Recent executive compensation and fringe benefit changes.

• Author: Murthy, Veena K.

EXECUTIVE SUMMARY

* The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, eliminated most deductions of business-related entertainment expenses and reduced the former 100% deduction for expenses of some meals provided to employees by employers to 50%. Subsequent guidance addressed distinguishing between the cost of food and beverages provided at or during an entertainment activity, which remain 50% deductible, from the nondeductible cost of the entertainment.

* Subsequent legislation and guidance temporarily allows a 100% deduction for food or beverages provided by a restaurant if paid or incurred during the 2021 and 2022 calendar years.

* The TCJA also eliminated the deduction of the cost of qualified transportation fringe and other commuting benefits. Guidance on determining the nondeductible portion of employer-provided parking benefits was issued in 2018 and 2020.

* Sec. 162(m), which limits the annual compensation deduction to $1 million for each covered employee of a publicly held corporation, also was significantly expanded by the TCJA. This limitation was further expanded in 2021 by the American Rescue Plan Act, P.L. 117-2, to take effect in tax years after 2026.

* Tax-exempt organizations also received an excess-compensation limitation from the TCJA in the form of an excise tax under Sec. 4960. Guidance has addressed a number of outstanding questions and issues, but some remain, such as coordination with Sec. 162(m).

The 2017 tax reform legislation referred to as the Tax Cuts and Jobs Act

(TCJA) (1) significantly affected the tax treatment of executive compensation and employee fringe benefits. The TCJA amended deduction limitations on employer costs for meals and entertainment and employer-provided transit and parking benefits under Sec. 274, significantly expanded the reach of the annual $1 million deduction limitation on the compensation of certain executives under Sec. 162(m), and enacted new Sec. 4960 imposing an excise tax on tax-exempt organizations providing excessive executive compensation. All of these changes are generally effective for tax years beginning after Dec. 31, 2017.

During 2018 and 2019, Treasury and the IRS released guidance with respect to these law changes in the form of notices (2) followed by four sets of proposed regulations. (3) Between October 2020 and January 2021, Treasury published final regulations implementing the TCJA changes to Secs. 274, 162(m), and 4960. (4) Within months after the release of these final regulations, Congress further tweaked the Sec. 274 treatment of business meals and which employees are covered under Sec. 162(m). (5) Outlined below are the more significant aspects of each of the four sets of final regulations, and the subsequent revisions in two of these areas by Congress.

Sec. 274 disallowance of deductions for entertainment expenses and reduction for some employee meal expenses

The TCJA amended Sec. 274 to generally eliminate the deduction for expenses of entertainment, amusement, or recreation (collectively referred to as entertainment) directly related to or associated with the taxpayer's active conduct of a trade or business. The law also reduced the former 100% deduction for expenses for on-premises meals provided by an employer for the employer's convenience under Sec. 119 and for costs associated with food and beverages provided through an employer-operated eating facility under Sec. 132(e)(2)--temporarily, to 50% for amounts paid or incurred before Jan. 1, 2026, and permanently to 0% for amounts paid or incurred on or after that date. (6)

Congress intended to preserve the 50% deduction for properly substantiated business meals unassociated with entertainment activities. Certain exceptions under Sec. 274(e) ("Subsection (e) exceptions") were also preserved, such as amounts that are properly included in an employee's wages, (7) or for expenses of certain recreational, social, or similar activities primarily for the benefit of employees, such as annual picnics and holiday parties, where such benefits are provided on a nondiscriminatory basis. (8)

A primary issue that emerged in relation to this law change was its impact on the deduction for business meal costs. Previously, distinguishing between whether an employerprovided meal was associated with business or entertainment was not as critical, since generally both business meal and entertainment costs were 50% deductible. (9) Clarifying the IRS's view of this issue was largely the focus of Notice 2018-76, which outlined how meal costs, particularly those of food or beverages provided along with or during an entertainment event, could remain 50% deductible. Although Congress intended to preserve the 50% business meal deduction only when dissociated from entertainment entirely, the notice provided that such meal expenses remain 50% deductible if all of the following requirements are met:

* The expenses are ordinary and necessary under Sec. 162 in carrying on any trade or business;

* The expenses are not lavish or extravagant under the circumstances;

* The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;

* The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and

* If the food and beverages are provided during or at an entertainment activity, they are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on relevant bills, invoices, or receipts and cannot be inflated to circumvent the entertainment disallowance.

Proposed regulations published on Feb. 26, 2020, (10) generally follow the notice in this regard, adding certain clarifications, including that the notice's requirements apply to all food or beverages, including travel meals and employer-provided meals, provided during an entertainment activity. Other clarifications relate to various definitions, including what constitutes "food and beverage expenses," and that the food or beverages must be provided to a "business associate" as a requirement for deductibility.

The proposed rules also make clear that stringent prior-law rules associated with substantiation of travel meal expenses, including limitations on any deduction for travel meal expenses of spouses and dependents, were unchanged. Additionally, while the TCJA did not generally eliminate various prior-law Sec. 274(e) exceptions from the deduction limitations, not every exception continues to apply, and taxpayers should distinguish between expenses for entertainment versus for food and beverages within those exceptions.

The final regulations, (11) published on Oct. 9, 2020, and effective for tax years beginning on or after the date of publication, substantially adopted the proposed rules, but the final regulations include a number of important clarifications. One is that the cost of transportation to a meal (for example, a taxi to a restaurant) is not part of food or beverage expenses. Also, the prior regulatory definition of entertainment under an objective standard was substantially unchanged.

Apparently in response to numerous taxpayer comments or questions of a similar nature, the final regulations reiterate certain...