IRC 162(m) Executive Compensation Deduction Limit: OBBBA Controlled-Group Expansion Guide

IRC 162(m) is one of the more precisely mechanical limitations in the Internal Revenue Code, but the OBBBA's controlled-group expansion has introduced significant new complexity for practitioners advising clients with subsidiaries, joint ventures, partnerships, and other entities that operate alongside a publicly held parent. This guide is written for enrolled agents, CPAs, and tax attorneys who need a citation-anchored reference for the core rule, the TCJA repeal of the performance-based exception, and the OBBBA's changes effective for tax years beginning after December 31, 2025.

All statutory citations, regulatory guidance references, and descriptions of OBBBA provisions must be verified against the current text of the Internal Revenue Code and any IRS guidance issued at IRS.gov before being relied on in any specific client matter. The OBBBA is recently enacted and subject to ongoing regulatory interpretation; no description of OBBBA-modified provisions here should be treated as settled without that verification. This guide is for informational purposes only and does not constitute legal or tax advice.

Section 1: The Core IRC 162(m) Rule

IRC 162(m)(1) provides that a publicly held corporation may not deduct compensation paid to a covered employee to the extent that compensation exceeds $1 million for the taxable year. The deduction is simply disallowed for the excess; there is no mechanism to carry it forward or carry it back. Confirm the current statutory text at IRS.gov and in the enacted IRC 162(m)(1).

The $1 Million Cap: Per Employee, Per Year, Not Inflation-Adjusted

The $1 million cap under IRC 162(m)(1) applies separately to each covered employee for each taxable year. A publicly held corporation with five covered employees must analyze each employee's compensation independently; the caps are not pooled or aggregated across employees. A corporation that pays its PEO $3 million and its PFO $800,000 loses the $2 million excess deduction for the PEO but retains the full PFO deduction (assuming the PFO is otherwise below the threshold for that year).

The $1 million threshold is not indexed for inflation. It has not changed since the original enactment of the cap. Confirm the current statutory amount at IRS.gov and in IRC 162(m)(1).

Covered Employees: IRC 162(m)(3) Post-TCJA

Under post-TCJA IRC 162(m)(3), "covered employees" are:

• The principal executive officer (PEO) of the corporation (or any individual acting in that capacity) as of the close of the taxable year.
• The principal financial officer (PFO) of the corporation (or any individual acting in that capacity) as of the close of the taxable year.
• The three other executive officers whose total compensation for the taxable year is the highest among the executive officers of the corporation.
• Any individual who was a covered employee of the corporation (or any predecessor) for any preceding taxable year beginning after December 31, 2016. This is the "once a covered employee, always a covered employee" rule. An executive who was a covered employee in 2019 and retired in 2020 remains a covered employee for all future years, including for compensation paid after departure and even after death (such as deferred compensation payments).

The OBBBA may have added an additional covered employee category beyond these five. Confirm at IRS.gov and in the enacted statute; this is recently enacted and subject to regulatory interpretation, as described in Section 4 below.

What Counts as "Compensation" for IRC 162(m) Purposes

IRC 162(m) applies to all remuneration paid by the corporation to the covered employee during the taxable year, including:

• Base salary and other current cash compensation.
• Annual bonuses and other incentive cash payments.
• Equity compensation (stock options, restricted stock, restricted stock units, performance stock units), generally when the award vests or, for options, when exercised and resulting in ordinary income recognition.
• Deferred compensation payable under a nonqualified deferred compensation plan, counted in the year it is paid (not when deferred or accrued).
• Other forms of remuneration paid by the corporation, subject to any applicable exclusions under the statute. Confirm the specific inclusions and exclusions under IRC 162(m) and applicable regulations at IRS.gov.

Section 2: The Performance-Based Compensation Exception (Repealed by TCJA)

Understanding what was repealed is as important as understanding what replaced it, because grandfathered pre-2018 arrangements still require practitioners to apply the pre-TCJA rules in specific cases.

The Pre-TCJA Performance-Based Exception (Pre-2018)

Prior to the TCJA, IRC 162(m)(4)(C) excluded "qualified performance-based compensation" from the $1 million cap. To qualify, the compensation had to be paid solely on account of the attainment of one or more performance goals, the goals had to be established by a compensation committee of the board of directors composed solely of two or more outside directors, the material terms under which the compensation was to be paid had to be disclosed to and approved by shareholders, and the compensation committee had to certify that the performance goals were attained before payment. Stock options and stock appreciation rights granted at fair market value were treated as performance-based compensation under a separate rule.

