Joint Committee on Taxation
June 3, 1992
JCX-19-92

PROPOSAL TO LIMIT DEDUCTION FOR EXECUTIVE COMPENSATION

(Scheduled for a Hearing Before the Senate Finance
Subcommittee on Taxation on June 4, 1992)

I. Present Law

Under present law, a deduction is allowed in computing
Federal income tax liability for ordinary and necessary
expenses paid or incurred during the taxable year in carrying
on a trade or business, including a reasonable allowance for
salaries or other compensation for personal services actually
rendered.

II. Description of Proposal

Background

The provision described below limiting the deduction for
executive compensation has been included in the following
bills that recently have been passed by the Congress or
reported by committee.

The conference report on H.R. 4210 ("Tax Fairness and
Economic Growth Act of 1992") was passed by the House and the
Senate on March 20, 1992 (see H. Rept. 102-461), and was
vetoed by the President on that date. H.R. 4727 was reported
by the House Committee on Ways and Means on May 27, 1992 (H.
Rept. 102-536, Part 1), and H.R. 5260 was reported by the
House Committee on Ways and Means on June 2, 1992 (H. Rept.
102-543, Part 1). H.R. 4727 and H.R. 5260 provide an
extension and revision of Federal unemployment compensation
benefits.

Explanation of Provision

For purposes of the regular income tax and the
alternative minimum tax, the otherwise allowable deduction
for compensation with respect to a covered employee is
limited to no more than $1 million per year. A covered
employee means any employee of the taxpayer who is an officer
of the taxpayer, other than an employee-owner of a personal
service corporation.

For purposes of the provision, whether an individual is
an officer is determined upon the basis of all the facts,
including, for example, the source of his or her authority,



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the term for which elected or appointed, and the nature or
extent of his or her duties. Generally, an officer is an
administrative executive who is in regular and continued
service, regardless of the employee's job title. An employee
who has the title of an officer but does not have the
authority of an officer is not considered an officer.
Similarly, an employee who does not have the title of an
officer but has the authority of an officer is an officer for
purposes of this rule.

An employee-owner of a personal service corporation is
generally defined as under section 269A of the Code. Thus, a
personal service corporation is a corporation the principal
activity of which is the performance of personal services if
the services are substantially performed by employee-owners.
An employee-owner is any employee who owns more than 10
percent of the outstanding stock of the personal service
corporation.

The provision applies only to compensation of employees
who are officers (or, in the case of former employees, who
were officers at any time while active employees). The
provision does not apply to payments to partners ina
partnership because they are not employees. The provision
also does not apply to payments to independent contractors.

The term covered employee includes former employees.
Thus, for example, the provision applies to compensa’ .on of a
former employee for services performed as an employee (e.g.,
nonqualified deferred compensation that is not received until
after termination of employment).

The deduction limitation generally applies to all
remuneration for services, including cash and the cash value
of all remuneration (including benefits) paid in a medium
other than cash. The limit does not apply to fringe benefits
excludable from income under section 132, meals and lodging
furnished on the business premises of the employer that are
excludable under section 119, or any payment made to, or on
behalf of, an employee or beneficiary (1) from or toa
qualified pension, profit-sharing, or annuity plan, or (2)
under a simplified employee pension (SEP) or tax-sheltered
annuity (other than elective deferrals to such a plan or
annuity). The deduction limitation applies to all
compensation paid to a covered employee, regardless of
whether the compensation is paid for services as an officer.

The deduction limitation applies at the time the
deduction would otherwise be taken by the employer, whether
or not the remuneration to which the deduction relates is for
service performed during the taxable year.

Certain related employers are treated as a single
employer for purposes of the provision. In particular,



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employers treated as a single employer under section 52(a) or
(b) or section 414(m) or (n) are treated as a single
employer. An employee who is an officer of any of the
members of a group of employers treated as a single employer
is treated as an officer of the single employer. Similarly,
compensation from related employers is aggregated for
purposes of the $1 mii-ion limit.

The report language on the H.R. 4210 conference
agreement, H.R. 4727, and H.R. 5260 indicates that it is
intended that the Secretary will prevent avoidance of the
rule through the use of arrangements other than
employee-employer arrangements or through other means.

Effective Dates

The provision in H.R. 4210 would be effective for
taxable years beginning after December 31, 1991.

The provision in H.R. 4727 would be effective for
amounts paid or accrued on or after July 1, 1992.

The provision in H.R. 5260 would be effective for
taxable years beginning on or after January 1, 1992.