Internal Revenue Code (IRC) § 162(m) generally prohibits a publicly traded corporation from deducting compensation paid to “covered employees” in excess of $1 million per year. There are several exceptions to this limitation. One important exception is for amounts paid as qualified performance-based compensation, which become payable on account of the achievement of certain performance goals.
To preserve deductibility, many restricted stock or restricted stock unit plan arrangements are structured to provide that vesting occurs only on achievement of a permissible performance goal under IRC § 162(m). In Rev. Rul. 2012-19, the Internal Revenue Service (IRS), provides some clarity with respect to treatment of dividends or dividend equivalents paid on restricted stock or restricted stock units. The IRS indicates that the payment of the dividend or dividend equivalent is a separate grant from the underlying restricted stock or restricted stock unit. Therefore, the deductibility of the dividend or dividend equivalent is based on whether those amounts are payable only on achievement of the performance-based goal. For example, in a situation where the plan accumulates the dividends and dividend equivalents and only pays those amounts if the underlying shares or units become vested on satisfaction of the performance goal, the IRS held that the dividend or dividend equivalent qualifies for the performance-based compensation exception. However, where the dividend or dividend equivalent is paid at the same time that dividends are generally paid on the other shares and thus is not subject to the condition that the performance goal must be satisfied, those amounts are subject to the $1 million deduction limitation. (Rev. Rul. 2012-19)