The OBBBA changed the entity aggregation rules for Section 162(m) effective for tax years beginning after December 31, 2025. For calendar-year companies, Q2 2026 is the second quarter under the new regime.
The change sounds technical but its practical effect is significant: more compensation is now nondeductible. Before 2026, Section 162(m)'s $1 million deduction limit was applied by aggregating compensation across an affiliated group of corporations defined under Section 1504. Starting January 1, 2026, the aggregation is done across the broader controlled group defined under Sections 414(b), (c), (m), and (o). The controlled group definition is wider. It includes entities that were outside the affiliated group. It includes partnerships, LLCs, and unincorporated entities under common control. And it includes entities in Up-C and UPREIT structures that were not previously pulled into the Section 162(m) calculation.
The PwC analysis of the OBBBA Section 162(m) changes is explicit about the complexity: for the 2026 tax year (the first year the OBBBA aggregation rule applies), a separate analysis is required that is distinct from the analysis that will apply in 2027 and later, when ARPA's additional covered employee expansion also takes effect. The compensation committee, legal, HR, and tax functions need to coordinate to identify the new controlled group perimeter, identify all executives whose compensation now needs to be aggregated across that perimeter, and recalculate the Section 162(m) deduction limitation and allocation for the full 2026 tax year before the Q2 provision is finalised.
This post explains the specific change from affiliated group to controlled group, which entities are now within the aggregation perimeter, who is a covered employee in 2026, how the change flows through the Q2 2026 ASC 740 deferred tax calculation, and what the Q2 10-Q needs to disclose.
What Is Section 162(m) and What Did It Limit Before?
Section 162(m) of the Internal Revenue Code limits the federal income tax deduction available to a publicly held corporation for compensation paid to covered employees. The limit is $1 million per covered employee per taxable year. Compensation in excess of $1 million paid to a covered employee is permanently nondeductible. The disallowed amount does not carry forward. It is simply lost as a deduction.
Prior to the OBBBA changes, covered employees for 2026 purposes included: the principal executive officer, the principal financial officer, and the three other most highly compensated executive officers of the publicly held corporation. This is the TCJA 2017 definition, which eliminated the prior performance-based compensation exception and expanded the covered employee group to include the PFO alongside the PEO. Anyone who was a covered employee in any year since 2017 is permanently a covered employee under the once-covered-always-covered rule, even after termination of employment.
The prior aggregation rule under the Section 162(m) regulations applied the $1 million limit by reference to an affiliated group under Section 1504. An affiliated group under Section 1504 requires 80% common ownership by vote and value among corporations. Partnerships, LLCs, and other non-corporate entities are excluded from the Section 1504 affiliated group. So a publicly held corporation that owned a partnership or LLC subsidiary, or that was part of a structure where the operating entity was a partnership (such as an UPREIT or Up-C structure), would not aggregate the partnership's compensation payments when applying the Section 162(m) limit.
The allocation of the disallowed deduction among affiliated group members was prorated based on each member's share of total compensation paid to the covered employee. This allocation rule remains conceptually intact under the OBBBA but is now applied across the broader controlled group.
What Did the OBBBA Change About Section 162(m) Aggregation?
The OBBBA added statutory aggregation rules for Section 162(m) that replace the prior regulatory framework under the affiliated group rules. The change is in Section 162(m) itself, meaning it supersedes the prior Treasury regulations that applied the Section 1504 affiliated group definition. PwC confirms: the OBBBA's amendments to Section 162(m) replace the current affiliated group and deduction limitation allocation rules under the regulations.
The new statutory rule provides: if a publicly held corporation is a member of a controlled group under Sections 414(b), (c), (m), and (o), all members of the controlled group are examined for purposes of the Section 162(m) deduction disallowance. If any member of the controlled group provides remuneration to a specified covered employee and the total amount of covered remuneration provided by all group members to that employee exceeds $1 million, the deduction allowed to the group is limited to $1 million. The allowable deduction is then allocated among the controlled group members that paid compensation to the covered employee in proportion to each member's share of total compensation paid.
The Covington and Burling analysis confirms the scope: the new rule applies to a broader group of entities than the aggregation rule in the existing Treasury regulations, which applied to affiliated groups of corporations under Section 1504.
