, fifth, and sixth highest compensated executive officers other than the PEO and PFO for 2020, and all three were serving at the end of 2020. On March 1, 2021, Corporation J filed its Form 10-K, Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 with the SEC. With respect to Item 11, Executive Compensation (as required by Part III of Form 10-K, or its successor), Corporation J disclosed the compensation of Employee K for serving as the PEO, Employees L and M for serving as the PFO, and Employees Q, R, and S pursuant to Item 402 of Regulation S-K, 17 CFR 229.402(a)(3)(iii). Corporation J also disclosed the compensation of Employees N and O pursuant to Item 402 of Regulation S-K, 17 CFR 229.402(a)(3)(iv). ( 2 ) Conclusion (PEO) . Because Employee K served as the PEO during 2020, Employee K is a covered employee for Corporation J’s 2020 taxable year.

( 3 ) Conclusion (PFO) . Because Employees L and M served as the PFO during 2020, Employees L and M are covered employees for Corporation J’s 2020 taxable year. ( 4 ) Conclusion (Three Highest Compensated Executive Officers) . Even though the executive compensation disclosure rules under the Exchange Act require Corporation J to disclose the compensation of Employees N, O, Q, R, and S for 2020, Corporation J’s three highest compensated executive officers who are covered employees for its 2020 taxable year are Employees N, O, and P, because these are the three highest compensated executive officers other than the PEO and PFO for 2020.

(C) Example 3 (Covered employees of a small- er reporting company) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(B) of this section ( Example 2 ), except that Corporation J is a smaller reporting company or emerging growth company for purposes of reporting under the Exchange Act. Accordingly, with respect to Item 11, Executive Compensation (as required by Part III of Form 10-K, or its successor), Corporation J disclosed the compensation of Employee K for serving as the PEO, Employees Q and R pursuant to Item 402(m) of Regulation S-K, 17 CFR 229.402(m)(2)(ii), and Employees N and O pursuant to Item 402(m) of Regulation S-K, 17 CFR 229.402(m)(2)(iii). ( 2 ) Conclusion . The result is the same as in paragraph (c)(2)(vi)(B) of this section ( Example 2 ). For purposes of identifying a corporation’s covered employees, it is not relevant whether the reporting obligation under the Exchange Act for smaller reporting companies and emerging growth companies apply to the corporation, nor is it relevant whether the specific executive officers’ compensation must be disclosed pursuant to the disclosure rules under the Exchange Act applicable to the corporation.

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three highest compensated executive officers for this taxable year.

(F) Example 6 (Predecessor of a publicly held corporation) —( 1 ) Facts . Corporation EE is a publicly held corporation for its 2021 taxable year. Corporation EE is a privately held corporation for its 2022 and 2023 taxable years. For its 2024 taxable year, Corporation EE is a publicly held corporation.

( 2 ) Conclusion. Corporation EE is a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(A) of this section because it became a publicly held corporation for a taxable year ending prior to April 15, 2025. Therefore, for Corporation EE’s 2024 taxable year, the covered employees of Corporation EE include the covered employees of Corporation EE for its 2021 taxable year and any additional covered employees determined pursuant to paragraph (c)(2) of this section.

(G) Example 7 (Predecessor of a publicly held corporation )—( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(F) of this section ( Example 6 ), except that Corporation EE remains a privately held corporation until it becomes a publicly held corporation for its 2027 taxable year.

( 2 ) Conclusion. Corporation EE is not a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(A) of this section because it became a publicly held corporation for a taxable year ending after April 15, 2025. Therefore, any covered employee of Corporation EE for its 2021 taxable year is not a covered employee of Corporation EE for its 2027 taxable year due to that individual’s status as a covered employee of Corporation EE for a preceding taxable year beginning after December 31, 2016 (but may be a covered employee due to status during the 2027 taxable year).

(H) Example 8 (Predecessor of a publicly held corporation that is party to a merger) —( 1 ) Facts . On June 30, 2021, Corporation FF (a publicly held corporation) merged into Corporation GG (a publicly held corporation) in a transaction that qualifies as a reorganization under section 368(a)(1)(A), with Corporation GG as the surviving corporation. As a result of the merger, Corporation FF has a short taxable year ending June 30, 2021. Corporation FF is a publicly held corporation for this short taxable year. Corporation GG does not have a short taxable year and is a publicly held corporation for its 2021 taxable year.

( 2 ) Conclusion . Corporation FF is a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(B) of this section. Therefore, any covered employee of Corporation FF for its short taxable year ending June 30, 2021, is a covered employee of Corporation GG for its 2021 taxable year. Accordingly, for Corporation GG’s 2021 and subsequent taxable years, the covered employees of Corporation GG include the covered employees of Corporation FF (for a preceding taxable year beginning after December 31, 2016) and any additional covered employees determined pursuant to paragraph (c)(2) of this section.

(I) Example 9 (Predecessor of a publicly held corporation that is party to a merger) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(H) of this section ( Example 8 ), except that, after the merger, Corporation GG is a privately held corporation for its 2021 taxable year.

(D) Example 4 (Covered employees of a pub- licly held corporation that is not required to file a Form 10-K) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(B) of this section ( Example 2 ), except that on February 4, 2021, Corporation J files Form 15, Certification and Notice of Termination of Registration under Section 12(g) of the Securities Exchange Act of 1934 or Suspension of Duty to File Reports under Sections 13 and 15(d) of the Securities Exchange Act of 1934 (or its successor), to terminate the registration of its securities. Corporation J’s duty to file reports under Section 13(a) of the Exchange Act is suspended upon the filing of the Form 15 and, as a result, Corporation J is not required to file a Form 10-K and disclose the compensation of its executive officers for 2020.

( 2 ) Conclusion . The result is the same as in paragraph (c)(2)(vi)(B) of this section ( Example 2 ). Covered employees include executive officers of a publicly held corporation even if the corporation is not required to disclose the compensation of its executive officers under the Exchange Act. Therefore, Employees K, L, M, N, O, and P are covered employees for 2020. The conclusion would be different if Corporation J filed Form 15, Certification and Notice of Termination of Registration under Section 12(g) of the Securities Exchange Act of 1934 or Suspension of Duty to File Reports under Sections 13 and 15(d) of the Securities Exchange Act of 1934 (or its successor), to terminate the registration of its securities prior to December 31, 2020. In that case, Corporation J would not be a publicly held corporation for its 2020 taxable year, and, therefore, Employees K, L, M, N, O, and P would not be covered employees for Corporation J’s 2020 taxable year.

(E) Example 5 (Covered employees of two pub- licly held corporations after a corporate trans- action) —( 1 ) Facts . Corporation T is a domestic publicly held corporation for its 2019 taxable year. Corporation U is a domestic privately held corporation for its 2019 and 2020 taxable years. On July 31, 2020, Corporation U acquires for cash 80% of the only class of outstanding stock of Corporation T. The group (comprised of Corporations U and T) elects to file a consolidated Federal income tax return. As a result of this election, Corporation T has a short taxable year ending on July 31, 2020. Corporation T does not change its fiscal year for reporting purposes under the Exchange Act to correspond to the short taxable year. Corporation T remains a domestic publicly held corporation for its short taxable year ending on July 31, 2020, and its subsequent taxable year ending on December 31, 2020, for which it files a consolidated Federal income tax return with Corporation U. For Corporation T’s taxable year ending July 31, 2020, Employee V serves as the only PEO, and Employee W serves as the only PFO. Employees X, Y, and Z are the three most highly compensated executive officers of Corporation T for the taxable year ending July 31, 2020, other than the PEO and PFO. As a result of the acquisition, effective July 31, 2020, Employee V ceases to serve as the PEO of Corporation T. Instead, Employee AA begins serving as the PEO of Corporation T on August 1, 2020. Employee V continues to provide services for Corporation T and never serves as PEO again (or as an individual acting in such capacity). For Corporation T’s taxable

year ending December 31, 2020, Employee AA serves as the only PEO, and Employee W serves as the only PFO. Employees X, Y, and Z continue to serve as executive officers of Corporation T during the taxable year ending December 31, 2020. Employees BB, CC, and DD are the three most highly compensated executive officers of Corporation T, other than the PEO and PFO, for the taxable year ending December 31, 2020.

( 2 ) Conclusion (Employee V) . Because Employee V served as the PEO during Corporation T’s short taxable year ending July 31, 2020, Employee V is a covered employee for Corporation T’s short taxable year ending July 31, 2020. Furthermore, Employee V is a covered employee for Corporation T’s short taxable year ending July 31, 2020, even though Employee V’s compensation is required to be disclosed pursuant to the executive compensation disclosure rules under the Exchange Act only for the fiscal year ending December 31, 2020. Because Employee V was a covered employee for Corporation T’s short taxable year ending July 31, 2020, Employee V is also a covered employee for Corporation T’s short taxable year ending December 31, 2020.

( 3 ) Conclusion (Employee W) . Because Employee W served as the PFO during Corporation T’s short taxable years ending July 31, 2020, and December 31, 2020, Employee W is a covered employee for both taxable years. Furthermore, Employee W is a covered employee for Corporation T’s short taxable year ending July 31, 2020, even though Employee W’s compensation is required to be disclosed pursuant to the executive compensation disclosure rules under the Exchange Act only for the fiscal year ending December 31, 2020. Employee W would be a covered employee for Corporation T’s short taxable year ending December 31, 2020, even if Employee W did not serve as the PFO during this taxable year because Employee W was a covered employee for Corporation T’s short taxable year ending July 31, 2020. ( 4 ) Conclusion (Employee AA) . Because Employee AA served as the PEO during Corporation T’s short taxable year ending December 31, 2020, Employee AA is a covered employee for this taxable year.

( 5 ) Conclusion (Employees X, Y, and Z) . Employees X, Y, and Z are covered employees for Corporation T’s short taxable years ending July 31, 2020, and December 31, 2020. Employees X, Y, and Z are covered employees for Corporation T’s short taxable year ending July 31, 2020, because these employees are the three highest compensated executive officers for this taxable year. Employees X, Y, and Z are covered employees for Corporation T’s short taxable year ending December 31, 2020, because they were covered employees for Corporation T’s short taxable year ending July 31, 2020. Accordingly, Employees X, Y, and Z would be covered employees for Corporation T’s short taxable years ending July 31, 2020, and December 31, 2020, even if their compensation would not be required to be disclosed pursuant to the executive compensation disclosure rules under the Exchange Act.

( 6 ) Conclusion (Employees BB, CC, and DD) . Employees BB, CC, and DD are covered employees for Corporation T’s short taxable year ending December 31, 2020 because these employees are the

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( 2 ) Conclusion. Because Corporation GG is a privately held corporation for its 2021 taxable year, it is not subject to section 162(m)(1) for this taxable year.

(J) Example 10 (Predecessor of a publicly held corporation that is party to a merger) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(I) of this section ( Example 9 ), except Corporation GG becomes a publicly held corporation on June 30, 2023, and is a publicly held corporation for its 2023 taxable year.

( 2 ) Conclusion . Because Corporation GG became a publicly held corporation for a taxable year ending prior to April 15, 2025, Corporation FF is a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(G) of this section. Therefore, any covered employee of Corporation FF for its short taxable year ending June 30, 2021, is a covered employee of Corporation GG for its 2023 and subsequent taxable years. Accordingly, for Corporation GG’s 2023 and subsequent taxable years, the covered employees of Corporation GG include the covered employees of Corporation FF (for a preceding taxable year beginning after December 31, 2016) and any additional covered employees determined pursuant to paragraph (c)(2) of this section.

(K) Example 11 (Predecessor of a publicly held corporation that is party to a merger) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(J) of this section ( Example 10 ), except that Corporation FF is a privately held corporation for its taxable year ending June 30, 2021, but was a publicly held corporation for its 2020 taxable year.

(L) Example 12 (Predecessor of a publicly held corporation that is party to a merger and subse- quently becomes member of an affiliated group) —( 1 ) Facts . The facts are the same as in paragraph (c)(2) (vi)(I) of this section ( Example 9 ). Additionally, on June 30, 2022, Corporation GG becomes a member of an affiliated group (as defined in paragraph (c)(1) (ii) of this section) that files a consolidated Federal income tax return. Corporation II is the parent corporation of the group and is a publicly held corporation. Employee HH was a covered employee of Corporation FF for its taxable year ending June 30, 2021. On July 1, 2022, Employee HH becomes an employee of Corporation II.

