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Final IRS Regs Clarify Deduction Limitation for Compensation in Excess of $1,000,000.

(Parker Tax Publishing April 11, 2015)

The IRS has issued final regulations clarifying that a performance-based compensation plan will meet the requirements of Reg. Sec. 1.162-27(e) for granting option or stock appreciation rights if it specifies a maximum number of shares for which such rights may be granted to an employee within a specified period. The regulations also clarify the application of the compensation deduction limitation for corporations that become publicly held. T.D. 9716.

Code Sec. 162(m)(1) precludes a publicly held corporation from deducting compensation paid to any covered employee (a CEO or the three other highest paid officers) in excess of $1,000,000. However, this limitation does not apply to qualified performance-based compensation that meets all of the requirements of Reg. Secs. 1.162-27(e)(2) through (e)(5).

Per-Employee Limitation Requirement

Proposed regulations issued in 2011 as REG-137125-08 clarified Reg. Sec. 1.162-27(e)(2)(vi)(A) by providing that plans granting option or stock appreciation rights must state "the maximum number of shares with respect to which options or rights may be granted during a specified period to any individual [emphasis added] employee" (per-employee limitation requirement).

In response to comments, the final regulations modify Reg. Sec. 1.162-27(e)(2)(vi)(A) to provide that a plan will satisfy the per-employee limitation requirement if it specifies an aggregate maximum number of shares with respect to which equity-based awards (such as stock options, stock appreciation rights, or restricted stock and restricted stock units) may be granted to any individual employee during a specified period under a plan approved by shareholders in accordance with Reg. Sec. 1.162-27(e)(4).

The final regulations provided that these clarifications apply to compensation attributable to stock options and stock appreciation rights that are granted on or after June 24, 2011.

Limitation Rules for Corporations that Become Publicly Held

In general, Reg. Sec. 1.162-27(f)(1) provides that when a corporation becomes publicly held, the Code Sec. 162(m) deduction limitation does not apply to compensation based on a plan or agreement existing before the corporation became publicly held. Pursuant to Reg. Sec. 1.162-27(f)(2), a corporation may rely on that provision until the earliest of:

(1) the expiration of the plan or agreement;

(2) a 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 to elect directors that occurs three years after an initial public offering (IPO) or, if there was no IPO, the first year after the year in which the corporation becomes publicly held.

Reg. Sec. 1.162-27(f)(3) provides that this transitional relief from the deduction limitations applies to any compensation received pursuant to the exercise of a stock option or stock appreciation right, or the substantial vesting of restricted property, if the rights were granted under a plan or agreement before the earliest of the events specified above.

The proposed regulations clarified that compensation payable under a restricted stock unit arrangement (RSU) or a phantom stock arrangement is generally ineligible for this transition relief. Instead, compensation payable under a RSU will be eligible for transition relief only if it is actually paid to an employee, rather than merely granted, before the earliest of one of the specified events. The final regulations adopt this clarification, and provide that it will apply to remuneration otherwise deductible under a RSU that is granted on or after March 31, 2015.

For a discussion of the deductibility of compensation, see Parker ¶91,101. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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