The financial rescue legislation was passed by the Senate on Wednesday, October 1, and the House on October 3, 2008, and was promptly signed by the President the same day. As enacted, the legislation contains:
- Employee benefit and executive compensation provisions of general applicability, as well as
- Constraints on executive compensation and corporate governance limited to financial institutions that participate in the Treasury program for troubled assets.
For a copy of our prior legal alert that discusses the Emergency Bailout Bill becoming law, please click here.
For a copy of our prior legal alert that discusses the Act as approved by the Senate, please click here.
For a copy of our prior legal alert that discusses the Renewable Energy Tax Credit Extensions, please click here.
Provisions of General Applicability
In its energy and tax extender divisions, the legislation contains several provisions of general applicability affecting employee benefits and executive compensation, including the following:
- New section 457A is added to the Code, generally providing for the immediate taxation of executives on amounts deferred under nonqualified deferred compensation plans of tax-indifferent partnerships and foreign corporations (generally, offshore entities not subject to U.S. tax or a comprehensive foreign tax) at the time there is no substantial risk of forfeiture of the rights to such compensation, even if there is no current right to receipt of those amounts. If the compensation amount cannot be determined on the vesting date, taxation is postponed but substantial penalties apply.
For these purposes, a “nonqualified deferred compensation plan” is defined in the same manner as section 409A(d), but (i) also includes plans that provide a right to compensation based on the appreciation in value of a specified number of equity units of the service recipient, and (ii) excludes compensation that, when the right to payment vests, pays out within 12 months of the end of that taxable year or, in the case of a foreign corporation taxable under section 882, would have been deductible against effectively connected income.
Section 457A is generally effective with respect to deferred amounts attributable to services performed after December 31, 2008, subject to (x) a rule that brings into income in 2017 (or, if later, upon vesting) otherwise untaxed amounts attributable to services before 2009 and (y) instructions that Treasury issue guidance in 120 days permitting certain conforming amendments without violation of section 409A.
- Additional ISO AMT relief is included in the legislation. Any tax underpayment, interest and penalties outstanding on October 3, 2008, for pre-2008 tax years and attributable to the AMT treatment of incentive stock options are abated immediately, with the AMT refundable tax credit and minimum tax credit for each of 2008 and 2009 (without an income phase-out) increased by 50% of the interest and penalties paid by a taxpayer prior to enactment that otherwise would have been abated.
- The compromise legislation on mental health and addiction parity is incorporated in the enacted bill.
- The legislation adds to section 132 a “qualified bicycle commuting reimbursement” as a qualified transportation fringe benefit, starting in 2009. The permitted employer reimbursement is up to $20 per month for the purchase, repair and storage of a bicycle and bicycle improvements regularly used for travel between the employee’s residence and place of employment.
- The 0.2% FUTA surtax is extended through 2009.
- The rule permitting tax-free IRA distributions for charitable purposes is extended through 2009.
Provisions Limited to Financial Institutions Participating in Treasury Program for Troubled Assets
The Emergency Economic Stabilization Act of 2008 imposes executive compensation and corporate governance limitations on financial institutions from which the Treasury purchases troubled assets directly or at auction pursuant to the Troubled Asset Relief Program (“TARP”) established by the legislation.
While this point is not explicitly clear on the face of the legislation and will require clarification from the Treasury, it may be that U.S. retirement plans holding troubled assets will be eligible to take advantage of TARP. If so, a careful analysis of fiduciary and other considerations would seem appropriate prior to participation in the program.
If the Treasury directly purchases a financial institution’s troubled assets and the Treasury receives a meaningful equity or debt position in the institution, the Treasury must require that the institution meet “appropriate standards for executive compensation and corporate governance.” The standards include:
- A prohibition on compensation that provides incentives for senior executive officers to take unnecessary and excessive risks while the Treasury holds a debt or equity position;
- A provision for recovery of any bonus or incentive compensation that is paid to a senior executive officer and is based on financial statements later proven to be materially inaccurate (i.e., a “clawback”); and
- A prohibition on golden parachute payments while the Treasury holds a debt or equity position.
It appears that the Treasury may also require other standards for executive compensation and corporate governance, in addition to those specifically listed. For this purpose, a senior executive officer is one of the top five highly paid executives required to be disclosed in a public company’s proxy, or the comparable group for non-public companies.
If the Treasury purchases a financial institution’s troubled assets at auction and these purchases exceed $300,000,000 in the aggregate (including direct purchases) three limitations will apply to the institution while the Treasury’s authority under the Act remains in effect.
- The institution is prohibited from entering into a new employment contract with a senior executive officer that provides a golden parachute payable upon involuntary termination, bankruptcy filing, insolvency or receivership. The Treasury is required to issue guidance to carry out this provision within the next two months. This prohibition pertains to new employment contracts and not existing contracts that provide golden parachutes.
- Section 162(m) of the Code is modified to limit the deductible compensation of a covered executive to $500,000 (rather than $1,000,000) with respect to an applicable institution. A covered executive for this purpose is an entity’s CEO, CFO and top three most highly compensated officers, as determined under the proxy disclosure rules that apply to public companies. However, the provision is not limited to public companies, unlike the current section 162(m). In addition, the performance-based compensation exception of the current section 162(m) does not apply. Finally, the Act applies the $500,000 limit to compensation even if it is deferred for the applicable tax year, and further provides that if an employee is a covered executive for any applicable taxable year, the employee will be treated as a covered executive for all subsequent applicable taxable years that deferred compensation with respect to such applicable taxable years would, but for the Act, be deductible.
- The golden parachute payment provisions under section 280G of the Code are modified to apply to certain payments made to covered executives (applying the same definition as in the new section 162(m) provision described above) of applicable institutions. The payments covered by the new provisions are severance payments made by reason of involuntary termination, bankruptcy filing, liquidation, or receivership. Accordingly, if severance payments to a covered executive exceed three times the executive’s average annual compensation (as determined under section 280G), the amount of the payments that exceeds one times the executive’s average annual compensation would be subject to a 20 percent excise tax. The exceptions under section 280G for reasonable compensation and shareholder approval in the case of privately-held companies do not apply.
The section 162(m) and section 280G changes may also apply if the troubled assets are purchased in a manner other than a direct purchase by the Treasury or auction.