( 2 ) Conclusion . By becoming a member of an affiliated group (as defined in paragraph (c)(1)(ii) of this section) on June 30, 2022, Corporation GG became a publicly held corporation for a taxable year ending prior to April 15, 2025. Therefore, Corporation FF is a predecessor of a publicly held corporation (Corporation GG) within the meaning of paragraph (c)(2)(ii)(G) of this section. Furthermore, Corporation FF is a predecessor of a publicly held corporation (Corporation II) within the meaning of paragraph (c)(2)(ii)(G) of this section. Accordingly, for Corporation II’s 2022 and subsequent taxable years, Employee HH is a covered employee of Corporation II because Employee HH was a covered employee of Corporation FF for its taxable year ending June 30, 2021.

(M) Example 13 (Predecessor of a publicly held corporation that is party to a merger and subse- quently becomes member of an affiliated group) ( 1 ) Facts . The facts are the same as in paragraph (c) (2)(vi)(L) of this section ( Example 12 ), except that, Corporation FF was a privately held corporation for its taxable year ending June 30, 2021, and Employee HH was a covered employee of Corporation FF for its taxable year ending December 31, 2020.

( 2 ) Conclusion . Even though Corporation FF was a privately held corporation when it merged with Corporation GG on June 30, 2021, Corporation FF may still be a considered a predecessor corporation if Corporation GG becomes a publicly held corporation for a taxable year ending prior to April 15, 2024. Because Corporation GG became a publicly held corporation for its 2022 taxable year by becoming a member of an affiliated group (as defined in paragraph (c)(1)(ii) of this section), Corporation FF is a predecessor of a publicly held corporation (Corporation GG) within the meaning of paragraph (c)(2)(ii) (G) of this section. Furthermore, Corporation FF is a predecessor of a publicly held corporation (Corporation II) within the meaning of paragraph (c)(2)(ii)(G) of this section. Therefore, any covered employee of Corporation FF for its 2020 taxable year is a covered employee of Corporation II for its 2022 and subsequent taxable years. Accordingly, for Corporation II’s 2022 taxable year, Employee HH is a covered employee of Corporation II because Employee HH was a covered employee of Corporation FF for its 2020 taxable year. (N) Example 14 (Predecessor of a publicly held corporation that is a party to a merger) —( 1 ) Facts . Corporation JJ is a publicly held corporation for its 2019 taxable year. Corporation JJ is incorporated in State KK. On June 1, 2019, Corporation JJ formed a wholly-owned subsidiary, Corporation LL. Corporation LL is a publicly held corporation incorporated in State MM. On June 30, 2021, Corporation JJ merged into Corporation LL under State MM law in a transaction that qualifies as a reorganization under section 368(a)(1)(A), with Corporation LL as the surviving corporation. As a result of the merger, Corporation JJ has a short taxable year ending June 30, 2021. Corporation JJ is a publicly held corporation for this short taxable year.

( 2 ) Conclusion . Corporation JJ is a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(B) of this section. Therefore, any covered employee of Corporation JJ for its short taxable year ending June 30, 2021, is a covered em

ployee of Corporation LL for its taxable years ending after June 30, 2021. Accordingly, for taxable years ending after June 30, 2021, the covered employees of Corporation LL include the covered employees of Corporation JJ (for a preceding taxable year beginning after December 31, 2016) and any additional covered employees determined pursuant to paragraph (c)(2) of this section.

(O) Example 15 (Predecessor of a publicly held corporation becomes member of an affiliated group) —( 1 ) Facts . Corporations NN and OO are publicly held corporations for their 2021 and 2022 taxable years. On June 30, 2021, Corporation OO acquires for cash 100% of the only class of outstanding stock of Corporation NN. The group (comprised of Corporations NN and OO) elects to file a consolidated income tax return. As a result of this election, Corporation NN has a short taxable year ending on June 30, 2021. Corporation NN is a publicly held corporation for its taxable year ending June 30, 2021, and a privately held corporation for subsequent taxable years. On June 30, 2022, Corporation OO completely liquidates Corporation NN.

( 2 ) Conclusion . After Corporation OO acquired Corporation NN, Corporations NN and OO comprised an affiliated group as defined in paragraph (c)(1)(ii) of this section. Thus, Corporation NN is a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(D) of this section. Therefore, any covered employee of Corporation NN for its short taxable year ending June 30, 2021, is a covered employee of Corporation OO for its taxable years ending after June 30, 2021. Accordingly, for taxable years ending after June 30, 2021, the covered employees of Corporation OO include the covered employees of Corporation NN (for a preceding taxable year beginning after December 31, 2016) and any additional covered employees determined pursuant to paragraph (c)(2) of this section.

(P) Example 16 (Predecessor of a publicly held corporation becomes member of an affiliat- ed group) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(O) of this section ( Example 15 ), except that Corporation OO is a privately held corporation on June 30, 2021, and for its 2021 and 2022 taxable years.

( 2 ) Conclusion. Because Corporation OO is a privately held corporation for its 2021 and 2022 taxable years, it is not subject to section 162(m)(1) for these taxable years.

(Q) Example 17 (Predecessor of a publicly held corporation becomes member of an affiliat- ed group) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(P) of this section ( Example 16 ), except that on October 1, 2022, Corporation OO’s Securities Act registration statement in connection with its initial public offering is declared effective by the SEC, and Corporation OO is a publicly held corporation for its 2022 taxable year.

( 2 ) Conclusion (Taxable Year Ending December 31, 2021) . Because Corporation OO is a privately held corporation for its 2021 taxable year, it is not subject to section 162(m)(1) for this taxable year.

( 3 ) Conclusion (Taxable Year Ending December 31, 2022) . For the 2022 taxable year, Corporations NN and OO comprised an affiliated group as defined in paragraph (c)(1)(ii) of this section. Corporation

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NN is a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(D) and (F) of this section because Corporation OO became a publicly held corporation for a taxable year ending prior to April 15, 2025. Therefore, any covered employee of Corporation NN for its short taxable year ending June 30, 2021, is a covered employee of Corporation OO for its 2022 and subsequent taxable years. Accordingly, for Corporation OO’s 2022 and subsequent taxable years, the covered employees of Corporation OO include the covered employees of Corporation NN (for a preceding taxable year beginning after December 31, 2016) and any additional covered employees determined pursuant to paragraph (c)(2) of this section.

(R) Example 18 (Predecessor of a publicly held corporation and asset acquisition) —( 1 ) Facts . Corporations PP and QQ are publicly held corporations for their 2020 and 2021 taxable years. On June 30, 2021, Corporation PP acquires for cash 80% of the operating assets (determined by fair market value) of Corporation QQ. Employees RR, SS, TT, and UU were covered employees for Corporation QQ’s taxable year ending December 31, 2020. On April 1, 2020, Employee RR becomes an employee of Corporation PP. On June 30, 2021, Employee SS becomes an employee of Corporation PP. On October 1, 2021, Employee TT becomes an employee of Corporation PP. On August 1, 2022, Employee UU becomes an employee of Corporation PP.

( 2 ) Conclusion . Because Corporation PP acquired 80% of Corporation QQ’s operating assets (determined by fair market value), Corporation QQ is a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(E) of this section. Therefore, any covered employee of Corporation QQ for its 2020 taxable year (who commenced services for Corporation PP within the 12 months before or the 12 months after the acquisition) is a covered employee of Corporation PP for its 2021 and subsequent taxable years. Accordingly, for Corporation PP’s 2021 and subsequent taxable years, the covered employees of Corporation PP include Employees RR, SS, and TT, and any additional covered employees determined pursuant to paragraph (c)(2) of this section. Because Employee UU became an employee of Corporation PP after June 30, 2022, Employee UU is not a covered employee of Corporation PP for its 2022 taxable year, but may be a covered employee of Corporation PP by application of paragraph (c) (2) of this section to Employee UU’s employment at Corporation PP.

(S) Example 19 (Predecessor of a publicly held corporation and asset acquisition) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(R) of this section ( Example 18 ), except that Corporation PP is a privately held corporation on June 30, 2021 and for its 2021 taxable year.

( 2 ) Conclusion. Because Corporation PP is a privately held corporation for its 2021 taxable year, it is not subject to section 162(m)(1) for this taxable year.

(T) Example 20 (Predecessor of a publicly held corporation and asset acquisition) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(S) of this section ( Example 19 ), except that, on October 1, 2022, Corporation PP’s Securities Act registration statement in connection with its initial public offering is declared effective by the SEC, and Corporation

PP is a publicly held corporation for 2022 taxable year.

( 2 ) Conclusion (2021 taxable year) . Because Corporation PP is a privately held corporation for its 2021 taxable year, it is not subject to section 162(m) (1) for this taxable year.

( 3 ) Conclusion (2022 taxable year) . Corporation QQ is a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(G) of this section because Corporation PP became a publicly held corporation for a taxable year ending prior to April 15, 2025. Therefore, any covered employee of Corporation QQ for its 2020 taxable year is a covered employee of Corporation PP for its 2022 and subsequent taxable years. Accordingly, for Corporation PP’s 2022 and subsequent taxable years, the covered employees of Corporation PP include the covered employees of Corporation QQ and any additional covered employees determined pursuant to paragraph (c)(2) of this section.

(U) Example 21 (Predecessor of a publicly held corporation and asset acquisition) —( 1 ) Facts . Corporations VV, WW, and XX are publicly held corporations for their 2020 and 2021 taxable years. Corporations VV and WW are members of an affiliated group. Corporation WW is a direct subsidiary of Corporation VV. On June 30, 2021, Corporation VV acquires for cash 40% of the operating assets (determined by fair market value) of Corporation XX. On January 31, 2022, Corporation WW acquires an additional 40% of the operating assets (determined by fair market value) of Corporation XX. Employees YY, ZZ, and AAA are covered employees for Corporation XX’s 2020 taxable year. Employees BBB and CCC are covered employees for Corporation XX’s 2021 taxable year. On January 15, 2021, Employee AAA becomes an employee of Corporation WW. On July 1, 2021, Employee YY becomes an employee of Corporation WW. On February 1, 2022, Employees ZZ and BBB become employees of Corporation WW. On June 30, 2023, Employee CCC becomes an employee of Corporation WW.

( 2 ) Conclusion. Because an affiliated group, comprised of Corporations VV and WW, acquired 80% of Corporation XX’s operating assets (determined by fair market value), Corporation XX is a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(E) of this section. Therefore, any covered employee of Corporation XX for its 2020 and 2021 taxable years (who commenced services for Corporation WW within the period beginning 12 months before and ending 12 months after the acquisition), is a covered employee of Corporation WW for its 2021, 2022 and subsequent taxable years. Accordingly, for Corporation WW’s 2021 and subsequent taxable years, the covered employees of Corporation WW include Employees AAA and YY, and any additional covered employees determined pursuant to paragraph (c)(2) of this section. For Corporation WW’s 2022 and subsequent taxable years, the covered employees of Corporation WW include Employees AAA, YY, ZZ and BBB, and any additional covered employees determined pursuant to paragraph (c)(2) of this section. Because Employee CCC became an employee of Corporation WW after January 31, 2023, Employee CCC is not a covered employee of Corporation WW for its 2023 taxable year, but may be a covered employee of Corpora

tion WW by application of this paragraph (c)(2) to Employee CCC’s employment at Corporation WW.

(V) Example 22 (Predecessor of a publicly held corporation and asset acquisition) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(U) of this section ( Example 21 ), except that Corporations VV and WW are not publicly held corporations on June 30, 2021, and for their 2021 taxable years.

( 2 ) Conclusion. Because Corporations VV and WW are not publicly held corporations for their 2021 taxable years, they are not subject to section 162(m) (1) for this taxable year.

(W) Example 23 (Predecessor of a publicly held corporation and asset acquisition) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(V) of this section ( Example 22 ), except that, on October 1, 2022, Corporation VV’s Securities Act registration statement in connection with its initial public offering is declared effective by the SEC, and Corporation VV is a publicly held corporation for its 2022 taxable year.

( 2 ) Conclusion (2021 taxable year) . Because Corporations VV and WW are not publicly held corporations for their 2021 taxable years, they are not subject to section 162(m)(1) for this taxable year.

( 3 ) Conclusion (2022 taxable year) . Corporation XX is a predecessor of a publicly held corporation within the meaning of paragraph (c)(2)(ii)(G) of this section because the affiliated group, comprised of Corporations VV and WW, became a publicly held corporation for a taxable year ending prior to April 15, 2024. Therefore, any covered employee of Corporation XX for its 2020 taxable year is a covered employee of Corporation WW for its 2022 taxable year. Accordingly, for Corporation WW’s 2022 and subsequent taxable years, the covered employees of Corporation WW include the covered employees of Corporation XX (for a preceding taxable year beginning after December 31, 2016) and any additional covered employees determined pursuant to this paragraph (c)(2).