Three specific entity types that are newly within scope under the controlled group definition that were outside the affiliated group definition:
Partnerships under common control. Sections 414(c) and (o) extend controlled group principles to partnerships and other unincorporated entities based on common ownership or control. A publicly held corporation that is a partner in a partnership where one entity controls 80% or more of the interests is now in a controlled group with that partnership for Section 162(m) purposes.
Limited liability companies. LLCs treated as partnerships for tax purposes are subject to the Section 414 controlled group analysis. An LLC subsidiary of a publicly held corporation is now within the controlled group for Section 162(m) even though it was not within the affiliated group under Section 1504.
Operating entities in Up-C and UPREIT structures. Troutman Pepper Locke specifically identifies this: for publicly traded UPREITs or other Up-C structures, the OBBBA change will have a significant impact on the determination of the covered employees beginning with the 2026 tax year. In a typical Up-C structure, the publicly held corporation is a holding company that owns units in an operating partnership. Under prior law, the operating partnership was not in the affiliated group of the holding corporation. Under the OBBBA controlled group definition, the operating partnership is now within the controlled group.
The OBBBA also includes a statutory allocation rule for the disallowed deduction. When multiple members of the controlled group pay compensation to the same specified covered employee and the aggregate exceeds $1 million, the disallowed portion is allocated to each paying member in proportion to the compensation each member paid to that employee relative to the total group compensation paid to that employee.
Which Entities Are Now Treated as a Single Employer Under the Expanded Rules?
The Section 414 controlled group definition is the operative framework. There are four subsections, each addressing a different type of ownership or control relationship.
Section 414(b): Controlled group of corporations. Corporations that are members of a parent-subsidiary controlled group (80% ownership by vote and value), a brother-sister controlled group (common ownership by five or fewer persons totalling 80% or more control), or a combined group. This overlaps substantially with the Section 1504 affiliated group but without the exclusions in Section 1504(b) for foreign corporations, tax-exempt corporations, and others. For corporate entities, the Section 414(b) controlled group may be somewhat broader than the Section 1504 affiliated group because Section 1504's exclusions are not fully imported.
Section 414(c): Partnerships and other entities under common control. Organizations under common control include: a parent-subsidiary group (organization owning 80% or more of the interest in another organization) and a brother-sister group (common ownership by five or fewer persons totalling 80% or more). This is the provision that pulls partnerships, LLCs, and other non-corporate entities into the controlled group.
Section 414(m): Affiliated service groups. An affiliated service group exists when one organization performs services for another organisation and there is common ownership or management between them, or when an organisation is principally engaged in performing management functions for another organisation. The affiliated service group rules can capture service organisations connected through ownership or management that might not be connected through direct equity ownership. RSM's analysis of the OBBBA's Section 162(m) changes specifically notes this: the new rules might pull in certain service organisations connected through ownership or management.
Section 414(o): Other arrangements. Treasury has authority under Section 414(o) to create additional aggregation rules for other arrangements. This provision can capture arrangements not literally covered by (b), (c), or (m).
For most public companies with straightforward corporate structures, the Section 414(b) controlled group and the Section 1504 affiliated group overlap substantially, and the practical difference between the pre-OBBBA and post-OBBBA rules is limited. The practical difference is largest for:
Companies with partnership or LLC operating subsidiaries or joint venture interests meeting the 80% control threshold.
Companies in Up-C or UPREIT structures where the public entity is a holding company and the operating entity is a partnership.
Companies with joint venture arrangements where the 80% threshold is met through combined ownership by a small number of parties.
Companies with affiliated service groups where compensation payments to executives are split between the public entity and a service organisation.
The Crowe observation in its OBBBA compensation analysis confirms: the entity aggregation rules are already contained in the current Section 162(m) regulations but based on aggregation under Section 1504 rather than Section 414. The practical effect of moving from Section 1504 to Section 414 is the inclusion of non-corporate entities in the aggregation analysis.
Who Is a Covered Employee Under the Expanded 162(m)?
The covered employee definition for 2026 has not changed from the post-TCJA definition. What has changed is the entity perimeter across which covered employees are identified.
Covered employees in 2026 are: the principal executive officer, the principal financial officer, and the three other most highly compensated executive officers of the publicly held corporation, plus any individual who was a covered employee in any prior taxable year beginning after December 31, 2016, under the once-covered-always-covered rule.
