Series Installment: “publicly held corporation”
As we noted in our December 24, 2019 blog entry, on December 16, 2019, the Treasury Department released proposed regulations (the “Proposed Regulations”) addressing the amendments made to Internal Revenue Code Section 162(m) by the Tax Cuts and Jobs Act (the “Amendment”). As a reminder, Code Section 162(m) generally limits the compensatory deduction to the first $1.0 million of compensation paid by a “publicly held corporation” to each covered employee.
Today’s entry highlights the broadening of the term “publicly held corporation.”
General Broadening of the term “publicly held corporation.” First, consistent with the Amendment, and as noted in the preamble, the Proposed Regulations expand the definition of “publicly held corporation” in two ways to include (1) a corporation with any class of securities (rather than only a class on common equity securities), and (2) a corporation that is required to file reports under Section 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”).
As a result, among other things, the Proposed Regulations make clear that an S corporation would qualify as a “publicly held corporation” if it (1) issues securities required to be registered under Section 12(b) of the Exchange Act, or (2) is required to file reports under Section 15(d) of the Exchange Act. Importantly, this would include an S corporation that has issued publicly traded debt. In similar fashion, the Proposed Regulations make clear that a publicly held subsidiary is separately subject to Section 162(m) with its own set of covered employees. The Proposed Regulations continue to look to the last day of the corporation’s taxable year to determine whether it is a “publicly held corporation.”
Foreign Private Issuers. Before the Amendment, the IRS had ruled in private letter rulings that Code Section 162(m) does not apply to foreign private issuers (“FPIs”) because FPIs are not required to file a summary compensation table pursuant to the reporting obligations under the Exchange Act. Citing the legislative history to the Amendment, the Proposed Regulations reject the proposition that FPIs are excluded from the reach of Code Section 162(m). However, recognizing that FPIs do not prepare summary compensation tables, the IRS is seeking input on whether a safe harbor for the determination of the three highest paid executive officers is appropriate and how that safe harbor should be designed.
Publicly Traded Partnerships. Partnerships may issue equity interests that are required to be registered under Section 12 of the Exchange Act because they are traded on an established securities market (“PTPs”). A PTP that is treated as a corporation under Code Section 7704 is a “publicly held corporation” if its securities are required to be registered under Section 12 of the Exchange Act or it is required to file reports under Section 15(d) of the Exchange Act.
Affiliated Groups. While affiliated group members were potentially subject to Code Section 162(m) before the Amendment, affiliated groups are now more likely to have more than one member considered a “publicly held corporation.” A significant feature of the Proposed Regulations is that the privately held parent of a public held subsidiary will be subject to Code Section 162(m). Should this expansion worry private equity sponsors, especially where the target happens to have public debt? Only time will tell but we think this is a notable development.
Disregarded Entities and Qualified Subchapter S Subsidiaries. Consistent with the expansive reach of “publicly held corporation,” the Proposed Regulations provide that a privately held corporation that is the owner of a disregarded entity is treated as the issuer of any securities issued by its disregarded entity. Accordingly, such parent will be a treated as “publicly held corporation” if the disregarded entity’s securities are required to be registered under Section 12(b) of the Exchange Act or the disregarded entity is required to file reports under Section 15(d) of the Exchange Act. The same principle applies to an S corporation that is the owner of a qualified subchapter S subsidiary.
Privately Held Corporations that Become Publicly Held. If one considers facilitating access to the public capital markets an important policy objective, the Proposed Regulations provide a disappointing elimination of the special transition relief applicable to IPOs occurring on or after December 20, 2019. Any such newly “publicly held corporations” will be immediately subject to Code Section 162(m). According to the preamble, the IRS believes that with the Amendment’s elimination of the “performance-based” exception to Code Section 162(m), the IPO transition relief no longer makes sense. Fortunately, for IPOs closing prior to December 20, 2019, the prior IPO transition relief will continue to be available (generally for three years following the date of the IPO provided appropriate disclosure had been made to shareholders).
Next week we will look more closely at who is a “covered employee.”