Last month, the Washington Court of Appeals affirmed a lower court’s decision to dismiss a challenge to the recently enacted payroll expense tax in Seattle, WA. Seattle Metro. Chamber of Commerce v. City of Seattle, No. 82830-4-I, 2022 WL 2206828 (Wash. Ct. App. June 21, 2022).
The tax, which went into effect on January 1, 2021, applies to entities “engaging in business within Seattle” and is measured using the business’s “payroll expense” (defined as “compensation paid in Seattle to employees,” including wages, commissions, salaries, stock, grants, gifts, bonuses and stipends). The tax only applies to businesses with a payroll expense of more than $7 million in the prior calendar year, and compensation is considered “paid in Seattle” if the employee works more than 50% of the time in the city.
Section 162(m) of the Internal Revenue Code (Code) previously limited the tax deduction to $1M annually for covered employee compensation paid by a company that is publicly traded, subject to some important exceptions. The Tax Cuts and Jobs Act modified the reach of Code Section 162(m) in several significant ways.
Expanding the number of companies to which Section 162(m) will apply, including non-public companies that register debt or equity securities with the Securities and Exchange Commission, like foreign companies publicly traded through American depositary receipts (ADRs);
Expanding the number of covered employees to five and including the chief financial officer, with a provision that any covered employee after 2016 permanently remains a covered employee;
Eliminating performance-based and commission-based exceptions to the $1M deduction limit; and
Grandfathering certain compensation provided under a written and binding agreement in effect on November 2, 2017, if no material changes are made to such agreement.
These changes will have a significant effect not just on performance-based compensation, but also on stock options, stock appreciation rights and even nonqualified deferred compensation plans and supplemental executive retirement plans. To navigate these changes, Andrew Liazos stressed the importance of understanding the new grandfathering provisions under Section 162(m) and their corresponding planning opportunities at the Mid-Year Meeting of the American Bar Association’s Tax Section on February 10, 2018 in the attached slides.
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