By James Hamilton, J.D., LL.M.
A private letter ruling recently made public by the IRS (LTR 200804004) cast doubt on the exclusion of some performance-based compensation from the $1 million pay cap mandated by IRC §162(m) if a company wants a deduction.
Under present law, compensation in excess of $1 million paid by a publicly-held corporation to the corporation's covered employees generally is not deductible. Notice 2007-49 states the term "covered employee," for purposes of §162(m), will apply to the principal executive officer and the three highest compensated officers (other than the principal executive officer and principal financial officer).
Performance-based compensation is not subject to the deduction limitation and is not taken into account in determining whether other compensation exceeds $1 million. In general, performance-based compensation is compensation payable solely on account of the attainment of one or more performance goals and with respect to which certain requirements are satisfied.
The IRS responded to a requested ruling that compensation paid under the a compensation plan upon attainment of a performance goal will be considered performance-based compensation under 162(m)(4)(C) even though the compensation could have been paid upon an executive's termination without cause or by the executive for good reason, without attaining the performance goal.
The IRS said that the provision allowing for payment of performance share or performance unit awards under the plan upon an executive's termination without cause or by executive with good reason does not meet the exception in section 1.162-27(e)(2)(v) of the regulations that allows compensation to be payable upon death, disability or change of ownership or control. Thus, compensation paid to the executive with respect to performance share or performance unit awards is not payable solely upon attainment of a performance goal, for purposes of section 162(m)(4)(C) of the Code. It thus followed that compensation paid to an executive in the scenario presented would not be considered performance-based compensation under section 162(m)(4)(C) of the Code.
It should be noted that, when it adopted the new executive disclosure regime, the SEC emphasized that any tax or accounting treatment, including a company’s section 162(m) policy, that is material to the company’s compensation policy or decisions with respect to a named executive officer is covered by Compensation Discussion and Analysis and should be discussed. Tax consequences to the named executive officers, as well as tax consequences to the company, may fall within this example.