IRC 162(m)(4)(B) also excluded commissions from the cap prior to the TCJA.

Both exceptions made the pre-TCJA IRC 162(m) limit substantially less impactful in practice. Large equity grant programs (stock options, performance stock units) were routinely designed to satisfy the performance-based exception, keeping billions of dollars of equity compensation deductible regardless of total compensation levels.

TCJA Repeal (Effective for Tax Years Beginning After December 31, 2017)

The TCJA repealed both IRC 162(m)(4)(C) (performance-based exception) and IRC 162(m)(4)(B) (commissions exception) effective for taxable years beginning after December 31, 2017. All compensation paid to a covered employee in excess of $1 million per year is now subject to the deduction limit, regardless of whether it is performance-based, tied to objective metrics, approved by shareholders, or paid as commissions.

The practical impact on equity compensation is significant. Stock options, performance stock units (PSUs), and restricted stock units (RSUs) granted after November 2, 2017, to covered employees are fully counted toward the $1 million cap when they are included in the covered employee's income (at exercise for options, at vesting for full-value awards). For covered employees already near the $1 million threshold from base salary and bonus, even modest equity vesting can create a non-deductible excess. See our guide on the Section 83(b) election and restricted property for the interaction between equity compensation income recognition timing and covered employee compensation thresholds.

Grandfathered Pre-2018 Arrangements

The TCJA included a transition rule: compensation payable under a written binding contract in effect on November 2, 2017, that has not been materially modified after that date may continue to be treated under the pre-TCJA rules, including eligibility for the performance-based compensation exception.

Applying the grandfathering rule requires careful analysis. Determining whether a contract was "binding" on November 2, 2017, whether it has been "materially modified" since that date, and whether the performance-based conditions continue to be satisfied involves both factual and legal analysis. Hedge all specific grandfathering mechanics to IRS Notice 2018-68 and any final regulations issued at IRS.gov. Do not treat grandfathering as automatic for any pre-2018 arrangement without this analysis.

Section 3: "Publicly Held Corporation" Definition -- Pre-OBBBA

Understanding the pre-OBBBA definition is essential because the OBBBA expansion builds on that definition, and grandfathered situations and multi-year analyses may require applying the pre-OBBBA rule for tax years beginning on or before December 31, 2025.

TCJA Version of "Publicly Held Corporation" (IRC 162(m)(2))

Under the TCJA-amended IRC 162(m)(2), a "publicly held corporation" was defined as any domestic corporation that:

• Has issued any class of common equity securities required to be registered under Section 12 of the Securities Exchange Act of 1934 (Exchange Act), or
• Is required to file annual reports under Section 15(d) of the Exchange Act.

This definition captured both NYSE/Nasdaq-listed domestic corporations (registered under Section 12) and companies that issued public debt or equity in registered transactions and thereby became subject to Exchange Act reporting obligations under Section 15(d), even without a class of equity listed on a national exchange.

Foreign private issuers that were required to file annual reports under Section 15(d) of the Exchange Act could also be subject to the definition. Hedge the specific application to foreign private issuers to IRC 162(m)(2) and IRS.gov.

Subsidiaries Under the Pre-OBBBA Rule

Under the pre-OBBBA rule, a wholly owned subsidiary that was not itself a publicly held corporation (that is, it did not independently have a class of registered equity securities or Exchange Act reporting obligations) was not directly subject to the IRC 162(m) deduction limit. The limit applied at the level of the publicly held parent. Compensation paid by the subsidiary to the parent's covered employees could raise questions about whose deduction is at stake, but the subsidiary itself was not a "publicly held corporation" within the pre-OBBBA definition.

This pre-OBBBA subsidiary rule is one of the areas most directly affected by the OBBBA expansion described in Section 4.

Section 4: OBBBA Controlled-Group Expansion (Effective for Tax Years Beginning After December 31, 2025)

The Controlled-Group Expansion

As provided in the OBBBA as enacted (confirm current rules and any regulatory guidance at IRS.gov), the OBBBA expanded the scope of entities subject to IRC 162(m) by treating entities that are members of a controlled group with a publicly held corporation as themselves subject to the IRC 162(m) deduction limit for compensation paid to covered employees of those entities.

This is a significant departure from the pre-OBBBA rule. Under the pre-OBBBA framework, only the publicly held corporation itself was subject to IRC 162(m). Under the OBBBA expansion, entities that are part of a controlled group including a publicly held corporation are now subject to the limit, even if they are not themselves publicly held. Confirm the specific mechanics of this expansion at IRS.gov and in the enacted OBBBA text.

