Par. 2. Section 1.162-33 is amended by: a. Revising paragraphs (c)(1)(vi)(W)( 2 ) and (c)(2)(i)(C); b. Adding paragraphs (c)(2)(i)(D) and (c)(2)(vii)(CC) through (EE); c. Redesignating paragraphs (c)(3)(iii) and (iv) as paragraphs (c)(3)(v) and (vi); d. Adding new paragraphs (c)(3)(iii) and (iv) and adding paragraphs (c)(3)(vi)(D) and (E); e. Revising paragraph (h)(2)(ii)(C); and f. Adding paragraphs (h)(2)(ii)(F) and G. The revisions and additions read as follows:
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(c) * * *
(1) * * *
(vi) * * *
(W) * * *
( 2 ) Conclusion. The result is the same as in paragraph (c)(1)(vi)(T) of this section ( Example 20 ). Even though Corporations P, Q, and R each are publicly held corporations, they comprise an affiliated group. Because Employee C is a covered employee of both Corporations P and Q, the amount disallowed as a deduction is prorated separately between Corporations P and R and between Corporations Q and R.
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(2) * * *
(i) * * *
(C) Any individual who was a covered employee of the publicly held corporation (or any predecessor of a publicly held corporation, within the meaning of paragraph (c)(2)(ii) of this section) for any preceding taxable year beginning after December 31, 2016, other than an individual who was a covered employee in that year solely on account of paragraph (c)(2)(i)(D) of this section. For taxable years beginning prior to January 1, 2018, covered employees are identified in accordance with the rules in § 1.162-27(c)(2).
(D) The five highest compensated employees of the publicly held corporation for the taxable year regardless of whether the individual is serving at the end of the publicly held corporation's taxable year, other than any individual described in paragraph (c)(2)(i)(A) or (B) of this section, determined in accordance with the rules in this paragraph (c)(2)(i)(D). See paragraph (c)(3)(iv) of this section for a special rule treating certain employees of a person other than the publicly held corporation as employees of the publicly held corporation.
( 1 ) Compensation. The amount of compensation used to identify the five most highly compensated employees for the taxable year for purposes of paragraph (c)(2)(i)(D) of this section is the amount of compensation as defined in paragraph (c)(3) of this section, provided that, in determining compensation for purposes of applying this paragraph (c)(2)(i)(D), references to “covered employee” or “covered employee (as defined in paragraphs (c)(2)(i) through (v) of this section)” in paragraph (c)(3) of this section shall be replaced with references to “employee.”
( 2 ) Employee. For purposes of this paragraph (c)(2)(i)(D), the term “employee” means an employee as defined in section 3401(c).
( 3 ) Determining the employees eligible to be the five highest compensated employees with respect to an affiliated group with one publicly held corporation. In the case of an affiliated group (as defined in paragraph (c)(1)(ii) of this section) that includes one publicly held corporation (as defined in paragraph (c)(1)(i) of this section), an employee of any member of the affiliated group is eligible to be one of the five highest compensated employees of the publicly held corporation regardless of whether the individual is an employee of the publicly held corporation itself or performs services for the publicly held corporation itself.
