The Internal Revenue Service has issued proposed regulations with respect to the performance-based compensation exemption under Code Section 162(m). Generally, Section 162(m) disallows a deduction for annual compensation in excess of $1 million paid to certain "covered employees" (the principal executive officer and the three highest-paid executive officers other than the principal executive officer or the principal financial officer). Stock options or stock appreciation rights may qualify for an exemption from the deduction limit set forth in the current regulations under Section 162(m) for "performance-based compensation." The proposed regulations clarify that in order to qualify for the exemption (i) a plan must state a per-employee limitation on the number of shares that may be granted during a specified period; and (ii) the shareholder disclosure must include both the maximum number of shares for which grants may be made to each individual employee during a specified period and the exercise price of the options to satisfy the performance-based compensation exemption.

In addition, the current regulations provide new public companies temporary relief from Section 162(m)'s $1 million deduction limit for any compensation paid under a plan that existed prior to the company going public. The relief is available to new public companies with respect to compensation attributable to the exercise of a stock option or a stock appreciation right, or the vesting of restricted property, so long as the grant is made under a pre-existing plan during the transition period, even if the compensation is paid after the transition period has expired. The clarification explains that this relief only applies to stock options, stock appreciation rights and restricted property -- equity awards in other forms, such as restricted stock units or phantom stock, must be paid during the transition period in order to qualify for the transition relief. If finalized during 2011, these regulations could apply to the 2011 tax year.