(X) Example 24 (Predecessor of a publicly held corporation and a division) —( 1 ) Facts . Corporation DDD is a publicly held corporation for its 2021 and 2022 taxable years. On March 2, 2021, Corporation DDD forms a wholly-owned subsidiary, Corporation EEE, and transfers assets to it. On April 1, 2022, Corporation DDD distributes all shares of Corporation EEE to its shareholders in a transaction described in section 355(a)(1). On April 1, 2022, Corporation EEE’s Securities Act registration statement in connection with its initial public offering is declared effective by the SEC. Corporation EEE is a publicly held corporation for its 2022 taxable year. Employee FFF serves as the PFO of Corporation DDD from January 1, 2022, to March 31, 2022. On April 2, 2022, Employee FFF joins Corporation EEE to serve as an advisor (as a common law employee) to the PFO of Corporation EEE. After March 31, 2022, Employee FFF ceases to provide services for Corporation EEE.

( 2 ) Conclusion . Because the distribution of the stock of Corporation EEE is a transaction described under section 355(a)(1), Corporation DDD is a predecessor of Corporation EEE within the meaning of paragraph (c)(2)(ii)(C) of this section. Accordingly, Corporation DDD is a predecessor of Corporation EEE within the meaning of paragraph (c)(2)(ii)

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(A) of this section even if Corporation EEE was a privately held corporation prior to its 2022 taxable year. Because Employee FFF was a covered employee of Corporation DDD for its 2022 taxable year, Employee FFF is a covered employee of Corporation EEE for its 2022 taxable year. The result is the same whether Employee FFF performs services for Corporation EEE as a common law employee or an independent contractor.

(Y) Example 25 (Predecessor of a publicly held corporation and a division) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(X) of this section ( Example 24 ), except that, Corporation DDD exchanges 100% of the shares of Corporation EEE with Corporation GGG in a transaction described in section 355(a)(1) and Corporation EEE does not register any class of securities with the SEC. Furthermore, Employee FFF performs services for Corporation GGG instead of for Corporation EEE. Corporation GGG is a privately held corporation for its 2022 taxable year. On October 1, 2023, Corporation GGG’s Securities Act registration statement in connection with its initial public offering is declared effective by the SEC. Corporation GGG is a publicly held corporation for its 2023 taxable year. On January 1, 2028, Employee FFF begins serving as a director of Corporation DDD. Corporation DDD is a publicly held corporation for its 2028 taxable year.

( 2 ) Conclusion (2022 taxable year) . Because Corporation GGG is a privately held corporation for its 2022 taxable year, section 162(m)(1) does not limit the deduction for compensation deductible for this taxable year.

( 3 ) Conclusion (2023 taxable year) . Because the exchange of the stock of Corporation EEE is a transaction described under section 355(a)(1), because Corporations EEE and GGG are an affiliated group, and because Corporation GGG became a publicly held corporation for a taxable year ending prior to April 15, 2025, Corporation DDD is a predecessor of Corporation GGG within the meaning of paragraphs (c)(2)(ii)(D) and (G) of this section. Employee FFF was a covered employee of Corporation DDD for its 2022 taxable year, and began performing services for Corporation GGG following April 1, 2021, and before April 1, 2023. Therefore, Employee FFF is a covered employee of Corporation GGG for its 2023 taxable year.

( 4 ) Conclusion (2028 taxable year) . Because Employee FFF served as the PFO of Corporation DDD from January 1, 2022, to March 31, 2022, Employee FFF was a covered employee of Corporation DDD for its 2022 taxable year. Because an individual who is a covered employee for a taxable year remains a covered employee for all subsequent taxable years (even after the individual has separated from service), Employee FFF is a covered employee of Corporation DDD for its 2028 taxable year.

(Z) Example 26 (Predecessor of a publicly held corporation and a division) —( 1 ) Facts . The facts are the same as in paragraph (c)(2)(vi)(Y) of this section ( Example 25 ), except that, Employee FFF begins performing services for Corporation GGG on June 30, 2023, instead of on April 2, 2022, and never performs services for Corporation DDD after June 30, 2023. Furthermore, on June 30, 2023, Employee HHH, a covered employee of Corporation EEE for all of its taxable years, begins performing services

for Corporation GGG as an independent contractor advising its PEO but not serving as a PEO.

( 2 ) Conclusion (2023 taxable year) . Because the exchange of the stock of Corporation EEE is a transaction described under section 355(a)(1) and because Corporation GGG became a publicly held corporation for a taxable year ending before April 15, 2025, Corporation DDD is a predecessor of Corporation GGG within the meaning of paragraphs (c)(2)(ii)(D) and (G) of this section. Even though Employee FFF was a covered employee of Corporation DDD for its 2022 taxable year, because Employee FFF began performing services for Corporation GGG after April 1, 2023, Employee FFF is not a covered employee of Corporation GGG for its 2023 taxable year. However, if Employee FFF is a PEO, PFO, or one of the three highest compensated executives (other than the PEO or PFO) of Corporation GGG for its 2023 or subsequent taxable years, then Employee FFF is a covered employee of Corporation GGG for such taxable year (and subsequent taxable years). Because Employee HHH was a covered employee of Corporation EEE for its 2022 taxable year, Employee is a covered employee of Corporation GGG for its 2023 taxable year.

(AA) Example 27 (Predecessor of a publicly held corporation and election under section 338(h) (10)) —( 1 ) Facts . Corporation III is the common parent of a group of corporations filing consolidated returns that includes Corporation JJJ as a member. Corporation III wholly-owns Corporation JJJ, a publicly held corporation within the meaning of paragraph (c) (1)(i) of this section. On June 30, 2021, Corporation LLL purchases Corporation JJJ from Corporation III. Corporation III and Corporation LLL make a timely election under section 338(h)(10) with respect to the purchase of Corporation JJJ stock. For its taxable year after the purchase ending December 31, 2021, Corporation JJJ continues to be a publicly held corporation within the meaning of paragraph (c)(1)(i) of this section.

( 2 ) Conclusion . As provided in paragraph (c)(2) (ii)(H), Corporation JJJ is treated as the same corporation for purposes for purposes of paragraph (c)(2). Accordingly, any covered employee of Corporation JJJ for its short taxable year ending June 30, 2021, is a covered employee of Corporation JJJ for its short taxable year ending on December 31, 2021, and subsequent taxable years.

(BB) Example 28 (Disregarded entity) –( 1 ) Facts . Corporation MMM is a privately held corporation for its 2020 taxable year. Entity NNN is a wholly-owned limited liability company and is disregarded as an entity separate from its owner, Corporation MMM, under §301.7701-2(c)(2)(i) of this chapter. As of December 31, 2020, Entity NNN is required to file reports under section 15(d) of the Exchange Act. For the 2020 taxable year, Employee OOO is the PEO and Employee PPP is the PFO of Corporation MMM. Employees QQQ, RRR, and SSS are the three most highly compensated executive officers of Corporation MMM (other than Employees OOO and PPP). Employee TTT is the PFO of Entity NNN and does not perform any policy making functions for Corporation MMM. Entity NNN has no other executive officers.

(2) Conclusion . Because Entity NNN is disregarded as an entity separate from its owner, Corpo

ration MMM, and is required to file reports under section 15(d) of the Exchange Act, Corporation MMM is a publicly held corporation under paragraph (c)(1)(iii) of this section for its 2020 taxable year. Even though Employee TTT is a PFO of Entity NNN, Employee TTT is not considered a PFO of Corporation MMM under paragraph (c)(2)(iii) of this section. As PEO and PFO, Employees OOO and PPP are covered employees of Corporation MMM under paragraph (c)(2)(i) of this section. Additionally, as the three most highly compensated executive officers of Corporation MMM (other than Employees OOO and PPP), Employees QQQ, RRR, and SSS are also covered employees of Corporation MMM under paragraph (c)(2)(i) of this section for Corporation MMM’s 2020 taxable year because their compensation would be disclosed if Corporation MMM were subject to the SEC executive compensation disclosure rules. The conclusion would be the same if Entity NNN was not required to file reports under section 15(d) of the Exchange Act and Corporation MMM was a publicly held corporation pursuant to paragraph (c)(1)(i) instead of paragraph (c)(1)(iii) of this section.

(CC) Example 29 (Disregarded entity) —( 1 ) Facts . The facts are the same as in paragraph (c)(2) (vi)(BB) of this section ( Example 28 ), except that Employee TTT performs a policy making function for Corporation MMM. If Corporation MMM were subject to the SEC executive compensation disclosure rules, then Employee TTT would be treated as an executive officer of Corporation MMM pursuant to 17 CFR 240.3b-7 for purposes of determining the three highest compensated executive officers for Corporation MMM’s 2020 taxable year. Employees QQQ, RRR and SSS are the three most highly compensated executive officers of Corporation MMM (other than Employees OOO and PPP). Employee TTT is compensated more than Employee QQQ, but less than Employees RRR and SSS.

(2) Conclusion . Because Entity NNN is disregarded as an entity separate from its owner, Corporation MMM, and is required to file reports under section 15(d) of the Exchange Act, Corporation MMM is a publicly held corporation under paragraph (c)(1)(iii) of this section for its 2020 taxable year. As PEO and PFO, Employees OOO and PPP are covered employees of Corporation MMM under paragraph (c)(2)(i) of this section. Employee TTT is one of the three highest compensated executive officers for Corporation MMM’s taxable year. Because Employees TTT, RRR, and SSS are the three most highly compensated executive officers of Corporation MMM (other than Employees OOO and PPP), they are covered employees of Corporation MMM under paragraph (c)(2)(i) of this section for Corporation MMM’s 2020 taxable year because their compensation would be disclosed if Corporation MMM were subject to the SEC executive compensation disclosure rules. The conclusion would be the same if Entity NNN was not required to file reports under section 15(d) of the Exchange Act and Corporation MMM was a publicly held corporation pursuant to paragraph (c)(1)(i) instead of paragraph (c)(1)(iii) of this section.

(DD) Example 30 (Individual as covered employ- ee of a publicly held corporation that includes the affiliated group) —( 1 ) Facts . Corporations UUU and

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VVV are publicly held corporations for their 2020, 2021, and 2022 taxable years. Corporation VVV is a direct subsidiary of Corporation UUU. Employee WWW is an employee, but not a covered employee, of Corporation UUU for its 2020, 2021, and 2022 taxable years. From April 1, 2020, to September 30, 2020, Employee WWW performs services for Corporation VVV. Employee WWW does not perform any services for Corporation VVV for its 2021 and 2022 taxable years. Employee WWW is a covered employee of Corporation VVV for its 2020, 2021, and 2022 taxable years. For the 2020 taxable year, Employee WWW receives compensation for services provided to Corporations UUU and VVV only from Corporation UUU in the amount of $1,500,000. Employee WWW receives $2,000,000 from Corporation UUU for performing services for Corporation UUU during each of its 2021 and 2022 taxable years. On June 30, 2022, Corporation VVV pays $500,000 to Employee WWW from a nonqualified deferred compensation plan that complies with section 409A.

( 2 ) Conclusion (2020 taxable year) . Because Employee WWW is a covered employee of Corporation VVV and because the affiliated group of corporations (composed of Corporations UUU and VVV) is a publicly held corporation, Employee WWW is a covered employee of the publicly held corporation that is the affiliated group pursuant to paragraph (c) (2)(v) of this section. Accordingly, compensation paid by Corporations UUU and VVV is aggregated for purposes of section 162(m)(1) and, as a result, $500,000 of the aggregate compensation paid is nondeductible. The conclusion would be the same if Corporation UUU was a privately held corporation for its 2020 taxable year.

( 3 ) Conclusion (2021 taxable year) . Because Employee WWW is a covered employee of Corporation VVV pursuant to paragraph (c)(2)(i)(C) of this section and because the affiliated group of corporations (composed of Corporations UUU and VVV) is a publicly held corporation, Employee WWW is a covered employee of the publicly held corporation that is the affiliated group pursuant to paragraph (c) (2)(v) of this section. Accordingly, compensation paid by Corporations UUU and VVV is aggregated for purposes of section 162(m)(1) and, as a result, $1,000,000 of the aggregate compensation paid is nondeductible. The conclusion would be the same if Corporation UUU was a privately held corporation for its 2021 taxable year.

( 4 ) Conclusion (2022 taxable year) . Because Employee WWW is a covered employee of Corporation VVV pursuant to paragraph (c)(2)(i)(C) of this section and because the affiliated group of corporations (composed of Corporations UUU and VVV) is a publicly held corporation, Employee WWW is a covered employee of the publicly held corporation that is the affiliated group pursuant to paragraph (c) (2)(v) of this section. Accordingly, compensation paid by Corporations UUU and VVV is aggregated for purposes of section 162(m)(1) and, as a result, $1,500,000 of the aggregate compensation paid is nondeductible. The conclusion would be the same if Corporation UUU was a privately held corporation for its 2022 taxable year.

