On February 4, 2008, Fried Frank issued a client memorandum describing a recent Private Letter Ruling in which the Internal Revenue Service (“IRS”) reversed its previous position on the effect that certain termination of employment provisions have on payments which are intended to qualify as “performancebased compensation” for purposes of section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”). That ruling held that performance-based arrangements that accelerate upon a termination without cause or for good reason would not qualify, whether or not the performance goals are actually attained. Although a Private Letter Ruling can be relied on only by the taxpayer receiving the ruling, a Private Letter Ruling is indicative of the IRS’ position on an issue.
On February 21, 2008, after pressure for guidance and reconsideration from commentators, the IRS released a Revenue Ruling confirming the holding of the Private Letter Ruling and also providing transition relief. Accordingly, provisions in contracts, plans, award agreements or other arrangements that accelerate the vesting of performance-based awards upon a termination without cause, for good reason or upon voluntary retirement will cause compensation attributable to the award to not be excepted from the $1,000,000 deduction limit under Section 162(m) of the Code (regardless of the circumstances of the actual payout). However, clauses that provide for acceleration of performance-based awards on the death or disability of the executive or on a change in ownership of the company will not cause performance-based arrangements paid on attainment of the performance goals to fail to qualify as performance-based under the regulations. Of course, if the performance-based award is accelerated on death, disability or change in control, the payment will not qualify as performance-based.
The IRS has provided two types of transition relief. The holding of the Revenue Ruling will not be applied to disallow a deduction for any compensation that otherwise satisfies the requirements for performancebased compensation and that is paid under a plan, agreement or contract if either (1) the performance period for such compensation begins on or before January 1, 2009 or (2) the compensation is paid pursuant to the terms of an employment contract as in effect on February 21, 2008 without regard to any renewal or extension. Please see the previous memorandum for a more detailed explanation of the regulatory background and operation of Section 162(m).