The critical change from the OBBBA aggregation rule is how "highly compensated" is determined. Under prior law, the three other most highly compensated executive officers were identified by reference to compensation paid by the corporation and its affiliated group members. Under the new law, they are identified by reference to compensation paid by the corporation and all members of its controlled group.
This means that an executive who receives $400,000 from the publicly held corporation and $700,000 from an affiliated partnership might now have $1.1 million of total controlled group compensation. That executive would not have been identified as a covered employee under the prior affiliated group rules (because the partnership compensation was not aggregated), but may now be identified as one of the three other most highly compensated executives based on the $1.1 million total.
For 2027 and later years, ARPA's five-highest-paid-employees expansion takes effect, adding the next five highest compensated employees of the controlled group (whether or not they are executive officers) to the covered employee list. This is an additional change layered on top of the OBBBA controlled group rule. For 2026, only the pre-existing covered employee categories apply (PEO, PFO, three other most highly compensated executive officers, and once-covered-always-covered former covered employees). The ARPA expansion does not apply in 2026.
The Troutman Pepper Locke analysis clarifies the once-covered-always-covered interaction: anyone who was a covered employee for a year beginning after December 31, 2016, remains a covered employee for all future years, even after termination of employment. The once-covered-always-covered rule does not apply to the ARPA five-highest-paid-employees group (which takes effect in 2027), but it does apply to the current covered employee group.
How Does the Expanded Aggregation Affect Your Q2 2026 Deferred Tax Asset?
The Section 162(m) expansion affects the Q2 2026 ASC 740 calculation in two places: the deferred tax analysis for compensation-related temporary differences and the current-period nondeductible compensation expense.
Current-period nondeductible compensation. For Q2 2026, the AETR reflects the current-year Section 162(m) disallowance as a permanent difference. Compensation paid to covered employees in excess of $1 million is permanently nondeductible. Unlike temporary differences that create deferred tax assets, the Section 162(m) disallowance is a permanent item: no DTA is created, and the disallowed amount never becomes deductible. The AETR effect is a higher effective tax rate, because the permanently disallowed compensation increases the gap between pre-tax book income and taxable income.
For companies where the controlled group expansion increases the covered employee population or increases the aggregate compensation subject to the limit, the 2026 effective tax rate will be higher than 2025 for that reason. The magnitude depends on how many additional executives fall within the expanded controlled group and how much compensation those executives receive from entities newly within the Section 162(m) perimeter.
Deferred tax impact from compensation-related temporary differences. Companies that have deferred compensation arrangements, restricted stock units, or other equity awards for covered employees will have built deferred tax assets representing the expected future tax deduction when those amounts are paid or vest. Under the Section 162(m) rules, those deferred compensation amounts are nondeductible to the extent they push aggregate covered employee compensation above $1 million. The expansion of the controlled group means that previously deductible deferred compensation for certain executives may now be reclassified as permanently nondeductible.
When an executive's total controlled group compensation exceeds $1 million in 2026 for the first time because of the aggregation expansion, any previously recognised DTA for that executive's deferred compensation needs to be reassessed. The portion of the DTA attributable to deferred compensation that will be nondeductible under the expanded aggregation must be written off as a valuation allowance or written down as a permanent difference, producing a deferred tax expense in Q2.
BDO's OBBBA ASC 740 bulletin specifically identifies the Section 162(m) change as one of the OBBBA provisions with ASC 740 implications that should be reflected in the applicable tax year's provision. Companies should evaluate whether the expanded aggregation changes the expected deductibility of any deferred compensation balances for executives newly within the Section 162(m) $1 million limit.
What Changes in Your Executive Compensation Deduction Modeling for 2026?
The expanded aggregation requires a full rebuild of the Section 162(m) deduction model for 2026, not just an incremental update to the prior year model.
Three specific modelling changes are required.
First: Redefine the entity perimeter for the controlled group analysis. The starting point is identifying every entity that is now within the Section 414(b), (c), (m), and (o) controlled group of the publicly held corporation. This requires reviewing corporate ownership charts, partnership ownership schedules, LLC operating agreements, and affiliated service group relationships. For companies with complex ownership structures including private equity-backed entities, Up-C structures, or joint ventures with majority control, legal counsel should confirm which entities fall within the controlled group definition.