( 4 ) Determining the employees eligible to be the five highest compensated employees with respect to an affiliated group with more than one publicly held corporation. In the case of an affiliated group (as defined in paragraph (c)(1)(ii) of this section) that includes more than one publicly held corporation (as defined in paragraph (c)(1)(i) of this section), the group of employees eligible to be the five highest compensated employees is determined separately with respect to the parent corporation (as defined below) and each publicly held corporation (as defined in paragraph (c)(1)(i) of this section) that is not the parent corporation (an additional publicly held corporation). For this purpose, the parent corporation is the highest corporation in the chain or chains of includible corporations (that comprise the affiliated group) that is a publicly held corporation as defined in paragraph (c)(1)(i) of this section. In the case of an affiliated group in which more than one member may be the parent corporation (such as where a common parent that is not publicly held owns multiple publicly held corporations), the affiliated group must choose which member to treat as the parent corporation for the taxable year. With respect to the parent corporation, an employee of any member of the affiliated group, excluding a member of an affiliated group of an additional publicly held corporation (as defined below), is eligible to be one of its five highest compensated employees regardless of whether the individual is an employee of the parent corporation itself or performs services for the parent corporation itself. Similarly, with respect to an additional publicly held corporation, any employee of the affiliated group of the additional publicly held corporation is eligible to be one of its five highest compensated employees regardless of whether the individual is an employee of the additional publicly held corporation itself or performs services for the additional publicly held corporation itself. For this purpose, an affiliated group of an additional publicly held corporation means, with respect to any corporation, the affiliated group which would be determined under section 1504(a) if such corporation were the common parent and if section 1504(b) did not apply. These rules similarly apply to all additional publicly held corporations, beginning at the bottom of each chain of corporations and proceeding up until all members of the affiliated group that may be so allocated have been allocated to one (and only one) affiliated group of an additional publicly held corporation. If the affiliated group includes only publicly held corporations (as defined in paragraph (c)(1)(i) of this section), the affiliated group used to determine the employees eligible to be each publicly held corporation's five highest compensated employees is that publicly held corporation itself.
( 5 ) Determining the five highest compensated employees in an affiliated group. In determining whether an employee is one of the five highest compensated employees with respect to the parent corporation (as defined in paragraph (c)(2)(i)(D)( 4 ) of this section) for the taxable year, compensation paid by each member of the affiliated group (as defined in paragraph (c)(1)(ii) of this section) in the taxable year, excluding any member of an affiliated group of an additional publicly held corporation (as defined in paragraph (c)(2)(i)(D)( 4 ) of this section), is aggregated. In determining whether an employee is one of the five highest compensated employees with respect to a publicly held corporation (as defined in paragraph (c)(1)(i) of this section) in an affiliated group of an additional publicly held corporation, compensation paid by each member of the affiliated group of the additional publicly held corporation in the taxable year is aggregated.
( 6 ) Application of proration rules. The proration rules in paragraph (c)(1)(ii)(B) of this section generally apply in the same way to covered employees determined under this paragraph (c)(2)(i)(D), except that a publicly held corporation or publicly held payor corporation refers to the portion of the affiliated group of which the publicly held corporation (as defined in paragraph (c)(1)(i) of this section) is a part, as determined under paragraph (c)(2)(i)(D)( 4 ) of this section.
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(vii) * * *
(CC) Example 29 (Individual as one of the five highest compensated employees of a publicly held corporation that includes the affiliated group) —( 1 ) Facts. Corporation CO is a publicly held corporation for its 2026 and 2027 taxable years. Corporation CP is a foreign corporation and is a wholly-owned subsidiary of Corporation CO. Corporation CP is a controlled foreign corporation, but the only income it has is effectively connected with a U.S. trade or business. Corporation CO is a partner in Partnership CQ (a partnership for Federal tax purposes). Under the partnership agreement, Corporation CO has a 50% distributive share of the partnership's income, gain, loss, deductions, and credits. These allocations comply with section 704(b) and its regulations. Employee E.O. is an employee of Corporation CO. In 2026, Employee E.O. is a covered employee of Corporation CO because Employee E.O. is one of the three highest compensated executive officers of Corporation CO. In 2027, Employee E.O. is not an executive officer of Corporation CO but performs services for and receives compensation from Corporations CO for services as its employee. Furthermore, in 2027, Employee E.O. performs services for and receives compensation from Corporation CP and Partnership CQ (Employee E.O. is not a partner of Partnership CQ). In 2027, the total compensation paid to Employee E.O. is $3,600,000, of which Corporation CO pays $1,500,000, Corporation CP pays $900,000, and Partnership CQ pays $1,200,000. For the 2027 taxable year, the total compensation paid to any employee of Corporations CO and CP did not exceed $2,500,000.
( 2 ) Conclusion (Compensation paid by Corporation CO). The $1,500,000 in compensation paid by Corporation CO is taken into account to determine whether Employee E.O. is one of the five highest compensated employees of Corporation CO for its 2027 taxable year.
