Over the years, lawmakers have tweaked the tax code to limit disfavored forms of executive compensation, while regulators have increased the amount of disclosure companies must make. Barbara Lee (D-Calif.) has introduced the Income Equity Act of 2011 (H. 382), which would amend the Internal Revenue Code to prohibit deductions for excessive compensation for any full-time employee; compensation is defined as “excessive” if it exceeds either 0,000 or 25 times the compensation of the lowest-paid employee, whichever is larger.
The objective of this study is to examine the impact of a prior limitation on deductibility of compensation, Internal Revenue Code Section 162(m).
With respect to reducing excessive, non-performance-based compensation, many consider Section 162(m) a failure, including Christopher Cox, the then-chairman of the Securities and Exchange Commission, who went so far as to suggest it belonged “in the museum of unintended consequences.” Sen. These sophisticated folks are working with Swiss-watch-like devices to game this Swiss-cheese-like rule.
Charles Grassley (R-Iowa), the then-chair of the Senate Committee on Finance, was even more direct, saying: 162(m) is broken. Since Section 162(m) passed nearly 20 years ago, both academic and practitioner research has shown a dramatic increase in executive compensation, with little evidence that it is more closely tied to performance than before.
As put forth in Section 162(a), entities are allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including, as noted in Section 162(a)(1), a reasonable allowance for salaries or other compensation for personal services actually rendered.
However, a number of sections of the Internal Revenue Code—in particular, sections 162(m), 162(m)(5), 162(m)(6), and 280(g)—limit the deductibility of executive compensation.
The topic of executive compensation has long been of interest to academics, the popular press, and politicians.
With the continued increase in executive compensation and resultant increase in pay disparity between those executives and the average worker, this issue is once again coming to the forefront of the public policy debate.
Adopted in 1993, Section 162(m), which applies to publicly traded corporations, limits the deduction for executive compensation to million per covered individual,1 with an exception for qualified performance-based compensation.That is, a company can deduct million of non-performance-based compensation per covered individual and an unlimited amount of performance-based compensation.