Controlled Group Definitions: IRC 414(b), (c), (m), and (o)

As provided in the OBBBA as enacted (confirm current rules and any regulatory guidance at IRS.gov), the expansion applies to entities that are members of groups defined under:

• IRC 414(b): Controlled groups of corporations. This includes parent-subsidiary controlled groups (a corporation that directly or indirectly owns 80 percent or more of the voting power or value of another corporation) and brother-sister controlled groups (two or more corporations owned by the same five or fewer individuals, estates, or trusts under specified ownership tests). These are the same definitions used for retirement plan controlled-group testing.
• IRC 414(c): Groups of trades or businesses under common control. This definition extends beyond corporations to include partnerships, LLCs, and sole proprietorships that are under common control with other entities. A partnership or LLC that is more than 80 percent controlled (under IRC 414(c) and Treasury Regulation 1.414(c)-2) by a publicly held corporation or its controlling owners is within this definition.
• IRC 414(m): Affiliated service groups. These include service organizations with specified functional and ownership relationships, including management companies and service organizations that perform services for related entities. The affiliated service group rules can pull in entities that would not otherwise meet the controlled group test under IRC 414(b) or (c).
• IRC 414(o): Catch-all aggregation authority. IRC 414(o) authorizes the IRS to prescribe regulations to prevent avoidance of the controlled group rules through the use of separate organizations, employee leasing, or other arrangements. OBBBA-specific guidance under IRC 414(o) is expected; confirm at IRS.gov.

All specific mechanics, thresholds, and application of these definitions in the context of the OBBBA expansion must be confirmed at IRS.gov and in the enacted OBBBA text as regulatory guidance is issued.

Practical Impact: Partnerships and LLCs in a Controlled Group

The most significant practical consequence of the OBBBA expansion involves pass-through entities (partnerships, LLCs taxed as partnerships) that are under common control with a publicly held parent. Under the pre-OBBBA rule, such entities were not subject to IRC 162(m). Under the OBBBA expansion, as provided in the enacted statute (confirm at IRS.gov), compensation paid by those entities to covered employees of the controlled group may now be subject to the $1 million deduction limit.

For private equity portfolio companies, joint ventures, and operating subsidiaries organized as partnerships or LLCs that are part of a publicly held group, this is a new compliance obligation requiring review of compensation arrangements that were previously outside the IRC 162(m) framework. See our guide on IRC 351 tax-free incorporation and the control test for background on controlled-group entity structures and their treatment under the Internal Revenue Code.

Which Employees Are "Covered" Under the OBBBA Expansion

The OBBBA expansion requires analysis of which employees of the controlled-group entities qualify as "covered employees" subject to the deduction limit. Under the pre-OBBBA rule, covered employee status was determined at the publicly held corporation level. The OBBBA expansion to controlled-group entities raises new questions about whether covered employee status is determined at the group level, the entity level, or some combination. Confirm the specific mechanics at IRS.gov and in the enacted OBBBA statute as regulatory guidance is issued.

Potential Additional Covered Employee Category Under the OBBBA

The OBBBA may have introduced an additional category of covered employees beyond the PEO, PFO, and three next highest-compensated executive officers described in pre-OBBBA IRC 162(m)(3). This potential additional category may extend to the five highest-compensated employees of the controlled group as a whole. All specifics regarding any such additional covered employee category are subject to ongoing regulatory interpretation and must be confirmed at IRS.gov and in the enacted OBBBA statute. Do not treat any expansion of the covered employee definition as settled without that confirmation.

Section 5: Consequences of Excess Compensation

The mechanics of what happens when a corporation pays a covered employee more than $1 million in a taxable year are straightforward, but practitioners encounter several misconceptions in practice.

Non-Deductible Excess: A Permanent Difference

The amount by which the covered employee's compensation for the year exceeds $1 million is not deductible by the corporation under IRC 162(m). This disallowance is a permanent difference for tax accounting purposes. Unlike a timing difference (where a deduction is deferred to a later period), the IRC 162(m) excess is gone permanently. There is no mechanism to carry it forward to a future year when the same employee earns less than $1 million; the excess deduction is simply lost.

The permanent disallowance affects the effective tax rate of a publicly held corporation. For financial reporting purposes (ASC 740), the IRC 162(m) disallowance creates a deferred tax asset that must be reversed when it becomes apparent the deduction will never be available, increasing the corporation's effective tax rate.