( 3 ) Conclusion (Compensation paid by Corporation CP). Corporations CO and CP are an affiliated group as defined in paragraph (c)(1)(ii) of this section. Therefore, the $900,000 in compensation paid by Corporation CP is taken into account to determine whether Employee E.O. is one of the five highest compensated employees of Corporation CO for its 2027 taxable year. Because a publicly held corporation includes an affiliated group for purposes of paragraph (c)(3) of this section, the result would be the same even if there were intermediary privately held subsidiaries between Corporations CO and CP as long as all these corporations comprised an affiliated group.
( 4 ) Conclusion (Compensation paid by Partnership CQ). Under paragraph (c)(3)(ii) of this section, Corporation CO's $600,000 distributive share of Partnership CQ's deduction (50% of $1,200,000) is compensation that is taken into account to determine whether Employee E.O. is one of the five highest compensated employees of Corporation CO for its 2027 taxable year. Because a publicly held corporation includes an affiliated group for purposes of paragraph (c)(3) of this section, the result would be the same even if there were an intermediary privately held subsidiary between Corporation CO and Partnership CQ (so that, instead of Corporation CO, an intermediary subsidiary was a partner in Partnership CQ), as long as Corporation CO and the intermediary subsidiary comprised an affiliated group.
( 5 ) Conclusion (Employee E.O. as a covered employee). Because the aggregate compensation taken into account with respect to Employee E.O. is $3,000,000 ($1,500,000 + $900,000 + $600,000), Employee E.O. is a covered employee of Corporation CO for its 2027 taxable year by reason of being one of its five highest compensated employees for the taxable year as provided in paragraph (c)(2)(i)(D) of this section (even though Employee E.O. is also a covered employee of Corporation CO for its 2027 taxable year by reason of being a covered employee for its 2026 taxable year (as provided in paragraph (c)(2)(i)(C) of this section)).
( 6 ) Conclusion (Amount disallowed as a deduction). Because the compensation paid by all affiliated group members is aggregated for purposes of section 162(m)(1), the aggregate compensation of $3,000,000 exceeds the limitation in section 162(m)(1) and $2,000,000 of the compensation paid to Employee E.O. is nondeductible. Corporations CO and CP each are treated as paying a ratable portion of the nondeductible compensation. Thus, two thirds of each corporation's payment will be nondeductible. Taking into account Corporation CO's $600,000 distributive share of the Partnership CQ's deduction, Corporation CO has an otherwise allowable deduction of $2,100,000 ($1,500,000 + $600,000). Therefore, Corporation CO has a nondeductible compensation expense of $1,400,000 ($2,100,000 × $2,000,000/$3,000,000). Corporation CP has an otherwise allowable deduction of $900,000, of which $600,000 ($900,000 × $2,000,000/$3,000,000) is a nondeductible compensation expense.
(DD) Example 30 (Individual as one of the five highest compensated employees of a publicly held corporation that includes the affiliated group and affiliated groups of additional publicly held corporations) —( 1 ) Facts. Corporations CR, CT, and CV are publicly held corporations for their 2027 taxable years. Corporations CS and CU are privately held for their 2027 taxable years. Corporation CT is a subsidiary of Corporation CS, which is a subsidiary of Corporation CR. Corporation CV is a subsidiary of Corporation CU, which is a subsidiary of Corporation CT. Corporations CR, CS, CT, CU, and CV are members of an affiliated group. Employee EP is an employee of Corporations CR, CS, CU, and CV. In 2027, Employee EP performs services for and receives compensation from Corporations CR, CS, CU, and CV. The total compensation paid to Employee EP from the affiliated group members is $7,000,000 for the taxable year, of which Corporation CR pays $1,200,000, Corporation CS pays $1,800,000, Corporation CU pays $1,500,000, and Corporation CV pays $2,500,000.
