UPDATE: COVID-19 Employee Benefits FAQs for Employers: Focus on Executive Compensation
Updated FAQs, Week of March 30
This document updates our FAQs focused on executive compensation matters related to COVID-19, with additional questions and answers for the week of March 30 based on provisions included in the ‘‘Coronavirus Aid, Relief, and Economic Security Act,’’ or ‘‘CARES Act,’’ signed into law on March 27, 2020. For our complete list of FAQs on COVID-19 executive compensation, retirement plan, and health and welfare plan matters, please visit the Pepper Hamilton LLP / Troutman Sanders LLP COVID-19 Resource Center.
Does the CARES Act impose any limits on employee compensation?
Yes. The CARES Act includes a provision intended to prevent federal loans or loan guarantees from being used to enhance senior executive compensation. Section 4004 of the CARES Act imposes the following compensation limits on employers receiving a loan or loan guaranty under the stimulus program:
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Limit on “total compensation” for any officer or employee who received “total compensation” in 2019 over $425,000 and up to $3,000,000: For any consecutive 12 months during the period beginning on the date of the stimulus loan or loan guarantee and ending one year after the loan or loan guarantee ceases to be outstanding (the “Restriction Period”), the officer or employee may not receive “total compensation” in excess of the “total compensation” received in 2019.
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Limit on “total compensation” for any officer or employee who received “total compensation” in 2019 over $3,000,000: For any consecutive 12 months during the Restriction Period, the officer or employee may not receive “total compensation” in excess of the sum of (i) $3,000,000 and (ii) 50% of the amount by which the individual’s “total compensation” for 2019 exceeded $3,000,000. For example, if 2019 “total compensation” was $5,000,000, the limit for any consecutive 12-months during the Restriction Period would be $4,000,000 (i.e., $3,000,000 plus 50% of the additional $2,000,000 received in 2019).
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Limit on severance for any officer or employee who received “total compensation” in 2019 over $425,000: During the Restriction Period, the officer or employee may not receive “severance pay or other benefits upon termination of employment” that exceed two times the “maximum total compensation” received by the individual in 2019.
Under Section 4116 of the CARES Act, air carriers and related contractors accepting financial assistance are subject to similar restrictions during the two-year period from March 24, 2020 through March 24, 2022.
What is “total compensation” for purposes of the employee compensation limits under the CARES Act?
For purposes of the CARES Act, “total compensation” is defined broadly to include “salary, bonus, awards of stock, and other financial benefits.” However, the ACT does not indicate whether total compensation will be measured when granted, vested or taxable, or by some other standard. How equity awards are counted for purposes of measuring “total compensation” will be especially important. Timely agency guidance will be needed to better define this critical term.
What are “severance pay and other benefits upon termination of employment” for purposes of the employee compensation limits under the CARES Act?
The CARES Act does not define “severance pay or other benefits upon termination of employment.” Interpretive questions include whether accelerated vesting of equity-based awards (or other forms of unvested compensation) will be considered “severance pay” and, if so, how the value of accelerated vesting will be measured. Similarly, clarification is necessary regarding whether non-qualified retirement plan benefits will count as “benefits upon termination of employment.”
How do we address employees with contractual commitments to compensation or severance that would exceed these limits?
Companies accepting loan, loan guarantees and other investments under the CARES Act are subject to the compensation limits described above during the Restriction Period. Employers with contractual commitments to pay employees compensation or severance in excess of the CARES Act limitations are advised to negotiate with those employees to bring the employee’s compensation or severance within the Act’s limits, unless agency rules are issued to provide protection for any grandfathered contractual obligations. Employers wishing to modify such contractual obligations should take into account Internal Revenue Code Section 409A to ensure any changes will not result in adverse tax consequences.
In cases where an executive expects to receive severance and the severance payable would exceed the CARES Act limits, an employer may need to accelerate the planned severance prior to accessing CARES Act loans or loan guarantees again subject to considerations under Code Section 209A.
What are some of the planning opportunities related to the compensation limits under the CARES Act?
If total compensation is measured when taxable, there may be opportunities for planning. The implementation of deferral arrangements may enable executives to postpone the recognition of income beyond the Restriction Period, if permitted by the rules adopted by the governing agencies. It may even be possible to implement such deferrals for certain 2020 compensation, especially for companies that do not have existing deferral programs. Any deferral strategy will need to consider compliance with Internal Revenue Code Section 409A.
The rolling 12-month compensation limitation also creates an opportunity for planning. Employers often have the flexibility to vary the timing of compensation within (and occasionally, somewhat beyond) the calendar year. By framing the compensation limit with reference to consecutive 12-month periods (rather than the calendar year), there will be a need (and an opportunity) for employers to carefully manage payment timing.
Example: Assume an employee with a $500,000 total compensation limit is scheduled to receive a $300,000 bonus payment in June 2021. Assume this would otherwise cause the employee to have received $650,000 during the rolling 12-month period from July 1, 2020 (when a CARES Act loan was taken) to June 30, 2021. The employer might be able to modify the bonus payment terms so that $150,000 is paid in June 2021 and the remaining $150,000 is paid in July 2021.