This article focuses on select provisions of the Act related to executive compensation and employee benefits. For a detailed summary of other provisions of the Act, see our companion piece, “Budget Reconciliation Bill Signed Into Law,” available here.
Expansion of deduction limitation and covered employee aggregation under Section 162(m)
Section 162(m) of the Code (“Section 162(m)”)—titled “Certain Excessive Employee Remuneration”—disallows deductions by any “publicly held corporation” for compensation paid to any “covered employee” in excess of USD1m.1 The Act amends Section 162(m) by (1) expanding the entities that could be aggregated with a publicly held corporation for purposes of applying the USD1m deduction limit, (2) allocating the deduction limit proportionately among the paying controlled group members and (3) clarifying that the five highest compensated employees prong of the “covered employee” definition that was added to Section 162(m) by the American Rescue Plan Act (ARPA) will also be determined on the same controlled group aggregated basis.
Aggregating and allocating compensation across controlled group
Section 162(m) already requires aggregation across affiliates, but the aggregation required under the Act is broader than the previous aggregation rule. Prior to the Act, a “publicly held corporation” only included affiliated entities under Section 1504 of the Code (or those entities that shared an 80% stock ownership and could be included in a consolidated return). Controlled groups under the Act are broader,2 and include parent-subsidiary controlled groups, brother-sister controlled groups and affiliated service groups. This means that more entities may be included in the controlled group subject to Section 162(m) aggregation under the Act than under prior law. As such, entities that previously were not considered affiliates of the “publicly held corporation” may now be considered part of the controlled group and limited to deducting only their pro rata share deduction limitation for the compensation they paid to the covered employee.
The Act also requires a publicly held corporation that is a member of a controlled group to allocate the maximum amount of the deduction on a controlled group basis. That is, if multiple members of the controlled group provide compensation to a covered employee, the USD1m deduction maximum must be allocated among such members in proportion to the amount such member paid to the covered employee. This could potentially have the effect of reducing the deduction amount that is available to the publicly held corporation itself (because a portion of such amount is allocated to another entity within the controlled group).
Aggregating across controlled group to determine five highest compensated employees
Section 162(m) applies to compensation paid to any “covered employee” and generally defines a covered employee as (a) anyone who served as the principal executive officer (PEO, which is generally the CEO) or principal financial officer (PFO, which is generally the CFO) at any time during the taxable year, (b) the next three most highly compensated executive officers (other than the PEO and PFO) who are required to be reported in the company’s annual proxy statement under SEC executive compensation disclosure rules (the “NEOs”), and (c) anyone who has been a covered employee under these categories since January 1, 2017.
In addition, in 2021, Section 162(m) was amended by ARPA to expand the definition of “covered employee” for taxable years beginning after December 31, 2026. ARPA added to the definition of “covered employee” any employee who is among the five highest compensated employees for the taxable year other than the PEO, PFO, or NEOs (the “Next Five”).
The Act further expands on this prong of covered employee by providing that, when a publicly held corporation determines its Next Five, it must do so on a controlled group basis (as noted above, a controlled group is the broad group under Section 414 of the Code used for benefit plan purposes). This change has the practical effect of expanding the pool of individuals who may be one of the Next Five and, consequently, subject to the deduction limitation of Section 162(m).
Employer tax credits for paid family and medical leave
The Act modifies and makes permanent the employer tax credits for paid family and medical leave originally established by the Tax Cuts and Jobs Act of 2017, which allows employers to claim a credit equal to a percentage of wages paid to qualifying employees while on paid family and medical leave.3
The Act expands and clarifies the circumstances under which employers may claim the paid family and medical leave credit. Specifically, employers in states that do not mandate paid leave may claim credits for leave provided to employees. In states where paid leave is mandated, employers may claim credits only for paid leave provided in excess of the state minimum requirements.
The Act also broadens the methods available for calculating the paid family and medical leave credit. Employers may elect to calculate the credit based either on the applicable percentage of wages paid to qualifying employees during periods of family and medical leave or on the applicable percentage of insurance premiums paid or incurred for policies that provide paid family and medical leave.