( 2 ) Conclusion (Employee EP is eligible to be a covered employee of Corporation CR). Because Employee EP is an employee of Corporation CR, Employee EP is eligible to be one of the five highest compensated employees of Corporation CR. Even though Corporations CR, CS, CT, CU, and CV comprise an affiliated group as defined in paragraph (c)(1)(ii) of this section, because Corporations CT and CV are additional publicly held corporations of the affiliated group, the affiliated group contains affiliated groups of these additional publicly held corporations (as defined in paragraph (c)(2)(i)(D)( 4 ) of this section). Compensation paid by the affiliated groups of these additional publicly held corporations is not taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CR for its 2027 taxable year. Accordingly, Corporations CT and CU comprise an affiliated group of an additional publicly held corporation (Corporation CT), and compensation paid by Corporation CU is not taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CR for its 2027 taxable year. Furthermore, Corporation CV is an affiliated group of an additional publicly held corporation (Corporation CV), and compensation paid by Corporation CV is not taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CR for its 2027 taxable year. Therefore, only the $1,200,000 in compensation paid by Corporation CR and the $1,800,000 paid by Corporation CS are taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CR for its 2027 taxable year.
( 3 ) Conclusion (Employee EP is eligible to be a covered employee of Corporation CT). Because Corporation CT is a publicly held corporation, Corporations CT and CU comprise an affiliated group of an additional publicly held corporation (as defined in paragraph (c)(2)(i)(D)( 4 ) of this section). Because an employee of any member of the affiliated group is eligible to be one of the five highest compensated employees of the publicly held corporation (regardless of whether the employee performs services for the publicly held corporation), Employee EP is eligible to be a covered employee of Corporation CT, even though Employee EP does not perform services for Corporation CT. Because only compensation paid by a member of the affiliated group of the additional publicly held corporation in the taxable year is taken into account to determine whether an individual is one of the five highest compensated employees with respect to the additional publicly held corporation, only compensation paid by Corporation CU is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CT for its 2027 taxable year. Accordingly, the $1,500,000 in compensation paid by Corporation CU is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CT for its 2027 taxable year.
( 4 ) Conclusion (Employee EP is eligible to be a covered employee of Corporation CV). Because Employee EP is an employee of Corporation CV, Employee EP is eligible to be one of the five highest compensated employees of Corporation CV. Because Corporation CV is a publicly held corporation, Corporation CV comprises an affiliated group of an additional publicly held corporation (as defined in paragraph (c)(2)(i)(D)( 4 ) of this section). Because only compensation paid by a member of the affiliated group of the additional publicly held corporation in the taxable year is taken into account to determine whether an individual is one of the five highest compensated employees with respect to the additional publicly held corporation, only compensation paid by Corporation CV is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CV for its 2027 taxable year. Accordingly, the $2,500,000 in compensation paid by Corporation CV is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CV for its 2027 taxable year.
( 5 ) Conclusion (Employee EP as covered employee of Corporation CR). The $1,200,000 in compensation paid by Corporation CR and the $1,800,000 in compensation paid by Corporation CS are taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CR for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Employee EP is a covered employee of Corporation CR, then Corporation CR's deduction for $1,200,000 and Corporation CS's deduction for $1,800,000 for the 2027 taxable year would be subject to the section 162(m)(1) limit. Because the compensation paid by the affiliated group members is aggregated for purposes of section 162(m)(1), the aggregate compensation of $3,000,000 exceeds the limitation in section 162(m)(1) and $2,000,000 of the compensation paid to Employee EP would be nondeductible. Corporations CR and CS each are treated as paying a ratable portion of the nondeductible compensation. Corporation CR has an otherwise allowable deduction of $1,200,000, of which $800,000 ($1,200,000 × $2,000,000/$3,000,000) would be a nondeductible compensation expense. Corporation CS has an otherwise allowable deduction of $1,800,000, of which $1,200,000 ($1,800,000 × $2,000,000/$3,000,000) would be a nondeductible compensation expense.
( 6 ) Conclusion (Employee EP as covered employee of Corporation CT). The $1,500,000 in compensation paid by Corporation CU is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CT for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Employee EP is a covered employee of Corporation CT, then Corporation CU's deduction for $1,500,000 for the 2027 taxable year would be subject to the section 162(m)(1) limit. Accordingly, pursuant to paragraph (c)(2)(i)(D)(6) of this section, Corporation CU would have a nondeductible compensation expense of $500,000.