Employee's Treatment: No Disgorgement Required

The IRC 162(m) deduction disallowance is a burden borne entirely by the corporation, not the employee. The employee receives and retains the full compensation, regardless of whether the corporation can deduct it. The excess over $1 million is taxable income to the employee in the ordinary course; IRC 162(m) does not change the employee's tax treatment or create any obligation to return, reduce, or modify the compensation already paid or committed.

This is an important point when advising compensation committees and boards: a decision to pay an executive more than $1 million is a deliberate, eyes-open choice to forgo a corporate tax deduction on the excess. The deduction loss is the cost of the compensation decision, not a regulatory violation or a penalty.

No Separate IRC 162(m) Return or Filing

There is no separate tax form or return for IRC 162(m) compliance. The deduction is simply not claimed (or is claimed subject to the limit) on the corporation's regular income tax return. The IRS enforces IRC 162(m) through examination of the corporation's income tax return, including review of executive compensation deductions.

SEC Proxy Statement Reporting

Publicly held corporations subject to SEC reporting are required to disclose executive compensation in their annual proxy statement (Form DEF 14A). The SEC's executive compensation disclosure rules (Regulation S-K, Item 402) require the Summary Compensation Table and related tables that capture total compensation paid to the named executive officers (NEOs). For SEC reporting purposes, the NEO group overlaps significantly with the IRC 162(m) covered employee group, though the definitions are not identical.

The SEC's Say on Pay rules also require shareholder advisory votes on executive compensation for larger reporting companies. The proxy statement disclosures and the Compensation Discussion and Analysis (CD&A) provide the primary tracking mechanism through which practitioners and investors can identify potential IRC 162(m) exposure. Companies often disclose IRC 162(m) non-deductibility in their CD&A as a note to shareholders.

Section 6: IRC 4960 -- Excise Tax on Excess Compensation by Tax-Exempt Organizations

Tax-exempt organizations are not subject to IRC 162(m) because they are not "publicly held corporations." Congress provided a parallel limitation for the tax-exempt sector through IRC 4960, enacted by the TCJA.

The IRC 4960 Excise Tax

IRC 4960 imposes an excise tax on "excess remuneration" paid by applicable tax-exempt organizations to their covered employees. Applicable tax-exempt organizations include organizations described in IRC 501(c) and certain governmental entities. "Covered employees" under IRC 4960 are the five highest-compensated employees of the organization for the taxable year, including any individual who was a covered employee for any taxable year beginning after December 31, 2016.

The excise tax under IRC 4960 is imposed on the applicable tax-exempt organization (not on the employee) for excess remuneration paid to a covered employee. Do not state the specific IRC 4960 rate without hedging to the current statute and IRS.gov; the rate is set by statute and the OBBBA may have modified it. Confirm the current rate and scope at IRS.gov and in the enacted statute before advising any tax-exempt organization client.

OBBBA and IRC 4960

The OBBBA may have modified IRC 4960 in connection with the IRC 162(m) controlled-group changes. All IRC 4960 specifics, including the applicable rate, the definition of covered employees, the definition of applicable tax-exempt organizations, and any interaction with the OBBBA's controlled-group expansion, must be confirmed at IRS.gov and in the enacted OBBBA text as regulatory guidance is issued. Do not rely on pre-OBBBA IRC 4960 guidance without verifying whether OBBBA modifications apply.

Form 4720: Reporting and Payment

Applicable tax-exempt organizations use Form 4720 (Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code) to report and pay the IRC 4960 excise tax. Confirm the current Form 4720 filing requirements, due dates, and instructions at IRS.gov before preparing any IRC 4960 filing. OBBBA changes may have affected the form or its instructions.

Section 7: Practitioner Planning Considerations

The OBBBA's expansion of IRC 162(m) to controlled-group entities requires a fresh compliance review for many clients who previously had no IRC 162(m) exposure. The following planning considerations apply to practitioners advising publicly held corporations and the entities in their controlled groups.

Identify All Affected Entities in the Controlled Group

For any client that is part of a controlled group including a publicly held corporation, the first step is mapping the full controlled-group structure under IRC 414(b), (c), (m), and (o). Entities that were previously outside IRC 162(m) (partnerships, operating LLCs, joint ventures, management companies) should be reviewed to determine whether, as provided in the OBBBA as enacted, they are now subject to the deduction limit for tax years beginning after December 31, 2025. Confirm at IRS.gov and in the enacted statute.

