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The recent amendments to the Section 162(m) regulations largely
follow the changes set forth in the proposed regulations issued in
2011, clarifying two exceptions from the Section 162(m) tax
deductibility limit:
The treatment of restricted stock units (RSUs) and certain
other forms of stock-based compensation under the transition rule
applicable to newly public companies; and
The requirement under the "qualified performance-based
compensation" exception to set a per-employee limit applicable
to stock options and stock appreciation rights (SARs) under an
equity plan intended to comply with such exception.
RSU Reliance Period Clarification
Generally, compensation paid by newly public companies under
plans or agreements in effect prior to the company's initial
public offering (IPO) (for which adequate disclosure is
provided in the IPO prospectus) must be "paid" during the
reliance period to be deemed performance-based compensation that
does not count against the annual $1 million deduction
limitation.
The reliance period ends on the earliest of: (a) the
first annual shareholders meeting at which directors are to be
elected that occurs after the third calendar year following the
year of the company's IPO (or, if no IPO, the first calendar
year following the year in which the company becomes a public
company), (b) the issuance of all employer stock and other
compensation allocated under the plan or agreement, or (c) the
expiration or material modification of the plan or agreement.
Under a special equity award rule, stock options, SARs, and
restricted stock that are granted during the reliance period will
be deemed to be performance-based compensation (subject to meeting
all the other specific requirements) even if the equity awards are
exercised or vest after the end of the reliance period.
The final regulations clarify that other forms of stock-based
compensation, most notably RSUs, do not qualify for the special
equity rule and must be settled during the reliance period.
However, this clarification does not apply to stock-based
compensation granted prior to April 1, 2015.
Practical Advice
Public companies that want to preserve both the flexibility of
their pre-IPO equity plans (e.g., evergreen increases to the share
reserve) and the tax deductibility of their equity award grants may
want to consider the following grant practices:
Grant performance-based restricted stock in lieu of
performance-based RSUs during the reliance period. Assuming
all of the other requirements are satisfied, the performance-based
restricted stock will not count against the annual $1 million
deduction limitation even if the vesting and income tax event
occurs after the end of the reliance period. Whether granting
restricted stock or RSUs, the tax consequences to the employee
generally will be the same (assuming the employee does not make a
Section 83(b) election to be taxed on the restricted stock at grant
and that the employee does elect to defer the settlement of the
RSUs).
Grant only stock options during the reliance period.
Grant a lesser number of RSUs with modified vesting schedules
such that all or a portion of the RSUs will be settled in stock
during the reliance period.
Per-Employee Limit Clarification
The final regulations retain the rule that using an aggregate
limit on the number of shares that could be granted under a
stockholder-approved plan will not meet the
requirement for establishing the maximum amount of compensation
that may be received by an individual covered employee.
This clarification does not apply to stock options or SARs
granted prior to the proposed regulations' effective date of
June 24, 2011. Further, the limit can be structured to
include all types of equity-based awards, other than stock options
and SARs.
Practical Advice
Public companies that want flexibility with their plans can have a
single limit for all equity grants or separate limits for different
classes of equity (e.g., separate limits for appreciation-based
awards such as stock options and SARs versus full-value awards such
as restricted stock and RSUs). Set forth below are example
plan provisions that generally will comply with the final
regulations subject to the specific terms of the applicable
plan:
Single Limit
No participant may be granted one or more awards during any
calendar year covering more than 10,000,000 shares in the
aggregate.
Seperate Limits
Limits on Options. Subject to adjustment pursuant to
Section __, no key employee shall receive options to purchase
shares during any calendar year covering in excess of 7,500,000
shares.
Limits on SARs. Subject to adjustment pursuant to Section
__, no key employee shall receive awards of SARs during any
calendar year covering in excess of 7,500,000 shares.
Limits on Stock Grants and Stock Units. Subject to
adjustment pursuant to Section __, no key employee shall receive
stock grants or stock units during any calendar year covering, in
the aggregate, in excess of 7,500,000 shares.
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.