( 7 ) Conclusion (Employee EP as covered employee of Corporation CV). The $2,500,000 in compensation paid by Corporation CV is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CV for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Employee EP is a covered employee of Corporation CV, then Corporation CV's deduction for $2,500,000 for the 2027 taxable year would be subject to the section 162(m)(1) limit. Accordingly, Corporation CV would have a nondeductible compensation expense of $1,500,000.
(EE) Example 31 (Individual as one of the five highest compensated employees of a publicly held corporation that includes the affiliated group that chooses a parent corporation) —( 1 ) Facts. Corporations CX and CY are publicly held corporations for their 2027 taxable years. Corporations CW and CZ are privately held corporations for their 2027 taxable years. Corporations CX and CY are subsidiaries of Corporation CW. Corporations CX and CY each directly own 50% (by vote and value) of Corporation CZ's only class of stock. In 2027, Employee EQ performs services for and receives compensation from Corporations CW, CX, CY, and CZ. The total compensation paid to Employee EQ from all corporations is $4,700,000 for the taxable year, of which Corporation CW pays $1,500,000, Corporation CX pays $900,000, Corporation CY pays $1,700,000, and Corporation CZ pays $600,000.
( 2 ) Conclusion (Employee EQ is eligible to be a covered employee of Corporations CX and CY). Because Employee EQ is an employee of Corporations CX and CY, Employee EQ is eligible to be one of the five highest compensated employees of these publicly held corporations. Because both Corporations CX and CY are the highest publicly held corporations in the chain of includible corporations that comprise an affiliated group (composed of Corporations CW, CX, CY, and CZ) as defined in paragraph (c)(1)(ii) of this section, the affiliated group may choose to treat either Corporation CX or CY as the parent corporation for the 2027 taxable year. If the affiliated group chooses to treat Corporation CX as the parent corporation, then only compensation paid by Corporations CW, CX, and CZ is taken into account to determine whether Employee EQ is one of the five highest compensated employees of Corporation CX for the 2027 taxable year. Because Corporation CY is an affiliated group of the additional publicly held corporation composed of one corporation (Corporation CY), only compensation paid by Corporation CY is taken into account to determine whether Employee EQ is one of the five highest compensated employees of Corporation CY. A similar analysis would apply if the affiliated group chose to treat Corporation CY as the parent.
( 3 ) Conclusion (Employee EQ as a covered employee of Corporation CX). The $1,500,000 in compensation paid by Corporation CW, the $900,000 paid by Corporation CX, and the $600,000 in compensation paid by Corporation CZ (that is, aggregate compensation of $3,000,000) are taken into account to determine whether Employee EQ is one of the five highest compensated employees of Corporation CX for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Employee EQ is a covered employee of Corporation CX, then Corporation CW's deduction for $1,500,000, Corporation CX's deduction for $900,000, and Corporation CZ's deduction for $600,000 for the 2027 taxable year would be subject to the section 162(m)(1) limit. Because the compensation paid by the affiliated group members is aggregated for purposes of section 162(m)(1), the aggregate compensation of $3,000,000 exceeds the limitation in section 162(m)(1) and $2,000,000 of the compensation paid to Employee EQ would be nondeductible. Corporations CW, CX, and CZ each are treated as paying a ratable portion of the nondeductible compensation. Corporation CW would have a nondeductible compensation expense of $1,000,000 ($1,500,000 × $2,000,000/$3,000,000). Corporation CX would have a nondeductible compensation expense of $600,000 ($900,000 × $2,000,000/$3,000,000). Corporation CZ would have a nondeductible compensation expense of $400,000 ($600,000 × $2,000,000/$3,000,000).
( 4 ) Conclusion (Employee EQ as a covered employee of Corporation CY). The $1,700,000 in compensation paid by Corporation CY is taken into account to determine whether Employee EQ is one of the five highest compensated employees of Corporation CY for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Employee EQ is a covered employee of Corporation CY, then Corporation CY's deduction for $1,700,000 for the 2027 taxable year would be subject to the section 162(m)(1) limit. Accordingly, Corporation CY would have a nondeductible compensation expense of $700,000.
