July 7, 2011 –
IRS Clarifies 162(m) Deduction Requirement

The IRS recently issued proposed regulations under Internal Revenue Code Section 162(m) relating to the deduction limitation for certain employee remuneration in excess of $1,000,000, which if passed, will have a significant impact on the design of equity based compensation plans for existing public companies and privately-held companies that ultimately become publicly held. Under Code Section 162(m), a publicly held corporation is restricted from taking a deduction for compensation paid to a covered employee in excess of $1,000,000. However, the deduction limit does not apply to “qualified” performance-based compensation.

Grants of stock options and stock appreciation rights (SARs) are considered qualified performance-based compensation if, among other things, the plan under which the option or right is granted states the maximum number of shares that may be granted during a specified period to any employee (currently the aggregate number of shares is stated in the plan document). The proposed regulations clarify that qualified performance-based compensation attributable to stock options and stock appreciation rights must specify the maximum number of shares with respect to which the options or rights may be granted to each individual employee. The IRS and the Treasury believe that the individual employee limit is consistent with the broader requirement that a performance goal include an objective formula for determining the maximum amount of compensation that an individual employee could receive if the performance goal were satisfied, and that a third party attempting to make this determination would need to know both the exercise price and the number of options that could be granted.fa

The proposed regulations apply to taxable years ending on or after the date the rules become final.

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