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Recently proposed IRS regulations reverse the reasoning of several past IRS private letter rulings regarding the application of the $1 million compensation cap of Section 162(m) to UPREIT structures in publicly traded REITs and other similarly structured businesses.
Proposed Treasury Regulation § 1.162-33(c)(3)(ii) provides that the allocated distributive share of the deduction attributable to compensation paid to a covered employee of a publicly held corporation by an affiliated partnership is subject to Section 162(m). This will effectively end the ability of publicly traded REITs and other similarly structured businesses, like “Up-C” structures, to take the position that compensation paid to their top executives by their operating partnerships is exempt from Section 162(m) deductibility limitations.
Because this new regulation contrasts with previously issued private letter rulings and the positions of many taxpayers, the IRS has established a special transition rule. The transition rule provides that the application of Section 162(m) to UPREIT structures (1) will only apply to tax years ending on or after December 20, 2019 (notwithstanding the earlier effective date of the Tax Cuts and Jobs Act generally), and (2) will not apply to compensation paid pursuant to written binding contracts in effect on December 20, 2019 and not materially modified or renewed after that date.
The takeaway for publicly traded REITs and other similarly structured businesses is that existing contracts should not be modified without careful consideration, and that other compensation arrangements (including all new compensation arrangements) will be subject to Section 162(m) deductibility limitations. End runs around Section 162(m) are now limited, but this development may increase the attractiveness of profits interest at the operating partnership level and deferred compensation and severance payable over multiple years (rather than in lump sums immediately following termination).
To discuss this development further, please contact David Kaplan or another member of our Employee Benefits and Executive Compensation Practice Group.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.