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(iii) Compensation paid by a controlled foreign corporation that is a member of an affiliated group. For purposes of paragraph (c)(3)(i) of this section, compensation includes a publicly held corporation's pro rata share (as determined under the principles of sections 951(a)(2) and 951A(e)(1)) of the amounts that would be claimed by a controlled foreign corporation (as defined in section 957) that is a member of an affiliated group (as defined in paragraph (c)(1)(ii) of this section) as properly allocable to gross income included under sections 951(a)(1) and 951A(a) under sections 954(b)(5), 951A(c)(2)(A)(ii), and similar provisions, determined without regard to the disallowance of any such expenses by reason of section 162(m) and these regulations, for compensation expenses attributable to the remuneration paid by the controlled foreign corporation to a covered employee of a publicly held corporation for services performed by the covered employee.
(iv) Amounts paid to individuals performing substantially all their services for a publicly held corporation. Notwithstanding paragraph (c)(2)(i)(D)( 2 ) of this section, for purposes of paragraph (c)(2)(i)(D) of this section, an employee of a publicly held corporation includes an individual who, pursuant to section 3401(c), is an employee of a person other than the publicly held corporation but performs substantially all the individual's services during the relevant taxable year for the publicly held corporation. Consequently, for purposes of paragraph (c)(3) of this section, compensation includes the aggregate amount allowable as a deduction to the publicly held corporation under chapter 1 of the Internal Revenue Code for the taxable year (determined without regard to section 162(m)(1)) to obtain the services performed by such individual, whether or not the particular services that give rise to the deduction were performed during the relevant taxable year. This rule applies regardless of how the amounts allowable as a deduction are paid or denominated, and regardless of whether the individual is compensated directly or by a third-party payor, including a related organization or certified professional employer organization under section 7705. The disallowance under paragraph (b) of this section likewise is applied to those amounts, however denominated, otherwise allowable as a deduction to obtain those services. Nothing in the previous sentence is intended to imply that such amounts paid to a third party for services by a covered employee, however denominated, are not already treated as remuneration for those services and thus compensation for purposes of paragraph (c)(3) of this section.
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(D) Example 4 —( 1 ) Facts. Corporation U is a publicly held corporation for its 2027 taxable year and is not a member of an affiliated group. Corporation U has a services agreement with unrelated Corporation V. In Corporation U's 2027 taxable year, it pays $1,500,000 to Corporation V pursuant to the agreement in exchange for the services of an interim chief accountant (Individual E) in the same year. The $1,500,000 is otherwise deductible for Corporation U's 2027 taxable year. Individual E performs substantially all Individual E's services in 2027 for Corporation U.
( 2 ) Conclusion. Pursuant to paragraph (c)(3)(iv) of this section, Individual E is treated as an employee of Corporation U for purposes of this section. The $1,500,000 paid to Corporation V by Corporation U in 2027 is compensation within the meaning of paragraph (c)(3) of this section and is taken into account to determine whether Individual E is a covered employee as one of the five highest compensated employees of Corporation U for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Individual E is a covered employee of Corporation U, then Corporation U's deduction for $1,500,000 for the 2027 taxable year is subject to the section 162(m)(1) limit. Because a publicly held corporation includes an affiliated group for purposes of paragraph (c)(3) of this section, the result would be the same even if Corporation U owned a privately held subsidiary, and Individual E performed substantially all Individual E's services for the subsidiary. In addition, the result would also be the same if Individual E performed substantially all Individual E's services for both Corporation U and its subsidiary, as long as Corporation U and its subsidiary comprised an affiliated group (regardless of whether Corporation U or its subsidiary paid the $1,500,000 to Corporation V). In such case, pursuant to paragraph (c)(1)(ii) of this section, the amount disallowed as a deduction would be prorated between Corporation U and its subsidiary. Furthermore, the result would be the same even if Individual E were an employee of Corporation U (regardless of whether Individual E were also an employee of Corporation V).
