On June 23, 2011, the IRS proposed two amendments to the current regulations under Code section 162(m). Code section 162(m) limits a publicly traded company's annual compensation deduction for compensation paid to the CEO and the three other highest paid officers (excluding the principal financial officer) to $1 million. The $1 million deduction limit does not apply to "qualifying performance-based compensation." To be considered "qualifying performance-based compensation," the equity plan must now state the maximum number of shares that could be issued under the plan to each individual employee and disclose to shareholders the methodology that will be used to set the exercise price of any option or right granted under the plan. Equity plans currently must specify only the aggregate limit of shares that may be awarded under the plan to all participants.
In addition, the proposed regulations clarify the scope of the transition rule for companies that become public. The transition rule excludes from the $1 million deduction limit any compensation from the exercise of stock options, stock appreciation rights or restricted stock granted before or shortly after the company becomes public. The proposed regulations clarify that this transition rule does not apply to other types of equity compensation, including restricted stock units and phantom stock. Although the preamble to the proposed regulations states that the IRS is not intending to change the substantive law, it is important to note that the IRS reached the opposite conclusion in a 2004 private letter ruling, where it found that restricted stock units were eligible for the transition relief. These regulations serve as a reminder that private letter rulings are only binding on the IRS with respect to the party to whom the ruling is issued.