In our recent blog about public equity compensation arrangements, we noted inconsistencies regarding the effective date of new guidance. The IRS and Treasury subsequently corrected the 162(m) guidance, and based upon this correction, we reaffirm that public companies need to review their equity compensation arrangements as soon as possible to minimize potential negative tax ramifications.

Public Companies Granting Stock Options and SARs to Covered Employees

Under existing Treasury regulations, certain equity compensation arrangements are exempt from the $1 million compensation deduction limit under Code Section 162(m), provided that a limit on the awards is stated. It appears that when the regulations are finalized, the requirement that limits be set for each individual employee (rather than in total) will be retroactively effective June 24, 2011. The IRS apparently believes that everyone should have interpreted the guidance this way from the outset, and believes that the proposed regulations provide sufficient notice of this. Given the retroactive date, public companies should immediately take the following actions steps:

  1. Immediately (before grants are exercised) identify any stock options or SARs granted to covered employees as of June 24, 2011 or later, and confirm that the documentation sets forth individual employee limits. If the documentation does not set forth the limits, consider whether the company can cancel these grants and issue new grants under amended plans.
  2. If any grants were exercised before the review and any required correction, evaluate the probable tax impact.
  3. Confirm that individual limits are in place before issuing any new stock options or SARs.
  4. If a Code Section 409A review has not already been done this year, consider doing so now to confirm that any arrangements comply with the latest IRS guidance and to protect executives from unintended adverse tax consequences.  (See our recent post for a further discussion on conducting a 409A review).

Private Companies Going Public

Certain compensation is exempt from the $1 million deduction limit for a limited grace period after a company becomes publicly traded. The proposed guidance has clarified that effective as of the date the regulations are finalized, this grace period will not apply to restricted stock units and phantom stock. Therefore, in addition to addressing their stock options and SARs, private companies should determine which of the following two scenarios applies to them:

  1. If the company is already in the process of going public, it should consider whether it has any affected arrangements, and whether revisions are permissible (under securities laws, etc.). If the company has affected arrangements and is unable to revise these arrangements, it should analyze the probable tax impact.. Note, it is possible the grace period will expire before the effective date of the final regulations, resulting in no tax impact.
  2. If the company is considering going public, analyze whether there are any affected arrangements and what alternatives (such as restricted stock) might limit tax ramifications.

Summing Up

If a company is public or is going public, it needs to review its equity compensation arrangements now. These companies need to determine whether they need to amend these arrangements or take other actions to eliminate or reduce potential negative tax impact.