The $1,000,000 limitation on deductions imposed by Section 162(m) of the Internal Revenue Code applies to “covered employees.” In Notice 2007-49, the IRS defined the term “covered employees” as follows:
“The IRS will interpret the term “covered employee” for purposes of § 162(m) to mean any employee of the taxpayer if, as of the close of the taxable year, such employee is the principal executive officer . . . of the taxpayer or an individual acting in such capacity, or if the total compensation of such employee for that taxable year is required to be reported to shareholders under the Exchange Act by reason of such employee being among the 3 highest compensated officers for the taxable year (other than the principal executive officer or the principal financial officer).”
Accordingly, since the release of Notice 2007-49, chief financial officers have been excluded from the definition of “covered employee” for purposes of Section 162(m) of the Code.
In a Chief Counsel Memorandum released late last year, the IRS revisited the definition of “covered employees” in the context of smaller reporting companies (generally those having public float of less than $75,000,000, or if no public float, those having annual revenues of less than $50,000,000). In the context of these smaller reporting companies, the Chief Counsel Memorandum provides that, the term “covered employee” could include a principal financial officer if such employee is among the 2 highest compensated officers for the taxable year (other than the principal executive officer).
Smaller reporting companies may wish to take note of the IRS’ change in position and may wish to consider whether compensation payable to the chief financial officer should be structured to qualify for the “performance-based compensation” exception to Section 162(m) of the Code.