Section 162(m) in 2027: Are You Ready for the ARPA Five?

Back in 2021, when the American Rescue Plan Act amended Section 162(m) to cover an additional five highest-paid employees (the “ARPA Five”) but delayed the requirement from going into effect until 2027, the need to comply felt like a long way away. But time has a way of marching on, and here we are, with 2027 just around the corner.

If you haven’t yet identified who your ARPA Five employees will be, here is a quick summary of what you need to know.

A Brief History of Section 162(m)

Did you know that when Section 162(m) was originally introduced in Congress, it was drafted to apply to all employees? That proved too controversial, and the bill was rejected. It was subsequently redrafted to apply to only the CEO, CFO, and the next three highest-paid officers (a maximum of five officers), and it is this version that was enacted into law in 1993.

Here’s another fun fact: the number of employees covered under Section 162(m) dropped to a maximum of four in 2007. At that time, a change in the SEC rules governing who is considered a named executive officer for proxy disclosure purposes inadvertently caused the CFO to no longer be covered under Section 162(m), which references the proxy disclosure regulations to determine who is covered. 

In 2017, the Tax Cuts and Jobs Act (TCJA) rectified this gap by amending Section 162(m) to expressly stipulate that the CFO is a covered employee. But it did more than that: It also stipulated that anyone serving as CEO or CFO during the year is covered under Section 162(m) even if no longer serving at year-end, and that former officers who would have been among the top three highest-paid officers, except for the fact that they terminated before year-end, are also covered.

Lastly, the TCJA implemented the “once covered, always covered” rule: beginning with 2017, any employees covered under Section 162(m) remain covered for as long as they receive compensation from the company, regardless of role or amount of compensation received.

Although we tend to think of Section 162(m) as covering the top five highest-paid officers, the TCJA amendments mean the number of officers covered under Section 162(m) can now be considerably more than five.

Does Filer Status Affect Who Is Subject to Section 162(m)?

As you may be aware, the SEC recently proposed recategorizing the majority of public companies to non-accelerated filer (NAF) status and making NAFs eligible for the same filing relief currently available to smaller reporting companies and emerging growth companies. For companies eligible for this relief, one effect of the change is that it would reduce the number of officers for whom compensation disclosure is required to the CEO and two other highest-paid officers (and up to two former officers).

Since the definition of covered employees under Section 162(m) is tied to the executive compensation disclosure rules, you might wonder whether this will reduce the number of employees subject to Section 162(m). No such luck, however. In Notice 2018-68, the IRS makes clear that a company’s filer status does not affect which employees are subject to Section 162(m).

Section 162(m) and the American Rescue Plan Act of 2021

Under Section 9708 of the American Rescue Plan Act of 2021, the number of employees covered under Section 162(m) will increase by five. Moreover, these five additional covered employees don’t have to be officers. Until the ARPA, anyone covered under Section 162(m) had to be an officer (or former officer), but this new group can be any employee.

Proposed Regulations Issued in Early 2025

In January 2025, the IRS proposed regs to clarify a number of practical implementation questions related to determining the additional five covered employees. Below are some highlights of the proposal.

The Five Newly Covered Employees: The additional five highest-paid employees can include any common law employee of the company who was employed during the tax year, regardless of whether they are employed by the company on the last day of the tax year and, as noted above, regardless of whether they are officers.

Affiliated and Unaffiliated Companies: These additional five highest-paid employees can include employees of affiliated companies (including foreign companies), and even employees of unaffiliated companies, such as a professional employer organization (PEO), if substantially all the services the employees perform during the year are for the covered company. The regs here are complicated; consult your tax advisors if this could apply to your company.

Compensation: For purposes of determining the next five highest-paid employees, “compensation” is defined as any compensation that would otherwise be deductible by the corporation. This differs from how the compensation of the first three highest-paid officers is determined, which is based on their compensation disclosed in the Summary Compensation Table (SCT) in the company’s proxy statement. It is helpful that the regs take a different approach because, as noted above, these five highest-paid employees can include individuals who aren’t officers; using all otherwise deductible compensation saves the company from having to expand the number of employees included in the SCT calculations.

Once Covered, Always Covered: The additional five covered employees won’t be subject to the “once covered, always covered” rule. Thus, if their compensation in future years isn’t sufficient to place them among the highest-paid employees, they will no longer be covered.

However, these additional five employees can include employees who are already covered under the “once covered, always covered” rule. Thus, it’s possible that this new requirement won’t affect some companies: If the next five highest-paid employees are all already covered, the total number of covered employees won’t increase.

Effective Date

The regs will be effective for tax years beginning after the later of December 31, 2026, or, if later, the date of publication of the final rules in the Federal Register. 

As of today, the final regs haven’t been issued yet, but I’m sure we will get an update on the status of them at the IRS and Treasury Speaks panel at this year’s NASPP Conference.

Tax Accounting Considerations for the ARPA Five

When companies are accounting for potential tax deductions they might be entitled to for equity awards, they should consider whether the deduction will be subject to limitation under Section 162(m). Thus, even though the requirement hasn’t gone into effect yet, companies may already need to forecast who the additional five covered employees will be and may need to update the deferred tax assets recorded for equity awards granted to these individuals.

More Information About Section 162(m) and Other Developments

The NASPP Conference is the place to catch up on this development, as well as other developments affecting your equity plan. Check out the following sessions for the latest news you need to know:

• What's Hot? What's Next? Public Company Equity Comp Design & Disclosure
• Planning for the 162(m) Expansion & the New Proxy Disclosure Landscape
• The IRS and Treasury Speak
• Your Compensation Disclosures: New & Improved (We Hope)!
• Future-Proofing Compliance: What New SEC Disclosure Rules Mean for You