As we informed you in an Alert (“IRS Takes Adverse Position in Ruling on Code Section 162(m)”) earlier this month, the Internal Revenue Service (IRS) released a private letter ruling in January 2008 that called into question certain common provisions in a public company’s performance-based compensation arrangements with certain officers. (Performancebased compensation is exempt from the $1-million annual limit on the deductibility of compensation paid to such offi cers by a public company.) The IRS has now issued Revenue Ruling 2008-13, which confi rms (and expands) the holding of the private letter ruling but makes the effect of the IRS’s new position prospective.
Revenue Ruling 2008-13 discusses two executive compensation plans sponsored by a public company that provides performance-based compensation. In one case, the plan provides that the compensation will be paid, even if the performance goal is not attained, in any year in which the executive is terminated by the company without “cause” or the executive terminates his or her employment with the company for “good reason.” In the other case, the plan provides that the compensation will be paid, even if the performance goal is not attained, in any year in which the executive voluntarily retires.
The IRS held that, in both cases, none of the compensation, whether payable in a year when the goals are achieved or when one of the events described above occurs, is performance-based compensation for purposes of the exclusion from the $1-million deduction limit. The IRS’s rationale is that section 162(m) of the Internal Revenue Code and the regulations issued under it require that, for purposes of the exemption, performance- based compensation must be paid “solely” on account of the attainment of one or more performance goals.
The IRS, apparently recognizing the accounting and other implications of its earlier position, has stated that it will not apply the new ruling to disallow a deduction for compensation that otherwise satisfi es the rules for performance-based compensation, provided that either (i) the performance period for such compensation begins on or before January 1, 2009, or (ii) the compensation is paid pursuant to an employment agreement that was in effect (without regard to future renewals or extensions, including automatic renewals or extensions) on February 21, 2008.
- A public company that wants to include any or all of the terms described above for a performance period beginning on or before January 1, 2009, may still do so without incurring adverse tax results under section 162(m). Further, an employment agreement that includes any or all of the terms described above that was in place on February 21, 2008 (without regard to future extensions or renewals, including automatic extensions or renewals) will not result in adverse tax consequences under section 162(m). Including such terms for performance periods that begin after January 1, 2009, or in employment agreements that are entered into (or that are extended or renewed, including automatic extensions or renewals) after February 21, 2008, however, will result in all compensation paid under that provision of the plan, arrangement or employment agreement being counted for purposes of the $1-million annual limit on the deductibility of compensation.
- Pursuant to the applicable regulations, performance- based compensation paid because of an executive’s death or disability or because of the change in control of the company (without regard to whether the performance goal is attained) will be counted for purposes of the limit for the year in which one of such events occurs. Performance-based compensation paid in other years, however, will still be excluded from the limit, if there are the only non-performancebased payments permitted.