(EE) Example 31 (Individual as covered employ- ee of a publicly held corporation that includes the affiliated group) —( 1 ) Facts . Corporation BBBB is a

publicly held corporation for its 2020 through 2022 taxable years. Corporations YYY and ZZZ are direct subsidiaries of Corporation BBBB and are privately held corporations for their 2020 through 2022 taxable years. Employee AAAA serves as the PFO of Corporation BBBB from January 1, 2020 to December 31, 2020, when Employee AAAA separates from service. On January 1, 2021, Employee AAAA commences employment with Corporation YYY. In 2021, Employee AAAA receives compensation from Corporation YYY in excess of $1,000,000. On April 1, 2022, Employee AAAA commences employment with Corporation ZZZ. On September 30, 2022, Employee AAAA separates from service from Corporations YYY and ZZZ. In 2022, Employee AAAA receives compensation from Corporations YYY and ZZZ in excess of $1,000,000. For the 2021 and 2022 taxable years, Employee AAA does not serve as either the PEO or PFO of Corporations YYY and ZZZ, and is not one of the three highest compensated executive officers (other than the PEO or PFO) of Corporations YYY and ZZZ.

( 2 ) Conclusion (2021 taxable year) . Employee AAAA is a covered employee of Corporation BBBB for the 2020 taxable year and subsequent taxable years. Because Employee AAAA is a covered employee of Corporation BBBB and because the affiliated group of corporations (composed of Corporations BBBB, YYY, and ZZZ) is a publicly held corporation, Employee AAAA is a covered employee of the publicly held corporation that is the affiliated group pursuant to paragraph (c)(2)(v) of this section for the 2020 taxable year and subsequent taxable years. Therefore, Corporation YYY’s deduction for compensation paid to Employee AAAA for the 2021 taxable year is subject to limitation under section 162(m)(1). The result would be the same if Corporation YYY was a publicly held corporation as defined in paragraph (c)(1)(i) of this section.

( 3 ) Conclusion (2022 taxable year) . Because Employee AAAA is a covered employee of Corporation BBBB and because the affiliated group of corporations (composed of Corporations BBBB, YYY, and ZZZ) is a publicly held corporation, Employee AAAA is a covered employee of the publicly held corporation that is the affiliated group pursuant to paragraph (c)(2)(v) of this section. Therefore, Corporation YYY’s and ZZZ’s deduction for compensation paid to Employee AAAA for the 2022 taxable year is subject to limitation under section 162(m) (1). Because the compensation paid by all affiliated group members is aggregated for purposes of section 162(m)(1), $1,000,000 of the aggregate compensation paid is nondeductible. Corporations YYY and ZZZ each are treated as paying a ratable portion of the nondeductible compensation. The result would be the same if either Corporation YYY or ZZZ (or both) was a publicly held corporation as defined in paragraph (c)(1)(i).

(3) Compensation —(i) In general . For purposes of the deduction limitation described in paragraph (b) of this section, compensation means the aggregate amount allowable as a deduction under chapter 1 of the Internal Revenue Code for the taxable year (determined without regard to section 162(m)(1)) for remuner

ation for services performed by a covered employee in any capacity, whether or not the services were performed during the taxable year. Compensation includes an amount that is includible in the income of, or paid to, a person other than the covered employee (including a beneficiary after the death of the covered employee) for services performed by the covered employee.

(ii) Compensation paid by a partner- ship . For purposes of paragraph (c)(3)(i) of this section, compensation includes an amount equal to a publicly held corporation’s distributive share of a partnership’s deduction for compensation expense attributable to the remuneration paid by the partnership for services performed by a covered employee of the publicly held corporation.

(iii) Exceptions . Compensation does not include—

(A) Remuneration covered in section 3121(a)(5)(A) through (D) (concerning remuneration that is not treated as wages for purposes of the Federal Insurance Contributions Act);

(B) Remuneration consisting of any benefit provided to or on behalf of an employee if, at the time the benefit is provided, it is reasonable to believe that the employee will be able to exclude it from gross income; or

(iv) Examples . The following examples illustrate the provisions of this paragraph (c)(3). For each example, assume that the corporation is a calendar year taxpayer.

(A) Example 1 —( 1 ) Facts . Corporation Z is a publicly held corporation for its 2020 taxable year, during which Employee A serves as the PEO of Corporation Z and also serves on the board of directors of Corporation Z. In 2020, Corporation Z paid $1,200,000 to Employee A plus an additional $50,000 fee for serving as chair of the board of directors of Corporation Z. These amounts are otherwise deductible for Corporation Z’s 2020 taxable year.

( 2 ) Conclusion . The $1,200,000 paid to Employee A in 2020 plus the additional $50,000 director’s fee paid to Employee A in 2020 are compensation within the meaning of paragraph (c)(3) of this section. Therefore, Corporation Z’s $1,250,000 deduction for the 2020 taxable year is subject to limitation under section 162(m)(1).

(B) Example 2 —( 1 ) Facts . Corporation X is a publicly held corporation for its 2020 through 2024 taxable years. Employee B serves as the PEO of Corporation X for its 2020 taxable year. In 2020, Corpo

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to any remuneration that is otherwise deductible for Corporation E’s taxable year ending on or after December 18, 2021.

(e) Coordination with disallowed ex- cess parachute payments under section 280G . The $1,000,000 limitation in paragraph (b) of this section is reduced (but not below zero) by the amount (if any) that would have been included in the compensation of the covered employee for the taxable year but for being disallowed by reason of section 280G . For example, assume that during a taxable year a corporation pays $1,500,000 to a covered employee. Of the $1,500,000, $600,000 is an excess parachute payment, as defined in section 280G(b)(1), and a deduction for that excess parachute payment is disallowed by reason of section 280G(a). Because the $1,000,000 limitation in paragraph (b) of this section is reduced by the amount of the excess parachute payment, the corporation may deduct $400,000 ($1,000,000 - $600,000), and $500,000 of the otherwise deductible amount is nondeductible by reason of section 162(m)(1). Thus $1,100,000 (of the total $1,500,000 payment) is non-deductible, reflecting the disallowance related to the excess parachute payment under section 280G and the application of section 162(m)(1).

(f) Coordination with excise tax on specified stock compensation . The $1,000,000 limitation in paragraph (b) of this section is reduced (but not below zero) by the amount (if any) of any payment (with respect to such employee) of the tax imposed by section 4985 directly or indirectly by the expatriated corporation (as defined in section 4985(e)(2)) or by any member of the expanded affiliated group (as defined in section 4985(e)(4)) that includes such corporation.

(g) Transition rules —(1) Amount of compensation payable under a written binding contract which was in effect on November 2, 2017 —(i) General rule . This section does not apply to the deduction for remuneration payable under a written binding contract that was in effect on November 2, 2017, and that is not modified in any material respect on or after such date (a grandfathered amount). Instead, section 162(m), as in effect prior to its amendment by Public Law 115-97, applies to limit the deduction for such remuneration. Accordingly, because §1.162-27 implemented

ration X established a new nonqualified retirement plan for its executive officers. The retirement plan provides for the distribution of benefits over a threeyear period beginning after a participant separates from service. Employee B separates from service in 2021 and becomes a member of the board of directors of Corporation X in 2022. In 2022, Employee B receives a $75,000 fee for services as a director and $1,500,000 as the first payment under the retirement plan. Employee B continues to serve on the board of directors until 2023 when Employee B dies before receiving the retirement benefit for 2023 and before becoming entitled to any director’s fees for 2023. In 2023 and 2024, Corporation X pays the $1,500,000 annual retirement benefits to Person C, a beneficiary of Employee B.

( 2 ) Conclusion (2022 Taxable Year) . In 2022, Corporation X paid Employee B $1,575,000, including $1,500,000 under the retirement plan and $75,000 in director’s fees. The retirement benefit and the director’s fees are compensation within the meaning of this paragraph (c)(3). Therefore, Corporation X’s $1,575,000 deduction for the 2022 taxable year is subject to limitation under section 162(m)(1).

( 3 ) Conclusion (2023 and 2024 Taxable Years) . In 2023 and 2024, Corporation X made payments to Person C of $1,500,000 under the retirement plan. The retirement benefits are compensation within the meaning of this paragraph (c)(3). Therefore, Corporation X’s deduction for each annual payment of $1,500,000 for the 2023 and 2024 taxable years is subject to limitation under section 162(m)(1).

(D) Example 3 —( 1 ) Facts . Corporation T is a publicly held corporation for its 2021 taxable year. Corporation S is a privately held corporation for its 2021 taxable year. On January 2, 2021, Corporations S and T form a general partnership. Under the partnership agreement, Corporations S and T each have a 50% share of the partnership’s income, loss, and deductions. For the taxable year ending December 31, 2021, Employee D, a covered employee of Corporation T, performs services for the partnership, and the partnership pays $800,000 to Employee D for these services, $400,000 of which is allocated to Corporation T.

( 2 ) Conclusion . Because Corporation T’s distributive share of the partnership’s $400,000 deduction is attributable to the compensation paid by the partnership for services performed by Employee D, a covered employee of Corporation T, the $400,000 is compensation within the meaning of this paragraph (c)(3) and section 162(m)(1) limits Corporation T’s deduction for this expense for the 2021 taxable year. Corporation T’s $400,000 share of the partnership’s deduction is aggregated with Corporation T’s deduction for compensation paid to Employee D, if any, in determining the amount allowable as a deduction to Corporation T for remuneration paid to Employee D for Corporation T’s 2021 taxable year. See §1.702-1(a)(8)(iii). The result is the same whether the covered employee performs services for the partnership as a common law employee, an independent contractor, or a partner, and whether the payment for services is a payment under section 707(a) or a guaranteed payment under section 707(c).

(4) Securities Act . The Securities Act means the Securities Act of 1933.

(5) Exchange Act . The Exchange Act means the Securities Exchange Act of 1934. (6) SEC . The SEC means the United States Securities and Exchange Commission.

(7) Foreign Private Issuer . A foreign private issuer means an issuer as defined in 17 CFR 240.3b-4(c).

(8) American Depositary Receipt (ADR) . An American Depositary Receipt means a negotiable certificate that evidences ownership of a specified number (or fraction) of a foreign private issuer’s securities held by a depositary (typically, a U.S. bank).

(9) Privately held corporation . A privately held corporation is a corporation that is not a publicly held corporation as defined in paragraph (c)(1) of this section (without regard to paragraph (c)(1)(ii) of this section).

(d) Corporations that become pub- licly held —(1) In general . In the case of a corporation that was a privately held corporation and then becomes a publicly held corporation, the deduction limitation of paragraph (b) of this section applies to any compensation that is otherwise deductible for the taxable year ending on or after the date that the corporation becomes a publicly held corporation. A corporation is considered to become publicly held on the date that its registration statement becomes effective either under the Securities Act or the Exchange Act. The rules in this section apply to a partnership that becomes a publicly traded partnership that is a publicly held corporation within the meaning of paragraph (c)(1)(i) of this section.

(2) Example . The following example illustrates the provision of this paragraph (d).

(i) Facts . In 2021, Corporation E plans to issue debt securities in a public offering registered under the Securities Act. Corporation E is not required to file reports under section 15(d) of the Exchange Act with respect to any other class of securities and does not have another class of securities required to be registered under section 12 of the Exchange Act. On December 18, 2021, the Securities Act registration statement for Corporation Z’s debt securities is declared effective by the SEC.

(ii) Conclusion . Corporation E is considered to become a publicly held corporation on December 18, 2021 because it is now required to file reports under section 15(d) of the Exchange Act. The deduction limitation of paragraph (b) of this section applies

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section 162(m), as in effect prior to its amendment by Public Law 115-97, the rules of §1.162-27 determine the applicability of the deduction limitation under section 162(m) with respect to the payment of a grandfathered amount. Remuneration is a grandfathered amount only to the extent that as of November 2, 2017, the corporation was and remains obligated under applicable law (for example, state contract law) to pay the remuneration under the contract if the employee performs services or satisfies the applicable vesting conditions. Accordingly, this section applies to the deduction for any amount of remuneration that exceeds the grandfathered amount if the employee performs services or satisfies the applicable vesting conditions. If a grandfathered amount and non-grandfathered amount are otherwise deductible for the same taxable year and, under the rules of §1.162-27, the deduction of some or all of the grandfathered amount may be limited (for example, the grandfathered amount does not satisfy the requirements of §1.162-27(e)(2) through (5) as qualified performance-based compensation), then the grandfathered amount is aggregated with the non-grandfathered amount to determine the deduction disallowance for the taxable year under section 162(m)(1) (so that the deduction limit applies to the excess of the aggregated amount over $1 million). If a portion of the remuneration payable under a contract is a grandfathered amount and a portion is subject to this section and payment under the contract is made in a series of payments, the grandfathered amount is allocated to the first payment of an amount under the contract that is otherwise deductible. If the grandfathered amount exceeds the initial payment, the excess is allocated to the next payment of an amount under the contract that is otherwise deductible, and this process is repeated until the entire grandfathered amount has been paid.