Review All Executive Compensation Arrangements

For each potentially affected entity, review all executive compensation arrangements to identify covered employees and assess potential IRC 162(m) exposure under the OBBBA expansion:

• Employment agreements: Review base salary, bonus commitments, and severance terms for covered employees.
• Equity incentive plans: Review outstanding grants (options, RSUs, PSUs) for covered employees of controlled-group entities, including vesting schedules and anticipated income recognition dates.
• Nonqualified deferred compensation plans: Review balances and anticipated payment schedules under IRC 409A plans for covered employees, including timing of payouts that may coincide with other compensation in the same taxable year.
• Supplemental executive retirement plans (SERPs): Review benefit accrual and payment terms for covered employees who may trigger the OBBBA expansion.

Identify Grandfathered Pre-2018 Arrangements

For entities that were previously subject to IRC 162(m) (publicly held corporations themselves), identify any compensation arrangements in place on November 2, 2017, that may still qualify for grandfathered treatment under the pre-TCJA rules. These arrangements require separate analysis under IRS Notice 2018-68 and any final regulations. Material modifications after November 2, 2017, can eliminate grandfathered status. Confirm at IRS.gov.

Monitor IRS Guidance on the OBBBA Expansion

The OBBBA's controlled-group expansion and the potential additional covered employee category are recently enacted provisions. The IRS is expected to issue regulatory guidance, proposed regulations, and notices addressing the mechanics of the expansion. Practitioners must monitor IRS.gov for updates, including new Revenue Procedures, Notices, and proposed and final regulations under IRC 162(m) as modified by the OBBBA.

Coordinate with Executive Compensation Counsel and Securities Counsel

The interaction of IRC 162(m) with related regimes creates a multi-disciplinary planning environment:

• IRC 409A (nonqualified deferred compensation): The timing rules under IRC 409A govern when deferred compensation is paid and therefore when it is counted toward the IRC 162(m) cap. Accelerating or deferring payments to manage the IRC 162(m) cap must be analyzed for IRC 409A compliance first.
• SEC proxy disclosure rules: Changes to executive compensation arrangements triggered by IRC 162(m) compliance may require disclosure in the proxy statement CD&A and may affect the Say on Pay vote. Securities counsel should review any material changes to compensation programs for affected covered employees.
• IRC 280G (golden parachute): Change-in-control payments to covered employees may implicate both IRC 162(m) (deduction limit) and IRC 280G (excise tax on excess parachute payments) simultaneously. The two regimes use different definitions and thresholds; analyze them separately for each relevant executive.
• State income tax deductibility: Not all states conform to the federal IRC 162(m) deduction limitation. In states that do not conform, the excess compensation may remain deductible for state purposes. Confirm state conformity with each relevant state's corporate income tax regime.

Frequently Asked Questions

Common questions from enrolled agents, CPAs, and tax attorneys advising public companies and controlled-group entities on the IRC 162(m) executive compensation deduction limit.

Related Practitioner Guides

The following guides cover adjacent Code sections and compensation-related topics relevant to practitioners advising on IRC 162(m) compliance.

• Section 83(b) Election and Restricted Property: Practitioner Guide -- covers income recognition timing for restricted stock and other property transferred in connection with services, including the interaction of IRC 83 vesting events with covered employee compensation thresholds under IRC 162(m).
• IRC 351 Tax-Free Incorporation and the Control Test: Practitioner Guide -- covers corporate formation and the control test under IRC 351, with background on controlled-group entity structures and their treatment under the Internal Revenue Code, relevant to assessing whether controlled-group entities fall within the OBBBA's expanded IRC 162(m) scope.
• IRC 162(f) Government Fines and Penalties Guide -- both are IRC 162 deductibility limitations, so IRC 162(f) is a natural companion to IRC 162(m), covering when government fines and penalties are deductible and the IRC 162(f)(2) restitution and remediation exception.
• IRC 4960 Excise Tax on Exempt Organization Executive Compensation Guide -- IRC 162(m) caps deductible executive compensation at for-profit corporations; IRC 4960 imposes an excise tax on excess compensation at tax-exempt organizations; they are companion provisions.
• IRC 280G Golden Parachute Payments and IRC 4999 Excise Tax Guide -- IRC 162(m) and IRC 280G are the two primary deduction disallowances applicable to executive compensation; IRC 162(m) caps deductible compensation at $1 million per year for covered employees of publicly held corporations; IRC 280G disallows the entire excess parachute payment when golden parachute thresholds are met; practitioners advising on M&A executive compensation must run both analyses independently for the same executives and model their compounding effect.
• IRC 162(a) and 162(e) business expense and lobbying -- Ordinary and necessary standard, lobbying disallowance, Cohan rule, and OBBBA 2026 meal changes.

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