Geithner Will Direct IRS to Examine Legislation Repealing IRC 162(m) Exemption for Performance-Based Executive Compensation

At his confirmation hearings, Treasury Secretary Tim Geithner agreed to consider legislation to amend section 162(m) of the Internal Revenue Code to eliminate the deduction of commissions and performance-based pay for a company’s most highly paid exexutives.The Emergency Economic Stabilization Act limited executive compensation for executives of companies that are participating in the Troubled Asset Relief Program (TARP). These restrictions include a limitation of $500,000 (instead of 162(m)’s $1 million cap) on the amount of compensation that can be deducted as an ordinary and necessary business expense. Also, the definition of compensation for TARP recipientas was expanded to include performance pay and stock options. Senator John Kerry has introduced legislation that would amend 162(m) to repeal the exemption for performance based pay and bonuses for all companies, not just TARP recipients.

Responding to a question from Senator Kerry, Mr. Geithner said that excessive executive compensation that provides inappropriate incentives has played a role in exacerbating the financial crisis. The SEC and Treasury are closely examining the issue. First, the Secretary will charge the Internal Revenue Service with ensuring that the regulations implementing the executive compensation provisions of the Economic Emergency Stabilization Act are fully complied. Second, he pledged that Treasury and IRS staff will study the Kerry legislative proposal to permanently limit the deductibility of performance-based executive compensation.

Under current law, the allowable deduction for the compensation of the top five highly paid individuals, including the CEO and the chief financial officer, CFO, is limited to $1 million per year. This limitation does not include commissions and performance-based pay. Congress is concerned that these exceptions have weakened the effectiveness of the limitation and encourage performance-based pay arrangements which could cause executives to manipulate earnings

The Compensation Fairness Act would make several changes to the limitation on deduction for compensation. It would repeal the exceptions for commission and performance-based pay. Under current law, an employee that is covered by the limitation has to be an employee the last day of the year. The legislation would change this to make a covered employee one who is employed at any time during the year. This legislation would retain the $1 million limitation and index it for inflation.

The Compensation Fairness Act would not limit the amount of salary an executive can receive, it would just limit the tax subsidy.