(ii) Contracts that are terminable or cancelable . If a written binding contract is renewed after November 2, 2017, this section (and not §1.162-27) applies to any payments made after the renewal. A written binding contract that is terminable or cancelable by the corporation without the employee’s consent after November 2, 2017, is treated as renewed as of the

earliest date that any such termination or cancellation, if made, would be effective. Thus, for example, if the terms of a contract provide that it will be automatically renewed or extended as of a certain date unless either the corporation or the employee provides notice of termination of the contract at least 30 days before that date, the contract is treated as renewed as of the date that termination would be effective if that notice were given. Similarly, for example, if the terms of a contract provide that the contract will be terminated or canceled as of a certain date unless either the corporation or the employee elects to renew within 30 days of that date, the contract is treated as renewed by the corporation as of that date (unless the contract is renewed before that date, in which case, it is treated as renewed on that earlier date). Alternatively, if the corporation will remain legally obligated by the terms of a contract beyond a certain date at the sole discretion of the employee, the contract will not be treated as renewed as of that date if the employee exercises the discretion to keep the corporation bound to the contract. A contract is not treated as terminable or cancelable if it can be terminated or canceled only by terminating the employment relationship of the employee. A contract is not treated as renewed if upon termination or cancellation of the contract the employment relationship continues but would no longer be covered by the contract. However, if the employment continues after such termination or cancellation, payments with respect to such post-termination or post-cancellation employment are not made pursuant to the contract (and, therefore, are not grandfathered amounts).

(iii) Compensation payable under a plan or arrangement . If a compensation plan or arrangement is binding, the deduction for the amount that the corporation is obligated to pay pursuant to a written binding contract in effect on November 2, 2017, to an employee pursuant to the plan or arrangement is not subject to this section even if the employee was not eligible to participate in the plan or arrangement as of November 2, 2017, if the employee was employed on November 2, 2017, by the corporation that maintained the plan or arrangement, or the employee had the

right to participate in the plan or arrangement under a written binding contract as of that date.

(iv) Compensation subject to recovery by corporation . If the corporation is obligated or has discretion to recover compensation paid in a taxable year only upon the future occurrence of a condition that is objectively outside of the corporation’s control, then the corporation’s right to recovery is disregarded for purposes of determining the grandfathered amount for the taxable year. If the condition occurs, only the amount the corporation is obligated to pay under applicable law remains grandfathered taking into account the occurrence of the condition. Whether or not the corporation exercises its discretion to recover any compensation does not affect the amount of compensation that the corporation remains obligated to pay under applicable law.

(2) Material modifications —(i) If a written binding contract is modified after November 2, 2017, this section (and not §1.162-27) applies to any payments made after the modification. A material modification occurs when the contract is amended to increase the amount of compensation payable to the employee. If a written binding contract is materially modified, it is treated as a new contract entered into as of the date of the material modification. Thus, amounts received by an employee under the contract before a material modification are not affected, but amounts received subsequent to the material modification are treated as paid pursuant to a new contract, rather than as paid pursuant to a written binding contract in effect on November 2, 2017.

(ii) A modification of the contract that accelerates the payment of compensation is a material modification unless the amount of compensation paid is discounted to reasonably reflect the time value of money. If the contract is modified to defer the payment of compensation, any compensation paid or to be paid that is in excess of the amount that was originally payable to the employee under the contract will not be treated as resulting in a material modification if the additional amount is based on applying to the amount originally payable either a reasonable rate of interest or the rate of return on a pre

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determined actual investment as defined in §31.3121(v)(2)-1(d)(2)(i)(B) of this chapter, (whether or not assets associated with the amount originally owed are actually invested therein) such that the amount payable by the employer at the later date will be based on the reasonable rate of interest or the actual rate of return on the predetermined actual investment (including any decrease, as well as any increase, in the value of the investment).

(iii) The adoption of a supplemental contract or agreement that provides for increased compensation, or the payment of additional compensation, is a material modification of a written binding contract if the facts and circumstances demonstrate that the additional compensation to be paid is based on substantially the same elements or conditions as the compensation that is otherwise paid pursuant to the written binding contract. However, a material modification of a written binding contract does not include a supplemental payment that is equal to or less than a reasonable cost-of-living increase over the payment made in the preceding year under that written binding contract. In addition, the failure, in whole or in part, to exercise negative discretion under a contract does not result in the material modification of that contract.

(iv) If a grandfathered amount is subject to a substantial risk of forfeiture (as defined in §1.409A-1(d)), then a modification of the contract that results in a lapse of the substantial risk of forfeiture is not considered a material modification. For compensation received pursuant to the substantial vesting of restricted property, or the exercise of a stock option or stock appreciation right that do not provide for a deferral of compensation (as defined in §1.409A-1(b)(5)(i) and (ii)), a modification of a written binding contract in effect on November 2, 2017, that results in a lapse of the substantial risk of forfeiture (as defined §1.83-3(c)) is not considered a material modification.

(3) Examples . The following examples illustrate the provisions of this paragraph (g). For each example, assume for all relevant years that the corporation is a publicly held corporation within the meaning of paragraph (c)(1) of this section and is a calendar year taxpayer. Furthermore, assume that, for each example, if any ar

rangement is subject to section 409A, then the arrangement complies with section 409A, and that no arrangement is subject to section 457A.

(i) Example 1 (Multi-year agreement for annual salary) —(A) Facts . On October 2, 2017, Corporation X executed a 3-year employment agreement with Employee A for an annual salary of $2,000,000 beginning on January 1, 2018. Employee A serves as the PFO of Corporation X for the 2017 through 2020 taxable years. The agreement provides for automatic extensions after the 3-year term for additional 1-year periods, unless the corporation exercises its option to terminate the agreement within 30 days before the end of the 3‑year term or, thereafter, within 30 days before each anniversary date. Termination of the employment agreement does not require the termination of Employee A’s employment with Corporation X. Under applicable law, the agreement for annual salary constitutes a written binding contract in effect on November 2, 2017, to pay $2,000,000 of annual salary to Employee A for three years through December 31, 2020. (B) Conclusion . If this §1.162-33 applies, Employee A is a covered employee for Corporation X’s 2018 through 2020 taxable years. Because the October 2, 2017, employment agreement is a written binding contract to pay Employee A an annual salary of $2,000,000, this section does not apply (and §1.162-27 does apply) to the deduction for Employee A’s annual salary. Pursuant to §1.162-27(c)(2), Employee A is not a covered employee for Corporation X’s 2018 through 2020 taxable years. Accordingly, the deduction for Employee A’s annual salary for the 2018 through 2020 taxable years is not subject to section 162(m)(1). However, the employment agreement is treated as renewed on January 1, 2021, unless it is previously terminated, and the deduction limit of this section (and not §1.162-27) will apply to the deduction for any payments made under the employment agreement on or after that date.

(ii) Example 2 (Agreement for severance based on annual salary and discretionary bonus) —(A) Facts . The facts are the same as in paragraph (g)(3) (i) of this section ( Example 1 ), except that the employment agreement also requires Corporation X to pay Employee A severance if Corporation X terminates the employment relationship without cause within the term of the agreement. The amount of severance is equal to the sum of two times Employee A’s annual salary plus two times Employee A’s discretionary bonus (if any) paid within 12 months preceding termination. Under applicable law, the agreement for severance constitutes a written binding contract in effect on November 2, 2017, to pay $4,000,000 (two times Employee A’s $2,000,000 annual salary) if Corporation X terminates Employee A’s employment without cause within the term of the agreement.

(B) Conclusion . If this §1.162-33 applies, Employee A is a covered employee for Corporation X’s 2018 through 2020 taxable years. Because the October 2, 2017, employment agreement is a written binding contract to pay Employee A $4,000,000 if Employee A is terminated without cause prior to December 31, 2020, this section does not apply (and §1.162-27 does apply) to the deduction for $4,000,000 of Employee A’s severance. Pursuant to §1.162-27(c)(2), Employee A is not a cov

ered employee for Corporation X’s 2018 through 2020 taxable years. Accordingly, the deduction for $4,000,000 of Employee A’s severance is not subject to section 162(m)(1). However, the employment agreement is treated as renewed on January 1, 2021, unless it is previously terminated, and this section (and not §1.162-27) will apply to the deduction for any payments made under the employment agreement, including for severance, on or after that date.

(iii) Example 3 (Agreement for severance based on annual salary and discretionary bonus) —(A) Facts . The facts are the same as in paragraph (g)(3) (ii) of this section ( Example 2 ), except that, on October 31, 2017, Corporation X paid Employee A a discretionary bonus of $10,000. Under applicable law, the agreement for severance constitutes a written binding contract in effect on November 2, 2017, to pay $4,000,000 (two times Employee A’s $2,000,000 annual salary) if Corporation X terminates Employee A’s employment without cause prior to December 31, 2020, and $20,000 if Corporation X terminates Employee A’s employment without cause prior to October 31, 2018. On June 30, 2018, Corporation X terminates Employee A without cause and makes a $4,020,000 severance payment to Employee A.

(B) Conclusion . If this §1.162-33 applies, Employee A is a covered employee for Corporation X’s 2018 taxable year. Because the October 2, 2017, agreement is a written binding contract to pay Employee A $4,000,000 if Employee A is terminated without cause prior to December 31, 2020, and $20,000 if Corporation X terminates Employee A’s employment without cause prior to October 31, 2018, this section does not apply (and §1.162-27 does apply) to the deduction for Employee A’s severance payment of $4,020,000. Pursuant to §1.16227(c)(2), Employee A is not a covered employee for Corporation X’s 2018 taxable year. Accordingly, the deduction for the entire $4,020,000 of Employee A’s severance payment is not subject to section 162(m) (1).

(iv) Example 4 (Effect of discretionary bonus payment on agreement for severance based on an- nual salary and discretionary bonus) —(A) Facts . The facts are the same as in paragraph (g)(3)(ii) of this section ( Example 2 ), except that, on May 14, 2018, Corporation X paid a $600,000 discretionary bonus to Employee A and, on April 30, 2019, terminated Employee A’s employment without cause. Pursuant to the terms of the employment agreement for severance, on May 1, 2019, Corporation X made a $5,200,000 severance payment (the sum of two times the $2,000,000 annual salary and two times the $600,000 discretionary bonus) to Employee A.

(B) Conclusion . If this §1.162-33 applies, Employee A is a covered employee for Corporation X’s 2019 taxable year. Because the October 2, 2017, agreement is a written binding contract to pay Employee A $4,000,000 if Employee A is terminated without cause prior to December 31, 2020, this section does not apply (and §1.162-27 does apply) to the deduction for $4,000,000 of Employee A’s severance payment. Accordingly, the deduction for $4,000,000 of Employee A’s severance payment is not subject to section 162(m)(1). Because the October 2, 2017, agreement is not a written binding contract to pay Employee A a discretionary bonus, the deduction for $1,200,000 (based on the discretionary bonus) of the

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$5,200,000 payment is subject to this section (and not §1.162-27).

(v) Example 5 (Effect of adjustment to annual salary on severance) —(A) Facts . The facts are the same as in paragraph (g)(3)(ii) of this section ( Ex- ample 2 ), except that the employment agreement provides for discretionary increases in salary and, on January 1, 2019, Corporation X increased Employee A’s annual salary from $2,000,000 to $2,050,000, an increase that was less than a reasonable, cost-of-living adjustment.

(B) Conclusion (Annual salary) : If this §1.16233 applies, Employee A is a covered employee for Corporation X’s 2018 through 2020 taxable years. Because the October 2, 2017, agreement is a written binding contract to pay Employee A an annual salary of $2,000,000, this section does not apply (and §1.162-27 does apply) to the deduction for Employee A’s annual salary unless the change in the salary is a material modification. Even though the $50,000 increase is paid on the basis of substantially the same elements or conditions as the salary that is otherwise paid under the contract, the $50,000 increase does not constitute a material modification because it is less than or equal to a reasonable cost-of-living increase to the $2,000,000 annual salary Corporation X is required to pay under applicable law as of November 2, 2017. However, the deduction for the $50,000 increase is subject to this section (and not §1.162-27).

(C) Conclusion (Severance payment) : Because the October 2, 2017, agreement is a written binding contract to pay Employee A severance of $4,000,000, this section would not apply (and §1.162-27 would apply) to the deduction for this amount of severance unless the change in the employment agreement is a material modification. Even though the $100,000 increase in severance (two times the $50,000 increase in salary) would be paid on the basis of substantially the same elements or conditions as the severance that would otherwise be paid pursuant to the written binding contract, the $50,000 increase in salary on which it is based does not constitute a material modification of the written binding contract since it is less than or equal to a reasonable cost-of-living increase. However, the deduction for the $100,000 increase in severance is subject to this section (and not §1.162-27).

