The IRS has issued guidance (Rev. Rul. 2012-19) on how dividends
and dividend equivalents are treated for purposes of the $1 million
compensation deduction limit under Section 162(m).
In general, Section 162(m) limits a public corporation's
annual income tax deduction for compensation paid to a covered
executive to $1 million per covered executive. Qualified
performance-based compensation, however, is excluded from the
Section 162(m) limit calculation. In Rev. Rul. 2012-19, the IRS
addressed two scenarios in which the corporation issued restricted
stock or restricted stock units (RSUs) to covered employees. The
restricted stock and RSUs met all of the qualified
performance-based compensation requirements under Section 162(m) so
that the corporation's compensation deduction for the
restricted stock and RSUs will not be included in the $1 million
limit calculation. In the facts presented in the ruling, the
restricted stock and RSUs allow for payment of dividends or
In the first scenario, the dividends or dividend equivalents
otherwise payable over the vesting period of the restricted stock
or RSUs are accumulated and become vested and payable to the
covered employee only if the performance goals are met and the
restricted stock or RSUs become vested. In the second scenario, the
dividends or dividend equivalents are paid to the employee at the
same time dividends are paid on common stock of the corporation,
regardless of whether the performance goals for the restricted
stock and RSUs were met.
In its analysis, the IRS determined that under Treas. Reg. Sec.
1.162-27(e)(2)(iv), the dividends and dividend equivalents are
grants of compensation that are separate and apart from the
restricted stock and RSUs. Thus, the grants of the dividends and
dividend equivalents must separately satisfy the qualified
performance-based compensation requirements.
The IRS ruled in the first scenario that the dividends and
dividend equivalents are qualified performance-based compensation
because they are payable only if the performance goals are met. In
the second scenario, the IRS ruled that the dividends and dividend
equivalents are not qualified performance-based compensation
because the rights to the dividend amounts do not vest and become
payable solely on account of the attainment of performance
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The Internal Revenue Service has recently published an IRS Large Business & International Directive, which updates an earlier directive to field agents addressing the examination of capitalization and repair costs issues.