The Act further clarifies employee eligibility requirements, including by permitting employers to use a six-month (rather than one-year) employment period to determine whether an employee qualifies for the paid family and medical leave credit. Additionally, the Act prohibits employers from receiving both a tax credit and a deduction for the same insurance premiums.
These amendments apply to tax years beginning after December 31, 2025.
Employer contributions to Trump Accounts
The Act introduces a new government-facilitated investment vehicle called “Trump Accounts.” Trump Accounts are designed to promote long-term savings for children born between January 1, 2025 and December 31, 2028 who are United States citizens with a Social Security number and whose parents also have Social Security numbers.
Trump Account holders are eligible to receive a one-time USD1,000 government contribution and can receive an additional USD5,000 (adjusted for inflation) annually in contributions from parents, relatives, and employers.
Employers can establish a Trump Account contribution program—a separate written plan for Trump Account contributions for the exclusive benefit of employees and their dependents. Under such a program, employers can make tax-free contributions of up to USD2,500 per year (indexed for inflation) to the Trump Accounts of employees or their dependents. These employer contributions are excluded from the employee’s gross income, provided they are made pursuant to a qualifying plan and do not exceed the statutory limit.
Health savings accounts
The Act has expanded access to health savings accounts, particularly for individuals enrolled in lower premium plans. Previously, only participants enrolled in qualified high-deductible health plans were eligible to make or receive health savings account contributions. Beginning in 2026, the Act will treat Bronze and Catastrophic plans as high-deductible health plans. Bronze and Catastrophic plans are both low-cost plans available through the Affordable Care Act and are designed to extend coverage primarily to those facing financial hardship. Under the Act, participants purchasing these plans through an Affordable Care Act Marketplace will be eligible to make or receive health savings account contributions.
Fringe benefits
The Act also affects numerous employee fringe benefits, summarized below. These changes are generally set to take effect after December 31, 2025.
Exclusion for employer-provided educational assistance
The Act permanently extends the rule allowing employers to provide up to USD5,250 per year in educational assistance to employees on a tax-free basis. This includes both tuition assistance and student loan repayment benefits. Additionally, the USD5,250 limit will now be adjusted annually for inflation. These amounts will be tax deductible for employers.
Elimination of tax exclusion for employer-provided meals
Beginning in 2026, the longstanding rule allowing employers to deduct 50% of the cost of certain qualified meals provided to employees will no longer apply. These meals will no longer be tax deductible in any amount for employers, and employees will generally need to include the value of such meals as taxable income.
Repeal of qualified bicycle commuting reimbursement
The Act permanently eliminates employer tax deductions for employee reimbursements relating to bicycle commuting expenses. Under prior law, employers could reimburse employees up to USD20 per month for qualified bicycle commuting costs tax free.
Repeal of tax-free qualified moving expense reimbursements
The Act permanently eliminates certain benefits related to employee moving expenses. Under prior law, employers were entitled to a deduction for covering employee moving expenses and employees were eligible for tax-free reimbursement of such expenses. Those amounts will now be taxed as income for employees, with limited exceptions.
Increased employer childcare tax credit
The Act increases the maximum tax credit available to employers that provide childcare benefits to their employees. Starting in 2026, employers can generally claim a tax credit equal to 40% of qualified childcare expenses, up to an aggregate maximum of USD500,000 per year.
Conclusion
The Act affects executive compensation in notable ways. The amendments to Section 162(m) will require publicly held corporations to consider compensation paid by any member of the controlled group toward the USD1m deduction limitation, and the requirement to allocate compensation among controlled group members may result in a reduction to the deduction amount that is available to the publicly held corporation.
Further, a wider range of employees may become subject to Section 162(m). Employers should consider whether to implement any changes relating to the other provisions of the Act, for instance the desirability of instituting programs for contributions to Trump accounts. Finally, the Act’s changes to fringe benefit provisions may result in tracking challenges and the need to implement new processes.
Footnotes
1. 26 U.S.C. § 162(m)(1).
2. Controlled group is defined for these purposes as any group treated as a single employer under subsection (b), (c), (m) or (o) of Section 414 of the Code. These are the same rules that treat all members of a controlled group as a single employer for qualified retirement plans and other employee benefit plans.
3. Tax Cuts and Jobs Act, Pub. L. No. 115-97, 131 Stat. 2054.