(vi) Example 6 (Effect of adjustment to annual salary on severance) —(A) Facts . The facts are the same as in paragraph (g)(3)(v) of this section ( Ex- ample 5 ), except that, on January 1, 2019, Corporation X increased Employee A’s annual salary from $2,000,000 to $3,000,000, an increase that exceeds a reasonable, cost-of-living adjustment.

(B) Conclusion (Annual salary) : If this §1.16233 applies, Employee A is a covered employee for Corporation X’s 2018 through 2020 taxable years. Because the October 2, 2017, agreement is a written binding contract to pay Employee A an annual salary of $2,000,000, this section does not apply (and §1.162-27 does apply) to the deduction for Employee A’s annual salary unless the change in the employment agreement is a material modification. The $1,000,000 increase is a material modification of the written binding contract because the additional compensation is paid on the basis of substantially the same elements or conditions as the compensation that is otherwise paid pursuant to the written binding

contract, and it exceeds a reasonable, annual costof-living increase from the $2,000,000 annual salary for 2018 that Corporation X is required to pay under applicable law as of November 2, 2017. Because the written binding contract is materially modified as of January 1, 2019, the deduction for all annual salary paid to Employee A in 2019 and thereafter is subject to this section (and not §1.162-27).

(C) Conclusion (Severance payment) : Because the October 2, 2017, agreement is a written binding contract to pay Employee A severance of $4,000,000, this section would not apply (and §1.162-27 would apply) to the deduction for this amount of severance unless the change in the employment agreement is a material modification. The additional $2,000,000 (two times the $1,000,000 increase in annual salary) constitutes a material modification of the written binding contract because the $1,000,000 increase in salary on which it is based constitutes a material modification of the written binding contract since it exceeds a reasonable cost-of-living increase from the $2,000,000 annual salary for 2018 that Corporation X is required to pay under applicable law as of November 2, 2017. Because the agreement is materially modified as of January 1, 2019, the deduction for any amount of severance payable to Employee A under the severance agreement is subject to this section (and not §1.162-27).

(vii) Example 7 (Elective deferral of an amount that corporation was obligated to pay under ap- plicable law) —(A) Facts . The facts are the same as in paragraph (g)(3)(i) of this section ( Example 1 ), except that, on December 15, 2018, Employee A makes a deferral election under a NQDC plan to defer $200,000 of annual salary earned and payable in 2019. Pursuant to the deferred compensation agreement, the $200,000, including earnings, is to be paid in a lump sum at Employee A’s separation from service. The earnings are based on the Standard & Poor’s 500 Index. Under applicable law, pursuant to the written binding contract in effect on November 2, 2017, (and absent the deferral agreement) Corporation X would have been obligated to pay $200,000 to Employee A in 2019, but is not obligated to pay any earnings on the $200,000 deferred pursuant to the deferral election Employee A makes on December 15, 2018. Employee A separates from service on December 15, 2020. On December 15, 2020, Corporation X pays $250,000 (the deferred $200,000 of salary plus $50,000 in earnings).

(B) Conclusion . If this §1.162-33 applies, Employee A is a covered employee for Corporation X’s 2020 taxable year. Employee A’s deferred compensation agreement is not a material modification of the written binding contract in effect on November 2, 2017, because the earnings to be paid under the deferred compensation agreement are based on a predetermined actual investment (as defined in §31.3121(v)(2)-1(d)(2)(i)(B)). The deduction for the $50,000 of earnings to be paid that exceed the amount originally payable to Employee A under the written binding contract ($200,000 of salary) are subject to this section (and not §1.162-27). This section does not apply (and §1.162-27 does apply) to the deduction for the $200,000 portion of the $250,000 payment because Corporation X was obligated under applicable law to pay as of November 2, 2017. Pursuant to §1.162-27(c)(2), Employee A is not a covered employee for Corporation X’s 2020 taxable

year; thus, the deduction for the $200,000 payment is not subject to section 162(m)(1).

(viii) Example 8 (Compensation subject to man- datory recovery by corporation) —(A) Facts . Employee B serves as the PFO of Corporation Z for its 2017 through 2019 taxable years. On October 2, 2017, Corporation Z executed a bonus agreement with Employee B that provides for a performance bonus of $3,000,000 to be paid on May 1, 2019, if Corporation Z’s net earnings increase by at least 10% for its 2018 taxable year based on the financial statements filed with the SEC. The agreement prohibits Corporation Z from reducing the amount of the bonus for any reason but provides that, if the bonus is paid and subsequently the financial statements are restated to show that the net earnings did not increase by at least 10%, then Corporation Z shall recover the $3,000,000 from Employee B within six months of the restatement. Under applicable law, the agreement for the performance bonus constitutes a written binding contract in effect on November 2, 2017, to pay $3,000,000 to Employee B if Corporation Z’s net earnings increase by at least 10% for its 2018 taxable year based on the financial statements filed with the SEC. On May 1, 2019, Corporation Z pays $3,000,000 to Employee B because its net earnings increased by at least 10% of its 2018 taxable year.

(B) Conclusion . If this §1.162-33 applies, Employee B is a covered employee for Corporation Z’s 2019 taxable year. The terms of the contract providing for recovery of the $3,000,000 do not preclude Corporation Z from being contractually obligated under applicable law to pay $3,000,000 to Employee B if the net earnings increase by at least 10% for its 2018 taxable year. Because the October 2, 2017, agreement is a written binding contract to pay Employee B $3,000,000 if Corporation Z’s net earnings increase by at least 10% for its 2018 taxable year based on the financial statements filed with the SEC, this section does not apply (and §1.162-27 does apply) to the deduction for the $3,000,000 payment. Pursuant to §1.162-27(c)(2), Employee B is not a covered employee for Corporation Z’s 2019 taxable year, so the deduction for the $3,000,000 payment is not subject to section 162(m)(1).

(ix) Example 9 (Compensation subject to dis- cretionary recovery by corporation) —(A) Facts . The facts are the same as in paragraph (g)(3)(viii) of this section ( Example 8 ), except that the agreement provides that, if the financial statements are restated to show that the net earnings did not increase by at least 10%, then Corporation Z may, in its discretion, recover all or a portion of the $3,000,000 bonus from Employee B within six months of the restatement. Under applicable law, the agreement constitutes a written binding contract in effect on November 2, 2017, to pay $3,000,000 to Employee B if the conditions are met. However, under applicable law, taking into account the employer’s ability to exercise discretion and the employer’s past exercise of such discretion with respect to a recovery in the event of an earnings restatement, on November 2, 2017, the bonus plan is a written binding contract only with respect to $500,000 if Corporation Z’s financial statements are restated to show that the net earnings did not increase by at least 10%. On May 1, 2019, Corporation Z pays $3,000,000 to Employee B. On July 1, 2019, Corporation Z’s financial statements are restated to show that its net earnings did not in

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crease by at least 10% for its 2018 taxable year. On July 30, 2019, Corporation Z recovers $1,000,000 from Employee B.

(B) Conclusion . If this §1.162-33 applies, Employee B is a covered employee for Corporation Z’s 2019 taxable year. Because the October 2, 2107, agreement is a written binding contract to pay Employee B $3,000,000 if the applicable conditions are met, this section does not apply (and §1.162-27 does apply) to the deduction for the $3,000,000 provided Corporation Z’s financial statements are not restated to show that its net earnings did not increase by at least 10%. However, because Corporation Z’s financial statements were so restated, then, on November 2, 2017, under applicable law, taking into account the employer’s ability to exercise discretion and the employer’s past exercise of such discretion, the bonus plan constitutes a written binding contract to pay only $500,000. Because Corporation Z recovered $1,000,000 of the $3,000,000 payment, this section does not apply (and §1.162-27 does apply) to the deduction for $500,000 of the $2,000,000 that Corporation Z did not recover. Pursuant to §1.162-27(c) (2), Employee B is not a covered employee for Corporation Z’s 2019 taxable year, so the deduction for the $500,000 is not subject to section 162(m)(1). The deduction for the remaining $1,500,000 is subject to this section (and not §1.162-27).

(x) Example 10 (Compensation subject to dis- cretionary recovery by corporation based on a condition) —(A) Facts . The facts are the same as in paragraph (g)(3)(viii) of this section ( Example 8 ), except that the agreement does not include a provision regarding an earnings restatement. Instead, the agreement provides that Corporation Z may, in its discretion, require Employee B to repay the $3,000,000 bonus if, within three years from the date of payment, Employee B engages in willful or reckless behavior that has a material adverse impact on Corporation Z, or is convicted of, or pleads nolo contendre or guilty to a felony. Under applicable law, the agreement constitutes a written binding contract in effect on November 2, 2017, to pay $3,000,000 to Employee B if the conditions are met. However, under applicable law, taking into account the employer’s ability to exercise discretion and the employer’s past exercise of such discretion, if conditions arise to permit Corporation Z to recover the $3,000,000 bonus from Employee B, then the bonus plan established on October 2, 2017, constitutes a written binding contract to pay only $2,000,000 to Employee B if Corporation Z’s net earnings increase by at least 10% for its 2018 taxable year based on the financial statements filed with the SEC. On May 1, 2019, Corporation Z pays $3,000,000 to Employee B. Prior to May 1, 2022, Employee B does not engage in willful or reckless behavior that has a material adverse impact on Corporation Z, and is not convicted of, or plead nolo contendre or guilty to a felony.

(B) Conclusion . If this §1.162-33 applies, Employee B is a covered employee for Corporation Z’s 2019 taxable year. Because the October 2, 2017, agreement is a written binding contract under applicable law to pay Employee B $3,000,000 if the applicable conditions are met, this section does not apply (and §1.162-27 does apply) to the deduction for the $3,000,000. Pursuant to §1.162-27(c)(2), Employee B is not a covered employee for Corpora

tion Z’s 2019 taxable year, so the deduction for the $3,000,000 is not subject to section 162(m)(1).

(xi) Example 11 (Compensation subject to dis- cretionary recovery by corporation based on a con- dition) —(A) Facts . The facts are the same as in paragraph (g)(3)(x) of this section ( Example 10 ), except that, on April 1, 2021, Employee B pleads guilty to a felony. Because Employee B pled guilty to a felony prior to May 1, 2022, Corporation Z has discretion to recover the $3,000,000 bonus from Employee B. Corporation Z chooses not to recover any amount of the $3,000,000 from Employee B.

(B) Conclusion . If this §1.162-33 applies, Employee B is a covered employee for Corporation Z’s 2019 taxable year. Because Employee B pled guilty to a felony prior to May 1, 2022, the bonus plan constitutes a written binding contract in effect on November 2, 2017, to pay only $2,000,000 to Employee B if the applicable conditions were met. Accordingly, this section does not apply (and §1.162-27 does apply) to the deduction for the $2,000,000 portion of the $3,000,000. Pursuant to §1.162-27(c)(2), Employee B is not a covered employee for Corporation Z’s 2019 taxable year; thus, the deduction for the $2,000,000 portion of the $3,000,000 is not subject to section 162(m)(1). The deduction for the remaining $1,000,000 of the $3,000,000 is subject to this section (and not §1.162-27).

(xii) Example 12 (Election to defer bonus) —(A) Facts . On December 31, 2015, Employee C, an employee of Corporation Y, makes an election under a NQDC plan to defer the entire amount that would otherwise be paid to Employee C on December 31, 2016, under Corporation Y’s 2016 annual bonus plan. Pursuant to the NQDC plan, the earnings on the deferred amount may be based on either of the following two investment choices (but not the greater of the two): annual total shareholder return for Corporation Y or Moody’s Average Corporate Bond Yield. On a prospective basis, Employee C may change the investment measure. The deferred amount and the earnings thereon are to be paid in a lump sum at Employee C’s separation from service. Employee C initially elects to have earnings based on annual total shareholder return for Corporation Y. On December 31, 2018, Employee C elects to have earnings based on Moody’s Average Corporate Bond Yield. The bonus plan provides that Corporation Y may not reduce the bonus or any applicable earnings. Employee C earns a $200,000 bonus for the 2016 taxable year. Under applicable law, the deferred compensation agreement constitutes a written binding contract in effect on November 2, 2017, to pay the $200,000 bonus plus earnings. Specifically, Corporation Y is obligated to pay earnings on the $200,000 deferred pursuant to the deferral election Employee C makes on December 31, 2015. On January 1, 2018, Employee C is promoted to serve as PEO of Corporation Y and becomes a covered employee for the first time. On December 15, 2020, Employee C separates from service and Corporation Y pays $225,000 (the deferred $200,000 bonus plus $25,000 in earnings) to Employee C.

