The IRS recently released final regulations (T.D. 9716) that clarify two issues under Section 162(m), which limits a public corporation's compensation deduction to $1 million per year for each covered employee.
The first issue is regarding the requirements a stock option or stock appreciation right (SAR) plan must meet to qualify as performance-based compensation. Performance-based compensation is excludible from the $1 million limit under Section 162(m). The final regulations clarify that the stock option or SAR plan must, among other things, specify the maximum number of shares related to which options or SARs may be granted to any individual employee during a specified period. To provide some flexibility within plans, the final regulations state that this requirement is met if the plan specifies a maximum number of shares related to options, SARs, restricted stock, restricted stock units and other equity-based awards that may be granted to any individual employee during a specified period.
If a plan states an aggregate maximum number of shares that may be granted under the plan but doesn't include a specific per-employee limitation, any compensation that can be attributed to the options or SARs granted under the plan won't qualify as performance-based compensation. The IRS's clarification in these final regulations applies to stock options and SARs granted on or after June 24, 2011, the date the proposed regulations were published.
The second issue addressed in the final regulations is regarding relief provided to new publicly held corporations. Under current rules, if a corporation becomes publicly held, the $1 million deduction limit doesn't apply to compensation paid pursuant to a plan that existed during the period in which the corporation wasn't publicly held. A corporation may rely on this relief until the earlier of (1) the expiration of the plan or agreement, (2) the material modification of the plan or agreement, (3) the issuance of all employer stock and other compensation that has been allocated under the plan or agreement, or (4) the first meeting of shareholders at which directors are elected that occurs after the close of the third calendar year following the calendar year in which the initial public offering (IPO) occurs, or if a corporation becomes publicly held without an IPO, the first calendar year following the calendar year in which the corporation becomes publicly held.
Special relief applies to stock options, SARs and restricted stock. The compensation recognized by a covered employee pursuant to stock options, SARs or restricted stock that was granted before the expiration of the relief period previously described isn't subject to the $1 million limit, even if the vesting or exercise of the option, SAR or restricted stock occurs after the relief expired.
The final regulations clarify that this special relief doesn't apply to restricted stock units, phantom stock or other forms of equity-based compensation. For the compensation payable under restricted stock units or phantom stock to qualify for the relief afforded to new publicly held corporations, the compensation must be paid to the employees before the relief period expires. This clarification applies to deductible remuneration from a stock option, SAR, restricted stock, restricted stock unit or any other form of equity-based compensation granted on or after March 31, 2015.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