Second: Aggregate compensation across all controlled group members for each potential covered employee. For each current covered employee and each former covered employee under the once-covered-always-covered rule, pull the total compensation paid by every controlled group member, not just the publicly held corporation. This requires payroll data from entities that may not have previously contributed to the Section 162(m) analysis.
Third: Identify newly covered employees under the expanded aggregation. After aggregating compensation across the controlled group, determine whether any executive who was not previously a covered employee is now one of the three other most highly compensated executive officers based on total controlled group compensation. If yes, that executive is a newly covered employee in 2026, and all compensation paid to them in excess of $1 million (from all controlled group sources in aggregate) is nondeductible.
The Godfrey and Kahn analysis confirms the practical compliance implication: publicly traded corporations will need to re-evaluate their Section 162(m) deduction limitations if they have highly compensated employees working for related entities that may receive more than $1 million in compensation in the aggregate from all such entities.
Grant Thornton specifically recommends that publicly held corporations consider whether there are any opportunities to change existing compensation arrangements to mitigate the impact of the expanded Section 162(m) limitations. The practical mitigation options are limited, given that the performance-based compensation exception was eliminated in 2017, but restructuring compensation levels across entities or adjusting the timing of compensation payments are considerations for the compensation committee to evaluate prospectively.
What MD&A or Tax Footnote Disclosure Is Required in Q2?
The Section 162(m) expanded aggregation change does not independently require a specific disclosure in the Q2 2026 10-Q. The disclosure obligation derives from the general income tax disclosure requirements under ASC 740 and the MD&A requirements under Item 303.
Rate reconciliation disclosure under ASU 2023-09. If the Section 162(m) disallowance produces a material permanent difference that affects the Q2 effective tax rate, it must appear in the rate reconciliation as a separately quantified line item if the amount exceeds the 5% threshold. For companies where the expanded aggregation materially increases the Section 162(m) disallowance compared to 2025, the rate reconciliation should identify the change as a Section 162(m) permanent difference and quantify it.
DTA writedown disclosure. If deferred tax assets previously recognised for covered employee deferred compensation were written off or reduced because of the expanded aggregation, the change in DTA should be disclosed in the income tax footnote with an explanation that the change resulted from the OBBBA's expansion of the Section 162(m) controlled group definition.
MD&A disclosure. If the Section 162(m) expansion materially affects the Q2 2026 effective tax rate compared to Q2 2025, the MD&A results of operations discussion should identify the expansion as a driver of the rate change and quantify its effect. The disclosure should note that this is a permanent change effective January 1, 2026, not a one-time item.
SAB 74 considerations. The OBBBA was enacted July 4, 2025. Its ASC 740 effects for calendar-year companies were recognised in the Q3 2025 and Q4 2025 provisions (as of enactment for permanent changes). For Q2 2026, the disclosure obligation is to reflect the ongoing 2026 tax year impact in the current provision, not to re-describe the enactment-date event.
Where the Section 162(m) expansion produces a material change in the annual effective tax rate for 2026 relative to 2025, disclosure in both the income tax footnote and the MD&A is appropriate. The BDO OBBBA ASC 740 bulletin identifies the Section 162(m) changes as one of the provisions that could have material impacts on financial statements.
What Should Your Compensation Committee and Tax Director Be Reviewing Right Now?
Four actions worth completing before the Q2 10-Q is filed.
Action 1: Confirm the controlled group perimeter. Have legal counsel review the entity structure and confirm which entities fall within the Section 414(b), (c), (m), and (o) controlled group of the publicly held corporation. This includes all wholly owned subsidiaries regardless of form, majority-owned partnerships and LLCs, and any entities within affiliated service groups. The controlled group determination is a legal question that should be confirmed with a contemporaneous written analysis, not assumed to be the same as the prior affiliated group.
Action 2: Aggregate compensation data for all covered employees across the newly identified group. For the 2026 tax year to date, pull total compensation paid by all controlled group members to each identified covered employee. Include salary, bonus, equity vesting and exercise, deferred compensation, and all other taxable remuneration. Identify any executive whose total controlled group compensation exceeds or is approaching $1 million who was not previously above the threshold under the affiliated group rules.
Action 3: Recalculate the Section 162(m) disallowance and allocation for 2026. Apply the $1 million limit to each covered employee's aggregate controlled group compensation for the 2026 year-to-date period. Allocate the disallowed deduction among the controlled group members that paid compensation to that employee in proportion to each member's share. Confirm that this calculation flows into the Q2 AETR model.