(B) Conclusion . If this §1.162-33 applies, Employee C is a covered employee for Corporation Y’s 2020 taxable year because Employee C served as the PEO of Corporation Y during the taxable year. The December 31, 2015, agreement is a written binding

contract to pay the $200,000 bonus plus earnings. Furthermore, Employee C’s December 31, 2018, election to change the earnings measure does not constitute a material modification. Accordingly, this section does not apply (and §1.162-27 does apply) to the deduction for the $225,000 payment from Corporation Y to Employee C. Pursuant to §1.162-27(c) (2), Employee C is not a covered employee because Employee C did not serve as the PEO at the close of the Corporation Y’s taxable year, so the deduction for the $225,000 payment is not subject to section 162(m)(1). (xiii) Example 13 (Nonaccount balance plan) (A) Facts . On November 2, 2012, Employee D commences employment with Corporation W as its PFO. Employee D separates from service as PFO on January 7, 2020. For each taxable year, Employee D receives a base salary of $2,000,000. On January 1, 2016, Corporation W and Employee D enter into a NQDC arrangement that is a nonaccount balance plan (as defined in §1.409A-1(c)(2)(i)(C). Under the terms of the plan, Corporation W will pay Employee D a lump sum payment equal to 25% of Employee D’s base salary in the year of separation from service multiplied by 1/12 for each month of service. The plan provides that this payment will be made six months after separation from service and that Corporation W may, at any time, amend the plan to reduce the amount of future benefits; however, Corporation W may not reduce the benefit accrued prior to the date of the amendment. Furthermore, under the terms of the plan and in accordance with §1.409A-3(j)(4)(ix)(C)(3), if Corporation W terminates the plan, the payments due under the plan may be accelerated to any date no earlier than 12 months after the date of termination and no later than 24 months after the date of termination. Under applicable law, if an employer terminates a NQDC plan and does not make a payment until 12 months after the date of termination, then, to reflect the time value of money, the employer is obligated to pay a reasonable rate of interest (compounded annually) on any benefit accrued under the plan at the date of termination until the date of payment. Assume for this purpose that for all applicable periods 3% is a reasonable rate of interest. As of November 2, 2017, Employee D has 60 months of service for Corporation W as calculated under the NQDC plan terms. Under applicable law, the plan constitutes a written binding contract in effect on November 2, 2017, to pay $2,575,000. The $2,575,000 is equal to the amount Corporation W is obligated to pay if it terminated the plan on November 2, 2017 (25% x $2,000,000 x 1/12 x 60 months of service ($2,500,000), plus a 3% reasonable rate of interest that the $2,500,000 earns after plan termination ($75,000)). On January 7, 2020, when Employee D separates from service, Corporation D pays $3,583,333.33 (25% x $2,000,000 x 1/12 x 86 months of service).

(B) Conclusion . If this §1.162-33 applies, Employee D is a covered employee for Corporation W’s 2020 taxable year. Because, as of November 2, 2017, the plan is a written binding contract with respect to $2,575,000, this section does not apply (and §1.16227 does apply) to the deduction for the $2,575,000 portion of the $3,583,333.33 payment. Pursuant to §1.162-27(c)(2), Employee D is not a covered employee, so the deduction for the $2,575,000 portion

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of the $3,583,333.33 payment is not subject to section 162(m)(1). The deduction for the remaining $1,008,333.33 portion of the $3,583,333.33 payment is subject to this section (and not §1.162-27).

(xiv) Example 14 (Nonaccount balance plan with offset) —(A) Facts . The facts are the same as in paragraph (g)(3)(xiii) of this section ( Example 13 ), except that the plan provides that the amount to be paid to an employee is decreased by the employee’s account balance in Corporation W’s 401(k) plan on the date of separation from service. The terms of the offset comply with section 409A. On November 2, 2017, and July 7, 2020, Employee D’s account balance in the 401(k) plan is $500,000 and $600,000, respectively. Under applicable law, the NQDC plan constitutes a written binding contract in effect on November 2, 2017, to pay $2,075,000, which is equal to the amount of remuneration Corporation W is obligated to pay if it terminated the NQDC plan on November 2, 2017. The $2,075,000 is the difference between the $500,000 401(k) plan account balance on November 2, 2017, and the $2,500,000 accumulated benefit (25% x $2,000,000 x 1/12 x 60 months of service), plus the 3% interest that the $2,500,000 earns after plan termination ($75,000). On July 7, 2020, under the terms of the NQDC plan, Corporation D pays $2,983,333.33 (the difference between the $600,000 401(k) account balance on July 7, 2020, and $3,583,333.33 (25% x $2,000,000 x 1/12 x 86 months of service)).

(B) Conclusion . If this §1.162-33 applies, Employee D is a covered employee for Corporation W’s 2020 taxable year. Because, as of November 2, 2017, the plan is a written binding contract with respect to $2,075,000, this section does not apply (and §1.162-27 does apply) to the deduction for $2,075,000 of the $2,983,333.33 payment. Pursuant to §1.162-27(c)(2), Employee D is not a covered employee, so the deduction for the $2,075,000 portion of the $2,983,333.33 payment is not subject to section 162(m)(1). The deduction for the remaining $908,333.33 portion of the $2,983,333.33 payment is subject to this section (and not §1.162-27).

(xv) Example 15 (Nonaccount balance plan) (A) Facts . The facts are the same as in paragraph (g) (3)(xiii) of this section ( Example 13 ), except that the nonaccount balance plan provides that Corporation W will pay Employee D a lump sum payment of $5,000,000 on November 7, 2020, if Employee D provides services from January 1, 2016, through June 30, 2017. Under applicable law, the plan constitutes a written binding contract in effect on November 2, 2017, to pay $4,712,979.55, which is the sum of $4,575,708.30 (the amount of remuneration Corporation W is obligated to pay if it reduced the amount of future benefits to $0 on November 2, 2017) and the increase in present value of $137,271.55 (the difference between $4,575,708.30 and $4,712,979.55 (the present value of $5,000,000 on November 2, 2018)). On November 7, 2020, Corporation W makes a lump sum payment of $5,000,000 to Employee D.

ment. Pursuant to §1.162-27(c)(2), Employee D is not a covered employee, so the deduction for the $4,712,979.55 portion of the $5,000,000 payment is not subject to section 162(m)(1). The deduction for the remaining $287,020.45 portion of the $5,000,000 payment is subject to this section (and not §1.16227). (xvi) Example 16 (Performance bonus plan with negative discretion) —(A) Facts . Employee E serves as the PEO of Corporation V for the 2017 and 2018 taxable years. On February 1, 2017, Corporation V establishes a bonus plan, under which Employee E will receive a cash bonus of $1,500,000 if a specified performance goal is satisfied. The compensation committee retains the right, if the performance goal is met, to reduce the bonus payment to no less than $400,000 if, in its judgment, other subjective factors warrant a reduction. On November 2, 2017, under applicable law which takes into account the employer’s ability to exercise negative discretion, the bonus plan established on February 1, 2017, constitutes a written binding contract to pay $400,000. On March 1, 2018, the compensation committee certifies that the performance goal was satisfied, but exercises its discretion to reduce the award to $500,000. On April 1, 2018, Corporation V pays $500,000 to Employee E. The payment satisfies the requirements of §1.162-27(e)(2) through (5) as qualified performance-based compensation.

(B) Conclusion . If this §1.162-33 applies, Employee E is a covered employee for Corporation V’s 2018 taxable year. Because the February 1, 2017, plan is a written binding contract to pay Employee E $400,000 if the performance goal is satisfied, this section does not apply (and §1.162-27 does apply) to the deduction for the $400,000 portion of the $500,000 payment. Furthermore, the failure of the compensation committee to exercise its discretion to reduce the award further to $400,000, instead of $500,000, does not result in a material modification of the contract. Pursuant to §1.162-27(e)(1), the deduction for the $400,000 payment is not subject to section 162(m) (1) because the payment satisfies the requirements of §1.162-27(e)(2) through (5) as qualified performance-based compensation. The deduction for the remaining $100,000 of the $500,000 payment is subject to this section (and not §1.162-27) and therefore the status as qualified performance-based compensation is irrelevant to the application of section 162(m) (1) to this remaining portion.

(xvii) Example 17 (Account balance plan) —(A) Facts . Employee F serves as the PFO of Corporation U for the 2016 through 2018 taxable years. On January 4, 2016, Corporation U and Employee F enter into a NQDC arrangement that is an account balance plan. Under the terms of the plan, Corporation A will pay Employee X’s account balance on June 30, 2019, but only if Employee F continues to serve as the PFO through December 31, 2018. Pursuant to the terms of the plan, Corporation U credits $100,000 to Employee F’s account annually on December 31 of each year for three years beginning on December 31, 2016, and credits earnings and losses on the account balance daily. The plan also provides that Corporation U may, in its discretion and at any time, amend the plan either to stop or to reduce the amount of future credits; however, Corporation U may not reduce Employee F’s account balance credited before the

date of any such amendment. Under the terms of the plan and in accordance with §1.409A-3(j)(4)(ix)(C) (3), if Corporation U terminates the plan, the payment under the plan may be accelerated, but may not be made within 12 months of the date of termination. Under the plan terms and applicable law, if Corporation U terminates the plan, then it is obligated to pay any earnings that accumulated through the date of payment. Under applicable law, the plan constitutes a written binding contract in effect on November 2, 2017, to pay $100,000 of remuneration that Corporation U credited to the account balance on December 31, 2016, plus any earnings credited on that amount through November 2, 2018, which is equal to the amount Corporation U is obligated to pay if it terminates the plan on November 2, 2017 (i.e., after that date, Corporation U is obligated to credit earnings but not any further contributions). On November 2, 2017, Employee E’s account balance under the plan is $110,000. On November 2, 2018, Employee E’s account balance under the plan would be $115,000 (the $110,000 account balance on November 2, 2017, plus $5,000 earnings on that amount). On June 30, 2019, Corporation U pays Employee F $350,000, the account balance on June 30, 2019.

(B) Conclusion . If this §1.162-33 applies, Employee F is a covered employee for Corporation U’s 2019 taxable year because Employee F served as the PFO of Corporation U during the taxable year. Because the January 4, 2016, agreement constitutes a written binding contract to pay $115,000, this section does not apply (and §1.162-27 does apply) to the deduction for the $115,000 portion of the $350,000. Pursuant to §1.162-27(c)(2), Employee F is not a covered employee of Corporation U for the 2019 taxable year, so the deduction for the $115,000 portion of the $350,000 is not subject to section 162(m) (1). The deduction for the remaining $235,000 portion of the payment is subject to this section (and not §1.162-27).

(xviii) Example 18 (Effect of increasing credits to an account balance plan) —(A) Facts . The facts are the same as in paragraph (g)(3)(xvii) of this section ( Example 17 ), except that on January 1, 2018, Corporation U increased the amount it would credit to Employee F’s account on December 31, 2018 to $200,000. The amount of the increase exceeds a reasonable, annual cost-of-living increase. On June 30, 2019, Corporation U pays Employee F the account balance of $455,000 (including earnings).

(B) Conclusion . If this §1.162-33 applies, Employee F is a covered employee for Corporation U’s 2019 taxable year. The January 1, 2018 increase in the amount credited to the account balance plan is a material modification of the plan because the additional compensation (the excess of $200,000 over $100,000) credited under the plan is credited on the basis of substantially the same elements or conditions as the compensation that would otherwise be credited pursuant to the plan ($100,000), and it exceeds a reasonable, annual cost-of-living increase. Because the plan is materially modified as of January 1, 2018, and all payments under the plan are made on or after January 1, 2018, the deduction for all payments under the plan is subject to this section (and not §1.162-27).

(xix) Example 19 (Equity-based compensation with underlying grants made prior to November 2,

Bulletin No. 2020–3 377 January 13, 2020

for Employee I’s annual salary unless the change in the employment agreement is a material modification. Pursuant to §1.162-27(c)(2), Employee I is not a covered employee of Corporation R for the 2019 taxable year, so the deduction for the $1,800,000 salary is not subject to section 162(m)(1). Even though the $40,000 increase is made on the basis of substantially the same elements or conditions as the salary, the $40,000 increase does not constitute a material modification of the written binding contract because the $40,000 is less than or equal to a reasonable costof-living increase applied to the $1,800,000 annual salary Corporation R owes under the agreement. However, the deduction for the $40,000 increase is subject to this section (and not §1.162-27).

