Wednesday, February 13, 2008
Section 162(m)'s $1 million limit on the amount that a public company can deduct for compensation to high-level executives does not not apply to "performance-based compensation." To qualify as performance-based, compensation must be payable only if pre-established, objective performance goals are attained. The § 162(m) regs provide an exception for termination payments upon death, disability, or change in control. In earlier rulings, the IRS had treated payments upon an executive's involuntary termination or termination for good cause as coming within the death, disability, or change in control exception. In PLR 200804004 (1/25/2008), the IRS reversed course and ruled that an incentive pay award would not qualify as performance-based compensation exempt from the § 162(m) $1 million cap where the executive is entitled to the payment in the event of an involuntary termination or termination for good reason. (Hat Tip: Steven Sholk.) See below the fold for some advice from Jones Day and Ropes & Gray in light of PLR 200804004:
Jones Day: In light of this ruling, each public company should consider the following. First, it should identify any of its bonus or incentive pay plans or programs that are intended to qualify as § 162(m) performance-based compensation and determine if they may be potentially affected. Completion of this step will require a review of the particular plans or programs, as well as any related employment or severance agreements that may guarantee a level of incentive pay in the event of involuntary termination or termination for good reason. Second, it should consider any potential effect to its statements made or to be made in its proxy. Finally, it should be aware of potential alternatives. For example, for prospective awards, it could provide in the case of an involuntary termination or termination for good reason that the executive would be entitled to a payout (full or pro-rata) based on the corporation's actual performance for the entire period. Since no amount would be guaranteed, such an award still should qualify as performance-based (assuming satisfaction of the other § 162(m) requirements such as shareholder approval and a properly constituted compensation committee).
Ropes & Gray: In a dramatic reversal of prior positions, the IRS in newly released PLR 200804004 has ruled that a performance award providing for payout at target on a mid-period involuntary termination or "good reason" quit does not qualify for the performance-based compensation exemption under § 162(m). As a result, the IRS ruled, no payments under the arrangement will qualify for the exemption, even if paid following attainment of the specified performance goals.