Action 4: Assess deferred compensation DTA balances for newly affected executives. For any executive who is now subject to the Section 162(m) limit because of the expanded aggregation, assess whether any previously recognised DTA for deferred compensation is now expected to be permanently nondeductible. Write off or adjust any DTA where the expected deductibility has changed.
Frequently Asked Questions
What did the OBBBA change about Section 162(m)?
The OBBBA replaced the affiliated group aggregation rules (Section 1504 corporations only) with a broader controlled group aggregation under Sections 414(b), (c), (m), and (o), effective for tax years beginning after December 31, 2025. The controlled group includes non-corporate entities such as partnerships and LLCs, which were previously excluded from the Section 162(m) aggregation. Compensation paid by all controlled group members to a covered employee is now aggregated when applying the $1 million deduction limit.
What is the Section 162(m) expanded aggregation rule?
The expanded aggregation rule requires that all members of a publicly held corporation's controlled group under Section 414 be treated as a single employer for Section 162(m) purposes. If any controlled group member pays compensation to a specified covered employee and the total from all group members exceeds $1 million, the deduction allowed to the group is limited to $1 million and allocated among the members in proportion to each member's share of total compensation paid to that employee.
Which entities are now aggregated for 162(m) purposes?
All members of the controlled group under Sections 414(b), (c), (m), and (o). This includes: corporations in a parent-subsidiary or brother-sister controlled group under Section 414(b), partnerships and LLCs under common control under Section 414(c), affiliated service groups under Section 414(m), and other arrangements under Treasury's authority in Section 414(o). The most significant addition compared to the prior affiliated group rules is the inclusion of non-corporate entities such as partnerships and LLCs.
Does the expanded 162(m) affect my Q2 2026 deferred tax calculation?
Yes, in two ways. First, any additional Section 162(m) disallowance in 2026 from the expanded aggregation is a permanent difference that increases the current-year effective tax rate. Second, if the aggregation expansion causes an executive's compensation to exceed the $1 million threshold for the first time, any deferred tax assets previously recognised for that executive's deferred compensation may need to be written off to the extent those amounts are now expected to be permanently nondeductible.
What disclosure is required in my Q2 10-Q for 162(m) changes?
Where the expanded Section 162(m) aggregation produces a material permanent difference affecting the Q2 effective tax rate, it should appear in the rate reconciliation as a separately quantified line under ASU 2023-09 if it exceeds the 5% threshold. If DTA balances were written off or reduced because of the expanded aggregation, that change should be disclosed in the income tax footnote. If the rate impact is material, the MD&A should quantify and explain it.
Key Takeaways
- The OBBBA replaced Section 162(m)'s affiliated group aggregation (Section 1504, corporations only) with a broader controlled group aggregation (Section 414, including non-corporate entities) effective for tax years beginning after December 31, 2025. For calendar-year companies, the expanded rule applies to the full 2026 tax year.
- The controlled group under Section 414 includes partnerships, LLCs, and other non-corporate entities under common control that were excluded from the prior affiliated group definition. Companies in Up-C, UPREIT, or other structures with partnership operating entities are most significantly affected.
- Compensation paid by all controlled group members to a specified covered employee is aggregated to determine whether the $1 million limit applies. The disallowed deduction is allocated among paying entities in proportion to each entity's share of total compensation paid to the covered employee.
- The covered employee definition for 2026 remains the post-TCJA definition: PEO, PFO, three other most highly compensated executive officers, and once-covered-always-covered former covered employees. The ARPA expansion adding the five highest paid employees does not take effect until 2027.
- The Q2 2026 provision must reflect additional Section 162(m) disallowance from the expanded aggregation as a permanent difference in the AETR. DTA balances for deferred compensation of newly affected executives should be assessed and written off where the compensation is expected to be permanently nondeductible.
- Rate reconciliation disclosure under ASU 2023-09 is required if the Section 162(m) expansion produces a material rate reconciling item. MD&A disclosure is required if the change materially affected Q2 results of operations.
- The PwC analysis confirms that the 2026 analysis is distinct from the 2027 analysis, where the ARPA amendments also take effect. Companies should separately model the 2026 controlled group impact (OBBBA only) and the 2027 impact (OBBBA plus ARPA combined).