(C) Conclusion (Salary increase to $2,400,000 in 2020) . The $560,000 increase in salary in 2020 is a material modification of the written binding contract because the additional compensation is paid on the basis of substantially the same elements or conditions as the salary, and it exceeds a reasonable, annual cost-of-living increase from $1,840,000. Because the written binding contract is materially modified as of January 1, 2020, the deduction for all salary paid to Employee I on and after January 1, 2020 is subject is subject to this section (and not §1.162-27).

(xxiii) Example 23 (Additional payment not considered a material modification) —(A) Facts . The facts are the same as in paragraph (g)(3)(xxii) of this section ( Example 22 ), except that instead of an increase in salary, in 2020 Employee I receives a restricted stock grant subject to Employee I’s continued employment for the balance of the contract.

(B) Conclusion . The restricted stock grant is not a material modification of the written binding contract because any additional compensation paid to Employee I under the grant is not paid on the basis of substantially the same elements and conditions as Employee I’s salary. However, the deduction attributable to the restricted stock grant is subject to this section (and not §1.162-27).

(xxiv) Example 24 (Modification of written bind- ing contract to provide for accelerated vesting) —(A) Facts . Employee J serves as the PFO of Corporation Q for the 2017 through 2020 taxable years. On July 14, 2017, Corporation Q and Employee J enter into an agreement providing that Corporation Q will pay $2,000,000 to Employee J if Employee J continues to serve as the PFO until the third anniversary of the agreement (July 14, 2020). The agreement provides that Corporation Q will make the payment on the date Employee J meets the service requirement. The right to the $2,000,000 payment is subject to a substantial risk of forfeiture as defined in §1.409A-1(d). Under applicable law, the plan constitutes a written binding contract in effect on November 2, 2017, to pay $2,000,000 to Employee J if Employee J serves as the PFO through July 14, 2020. On November 29, 2019, Corporation Q modifies the written binding contract to provide for substantial vesting of the $2,000,000 on that date and pays the $2,000,000 to Employee J.

(B) Conclusion . If this §1.162-33 applies, Employee J is a covered employee for Corporation Q’s 2019 taxable year because Employee J served as the PFO of Corporation Q during the taxable year. Because the July 14, 2017, agreement constitutes a written binding contract to pay $2,000,000, this section does not apply (and §1.162-27 does apply) to

2017) —(A) Facts . On January 2, 2017, Corporation T executed a 4-year employment agreement with Employee G to serve as its PEO, and Employee G serves as the PEO for the four-year term. Pursuant to the employment agreement, on January 2, 2017, Corporation T executed a grant agreement and granted to Employee G nonqualified stock options to purchase 1,000 shares of Corporation T stock, stock appreciation rights (SARs) on 1,000 shares, and 1,000 shares of Corporation T restricted stock. On the date of grant, the stock options had no readily ascertainable fair market value as defined in §1.83-7(b), and neither the stock options nor the SARs provided for a deferral of compensation under §§ 1.409A-1(b) (5)(i)(A) and (B). The stock options, SARs, and shares of restricted stock are subject to a substantial risk of forfeiture and all substantially vest on January 2, 2020. Employee G may exercise the stock options and the SARs at any time from January 2, 2020, through January 2, 2027. On January 2, 2020, Employee G exercises the stock options and the SARs, and the 1,000 shares of restricted stock become substantially vested (as defined in §1.83-3(b)). The grant agreement pursuant to which grants of the stock options, SARs, and shares of restricted stock are made constitutes a written binding contract under applicable law. The compensation attributable to the stock options and the SARs satisfy the requirements of §1.162-27(e)(2) through (5) as qualified performance-based compensation.

(B) Conclusion . If this §1.162-33 applies, Employee G is a covered employee for Corporation T’s 2020 taxable year. Because the January 2, 2017, grant agreement constitutes a written binding contract, this section does not apply (and §1.162-27 does apply) to the deduction for compensation received pursuant to the exercise of the stock options and the SARs, or the restricted stock becoming substantially vested (as defined in §1.83-3(b)). Pursuant to §1.162-27(e) (1), the deduction attributable to the stock options and the SARs is not subject to section 162(m)(1) because the compensation satisfies the requirements of §1.162-27(e)(2) through (5) as qualified performance-based compensation. However, the deduction attributable to the restricted stock is subject to section 162(m)(1) because the compensation does not satisfy the requirements of §1.162-27(e)(2) through (5) as qualified performance-based compensation.

(xx) Example 20 (Equity-based compensation with underlying grants made prior to November 2, 2017 for which vesting is accelerated) —(A) Facts . The facts are the same as in paragraph (g)(3)(xix) of this section ( Example 19 ), except that, on December 31, 2018, Corporation T modifies the grant agreement pursuant to which grants are made to provide that the stock options, SARs, and shares of Corporation T restricted stock are vested as of January 2, 2019. On January 3, 2019, Employee G exercises the stock options and the SARs.

(B) Conclusion . If this §1.162-33 applies, Employee G is a covered employee for Corporation T’s 2019 taxable year. The modification of the January 2, 2017, grant agreement is not a material modification. Because the January 2, 2017, agreement under which grants were made constitutes a written binding contract, this section does not apply (and §1.162-27 does apply) to the deduction for compensation received pursuant to the exercise of the stock options and the SARs, or the restricted stock becoming vested. Pur

suant to §1.162-27(e)(2)(iii)(B), the acceleration of substantial vesting of the stock options and SARs is not an impermissible increase in compensation to disqualify the compensation attributable to the stock options and SARs from satisfying the requirements of §1.162-27(e)(2) through (5) as qualified performance-based compensation, so the deduction attributable to the stock options and the SARs is not subject to section 162(m)(1). However, the deduction attributable to the restricted stock is subject to section 162(m)(1) because the compensation does not satisfy the requirements of §1.162-27(e)(2) through (5) as qualified performance-based compensation.

(xxi) Example 21 (Plan in which an employee is not a participant on November 2, 2017) —(A) Facts . On October 2, 2017, Employee H executes an employment agreement with Corporation Y to serve as its PFO, and commences employment with Corporation Y. The employment agreement, which is a written binding contract under applicable law, provides that if Employee H continues in his position through April 1, 2018, Employee H will become eligible to participate in the NQDC plan of Corporation Y and that Employee H’s benefit accumulated on that date will be $3,000,000. On April 1, 2021, Employee H receives a payment of $4,500,000 (the increase from $3,000,000 to $4,500,000 is not a result of a material modification as defined in paragraph (g)(2) of this section), which is the entire benefit accumulated under the plan through the date of payment.

(B) Conclusion . If this §1.162-33 applies, Employee H is a covered employee for Corporation Y’s 2021 taxable year. Even though Employee H was not eligible to participate in the NQDC plan on November 2, 2017, Employee H had the right to participate in the plan under a written binding contract as of that date. Because the amount required to be paid pursuant to the written binding contract is $3,000,000, this section does not apply (and §1.162-27 does apply) to the deduction for the $3,000,000 portion of the $4,500,000. Pursuant to §1.162-27(c)(2), Employee H is not a covered employee of Corporation Y for the 2021 taxable year. Accordingly, the deduction for the $3,000,000 portion of the $4,500,000 is not subject to section 162(m)(1). The deduction for the remaining $1,500,000 portion of the payment is subject to this section (and not §1.162-27).

(xxii) Example 22 (Material modification of an- nual salary) —(A) Facts . On January 2, 2017, Corporation R executed a 5-year employment agreement with Employee I to serve as Corporation R’s PFO, providing for an annual salary of $1,800,000. The agreement constitutes a written binding contract under applicable law. In 2017 and 2018, Employee I receives the salary of $1,800,000 per year. In 2019, Corporation R increases Employee I’s salary by $40,000, which is less than a reasonable costof-living increase from $1,800,000. On January 1, 2020, Corporation R increases Employee I’s salary to $2,400,000. The $560,000 increase exceeds a reasonable, annual cost-of-living increase from $1,840,000.

(B) Conclusion ($1,840,000 Payment in 2019) . If this §1.162-33 applies, Employee I is a covered employee for Corporation R’s 2018 through 2020 taxable years. Because the January 1, 2017, agreement is a written binding contract to pay Employee I an annual salary of $1,800,000, this section does not apply (and §1.162-27 does apply) to the deduction

January 13, 2020 378 Bulletin No. 2020–3

or after December 20, 2019 . A privately held corporation that becomes a publicly held corporation before December 20, 2019 may rely on the transition rules provided in §1.162-27(f)(1) until the earliest of the events provided in §1.162-27(f) (2).

(E) Transition rules . The transition rules in paragraphs (g)(1) and (2) of this section (providing that this section does not apply to remuneration payable under a written binding contract which was in effect on November 2, 2017, and which is not modified in any material respect on or after such date) apply to taxable years ending on or after September 10, 2018.

Par. 4. Section 1.338-1 is amended by revising paragraph (b)(2)(i) to read as follows:

§ 1.338-1 General principles, status of old target and new target.

(b) * * * (2) * * * (i) The rules applicable to employee benefit plans (including those plans described in sections 79, 104, 105, 106, 125, 127, 129, 132, 137, and 220), qualified pension, profit-sharing, stock bonus and annuity plans (sections 401(a) and 403(a)), simplified employee pensions (section 408(k)), tax qualified stock option plans (sections 422 and 423), welfare benefit funds (sections 419, 419A, 512(a) (3), and 4976), voluntary employee benefit associations (section 501(c)(9) and the regulations thereunder (26 CFR 1.501(c) (9)-1 through 1.501(c)(9)-8)) and certain excessive employee remuneration (section 162(m) and the regulations thereunder (26 CFR 1.162-27 and §1.162-31));

(Filed by the Office of the Federal Register on December 16, 2019, 4:15 p.m., and published in the issue of the Federal Register for December 20, 2019, 84 F.R. 70356)

the deduction for the $2,000,000 unless the contract is materially modified. Pursuant to §1.162-27(c)(2), Employee J is not a covered employee of Corporation Q for the 2019 taxable year. The change in terms of the contract on November 29, 2019, to accelerate vesting but to otherwise pay the amounts under the original terms is not a material modification. Accordingly, the deduction for the $2,000,000 is not subject to section 162(m)(1).

(h) Effective/Applicability dates —(1) Effective date . These regulations are effective on [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER].

(2) A pplicability dates —(i) General applicability date . Except as otherwise provided in paragraph (h)(2)(ii) of this section, these regulations apply to taxable years beginning on or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER] .

(ii) Special applicability dates —(A) Definition of covered employee . The definition of covered employee in paragraph (c)(2)(i) of this section applies to taxable years ending on or after September 10, 2018. However, for a corporation whose fiscal year and taxable year do not end on the same date, the rule in paragraph (c)(2) (i)(B) requiring the determination of the three most highly compensated executive officers to be made pursuant to the rules under the Exchange Act applies to taxable years ending on or after December 20, 2019 . (B) Definition of predecessor of a pub- licly held corporation —( 1 ) Publicly held corporations that become privately held . The definition of predecessor of a publicly held corporation in paragraph (c)(2) (ii)(A) of this section applies to any publicly held corporation that becomes a privately held corporation for a taxable year beginning after December 31, 2017, and, subsequently, again becomes a publicly held corporation on or after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER] . Accordingly, the definition of predecessor of a publicly held corporation in paragraph (c)(2)(ii)(A) of this section does not ap

ply to any publicly held corporation that became a privately held corporation for a taxable year beginning before January 1, 2018, with respect to the earlier period as a publicly held corporation; or a publicly held corporation that becomes a privately held corporation for a taxable year beginning after December 31, 2017, and, subsequently, again becomes a publicly held corporation before [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER].

( 2 ) Corporate transactions . The definition of predecessor of a publicly held corporation in paragraphs (c)(2)(ii)(B) through (H) of this section applies to corporate transactions that occur (as provided in the transaction timing rule of paragraph (c)(2)(ii)(I) of this section) on or after

[DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER] .

(C) Definition of compensation . The definition of compensation provided in paragraph (c)(3)(ii) of this section (relating to allocable shares of partnership deductions for compensation paid) applies to any deduction for compensation that is otherwise allowable for a taxable year ending on or after December 20, 2019. However, this definition of compensation does not apply to compensation paid pursuant to a written binding contract that is in effect on December 20, 2019 and that is not materially modified after that date. For purposes of this paragraph (h) (3), written binding contract and material modification have the same meanings as provided in paragraphs (g)(1) and (g)(2) of this section.

(D) Corporations that become public- ly held . The rule in paragraph (d) of this section (providing that the deduction limitation of paragraph (b) of this section applies to a deduction for any compensation that is otherwise deductible for the taxable year ending on or after the date that a privately held corporation becomes a publicly held corporation) applies to corporations that become publicly held on

Sunita Lough , Deputy Commissioner for Services

and Enforcement.

Bulletin No. 2020–3 379 January 13, 2020