Employee Benefits Advisory: Section 162(m)

Introduction1

Section 162(a) of the Internal Revenue Code of 1986, as amended (the "Code"), permits a business to deduct all the "ordinary and necessary" expenses associated with operating the business during the taxable year, including reasonable compensation for its employees (e.g., salaries, bonuses, and health benefits). Nonetheless, Code Section 162(m)(1) prohibits publicly held corporations from taking a deduction for amounts paid to "covered employees" in excess of $1,000,000. Covered employees are determined as of the last day of the taxable year and include the chief executive officer of the corporation and the three highest paid officers whose compensation must be reported to shareholders under the Securities Exchange Act of 1934.2