Following the issuance of proposed regulations in June 2011, the
Internal Revenue Service issued final regulations on March 30,
2015 clarifying certain exceptions to the compensation deduction
limitation imposed by Section 162(m) of the Internal Revenue
Code. Section 162(m) imposes a $1 million annual limit on the
compensation deduction permitted a public company employer for
compensation paid to its CEO and its three most highly paid
officers other than the CEO and CFO. However, exceptions to
the deduction limitation exist for certain compensation paid by
newly public companies and for "performance-based
compensation." The final regulations, which became effective
on April 1, (1) reiterate the IRS's position in the proposed
regulations that the transition relief for newly public companies
is limited to compensation attributable to options, stock
appreciation rights and restricted stock, but not restricted stock
units (RSUs) and (2) clarify the rules relating to the equity
incentive plan per participant limit necessary for compensation
attributable to options and stock appreciation rights to qualify as
"performance-based compensation." None of the changes
made by the final regulations are intended to be substantive
changes to the requirements of the Section 162(m) regulations
previously in effect.
Restricted Stock Units Granted During Transition
Period
Although Section 162(m) applies to all public company employers,
the rules provide that when a corporation first becomes publicly
held the compensation paid pursuant to a plan or agreement that
existed while the company was privately held will not be counted
against the Section 162(m) deduction limitation if certain
requirements are met. This transition relief expires on the
earliest of (i) the expiration of the plan or agreement; (ii) a
material modification of the plan or agreement; (iii) the issuance
of all employer stock and other compensation that has been
allocated under the plan or agreement; and (iv) for a company that
goes public in an IPO, the first meeting of shareholders at which
directors are to be elected that occurs after the close of the
third calendar year following the calendar year in which the IPO
occurs. The regulations under Section 162(m) explicitly apply
this transition relief to any compensation received (whether during
or after the transition period) pursuant to the exercise of a stock
option or stock appreciation right or the vesting of restricted
stock granted under a previously existing plan or agreement during
the transition period; however, until now, the regulations were
silent with respect to the application of the transition relief to
RSUs. The final regulations make clear that the compensation
resulting from RSUs or other phantom stock arrangements granted
after April 1 during a company's transition period under a
previously existing plan or agreement is not eligible for the same
relief. Therefore compensation under any such arrangements must be
actually paid, rather than just granted, on or before the end of
the transition period in order to escape the application of the
Section 162(m) deduction limitation.
Equity Plan Per Participant Limit Applicable to Options and
Stock Appreciation Rights
Companies must satisfy a number of requirements in order for the
compensation attributable to stock options and stock appreciation
rights to constitute "performance-based compensation"
that is exempt from the Section 162(m) deduction
limitation. Among them is the requirement that the equity
incentive plan pursuant to which the award is granted specify the
maximum number of shares with respect to which options or rights
may be granted during a specified period to any employee. To
the extent there was doubt on the matter, the final regulations
make clear that plans cannot satisfy this per participant
limitation requirement merely by providing an aggregate maximum
number of shares that may be granted under the plan. Instead,
the plan must separately specify a maximum per participant limit on
the number of options or rights that may be granted in a specified
period. In a departure from the proposed regulations, the
final regulations make clear that the per participant limit
requirement may be satisfied if the plan specifies an aggregate
maximum number of shares with respect to which stock options, stock
appreciation rights, restricted stock, RSUs and other equity-based
awards (i.e., not just options and stock appreciation rights) that
may be granted to any employee during a specified period. This
rule applies to compensation attributable to stock options and
stock appreciation rights that are granted on or after June 24,
2011.
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