(E) Example 5 —( 1 ) Facts. Corporation W is a publicly held corporation for its 2027 taxable year and is not a member of an affiliated group. Corporation W is a partner in Partnership X (a partnership for Federal tax purposes), that owns all the stock of Corporation Y. Under the partnership agreement, Corporation W has a 50% distributive share of the partnership's income, gain, loss, deductions, and credits. These allocations comply with section 704(b) and its regulations. Individual F is a partner of Partnership X. In 2027, Individual F performs services for the partnership, and the partnership pays $1,000,000 to Individual F as a guaranteed payment for these services. With respect to the $1,000,000 paid to Individual F, a deduction of $500,000 is allocated to Corporation W. Corporation W's $500,000 distributive share of the partnership's deduction is reported separately to Corporation W pursuant to § 1.702-1(a)(8)(iii). Individual F is also an employee (within the meaning of section 3401(c)) of Corporation Y. In Corporation W's 2027 taxable year, it pays $8,000,000 to Corporation Y in exchange for Individual F's services. The $8,000,000 is otherwise deductible for Corporation W's 2027 taxable year. Individual F performs substantially all Individual F's services in 2027 for Corporation W.
( 2 ) Conclusion. Pursuant to paragraph (c)(3)(iv) of this section, Individual F is treated as an employee of Corporation W for purposes of this section. The entire $8,000,000 paid to Corporation Y by Corporation W in 2027 is compensation within the meaning of paragraph (c)(3) of this section and is taken into account to determine whether Individual F is one of the five highest compensated employees of Corporation W for its 2027 taxable year. Because Corporation W's $500,000 distributive share of the partnership's deduction is attributable to the compensation paid by the partnership for services performed by Individual F (who is treated as an employee of Corporation W), the $500,000 is compensation within the meaning of paragraph (c)(3)(ii) of this section. Accordingly, Corporation W's $500,000 distributive share of the partnership's deduction is aggregated with Corporation W's deduction for $8,000,0000 paid to Corporation Y in determining whether Individual F is a covered employee as one of the five highest compensated employees of Corporation W for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Individual F is a covered employee of Corporation W, then Corporation W's deduction for $8,500,000 for its 2027 taxable year is subject to the section 162(m)(1) limit. Because a publicly held corporation includes an affiliated group for purposes of paragraph (c)(3) of this section, the result would be the same even if there were an intermediary privately held subsidiary between Corporation W and Partnership X (so that, instead of Corporation W, an intermediary subsidiary was a partner in Partnership X), as long as Corporation W and the intermediary subsidiary comprised an affiliated group, and as long as Individual F performed substantially all Individual F's services for the intermediary subsidiary. Furthermore, the result would also be the same if Individual F performed substantially all Individual F's services for both Corporation W and the intermediary subsidiary (regardless of whether Corporation W or the intermediary subsidiary paid the $8,000,000 to Corporation Y). In such case, pursuant to paragraph (c)(1)(ii) of this section, the amount disallowed as a deduction would be prorated between Corporation W and the intermediary subsidiary.
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(h) * * *
(2) * * *
(ii) * * *
(C) Definition of compensation. The definition of compensation provided in paragraph (c)(3)(ii) of this section (relating to distributive share of partnership deductions for compensation paid) applies to any deduction for compensation that is paid after December 18, 2020. The definition of compensation in paragraph (c)(3)(ii) of this section does not apply to compensation paid pursuant to a written binding contract that is in effect on December 20, 2019, and that is not materially modified after that date. For purposes of paragraph (h)(2)(C) of this section, written binding contract and material modification have the same meanings as provided in paragraphs (g)(1) and (2) of this section. The definition of compensation provided in paragraphs (c)(3)(iii) and (iv) of this section and the examples in paragraphs (c)(3)(vi)(D) and (E) of this section apply to any deduction for compensation that is otherwise deductible for taxable years beginning after the later of December 31, 2026, or the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register .
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(F) Five highest compensated employees. Paragraph (c)(2)(i)(D) of this section (describing the five highest compensated employees of a publicly held corporation) and the examples in paragraphs (c)(2)(vii)(CC) through (EE) of this section apply to taxable years beginning after the later of December 31, 2026, or the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register .
(G) Amendment to paragraph (c)(1)(vi)(W)(2) of this section. The amendment to paragraph (c)(1)(vi)(W)( 2 ) of this section ( Example 23 ) to reference paragraph (c)(1)(vi)(T) of this section ( Example 20 ) is proposed to apply to taxable years ending on or after January 16, 2025.