Many employers will be surprised to learn that the American Rescue Plan Act of 2021 (“ARPA”), which was signed into law on March 11, 2011 and is primarily intended to provide an economic stimulus package of $1.9 trillion, expanded the group of covered employees under section 162(m) of the Internal Revenue Code of 1986, as amended (“Section 162(m)”), to include the five most highly compensated employees in addition to certain of the individuals already included in this group, effective for taxable years beginning in 2027.

Section 162(m) generally limits the ability of public companies to deduct more than $1 million per year for compensation paid to the company’s covered employees, which currently includes (1) the principal executive officer and principal financial officer, (2) the next three most highly compensated employees who are required to be reported on the company’s proxy tables, and (3) any individual who was a covered employee of the company or any predecessor for any taxable year beginning after December 31, 2016.  The ARPA expands the group of covered employees to include the five most highly compensated employees — in addition to the current covered employees described in the first two categories, but not necessarily the covered employees described in the third category, at least based on the text of the law –  effective for taxable years beginning in 2027.  

It is noteworthy that this new additional category of covered employees applies to employees generally and therefore may include non-executive employees.  In a bit of good news for employers, this new category of the five most highly compensated employees does not appear to be subject to the requirement to be continued to be included among the “covered employees” for all subsequent tax years.  As the ARPA amendments to Section 162(m) did not address how “compensation” will be determined for purposes of identifying this new category of covered employees, we look forward to additional guidance from the IRS that will help companies determine which individuals will be covered under the expanded covered employee definition.

Compliance with the revisions under the ARPA is not required until taxable years beginning in 2027. However, once the IRS provides additional guidance on how to determine the new category of covered employees, employers should consider implementing administrative processes to identify the covered employees before the required compliance period.