Late in January, the Internal Revenue Service (IRS) released private letter ruling (PLR) 200804004, which appears to reverse the IRS’s previous position on one aspect of the $1 million compensation deduction limit in section 162(m) of the Internal Revenue Code (Code) that is applicable to publicly held corporations. The regulations under that section provide that performance-based compensation (which is not subject to the limit) “must be paid solely on account of the attainment of one or more preestablished, objective performance goals.” (Emphasis added.) The Code contains substantively identical language. (The regulations also state, however, that payment provisions in the event of death, disability or change in control do not violate the “paid solely” requirement, except in the year in which the event occurs when payment is made prior to the attainment of the performance goals.)
The executive who is discussed in the ruling entered into an employment agreement with his employer. The agreement provides for the payment of what would otherwise be performance-based compensation if he is terminated by the employer without cause or if he resigns his employment for good reason. In those situations, the performance goals would be deemed met. The IRS held that compensation paid to the executive, even in years in which the performance goals are met and the executive is not terminated without cause and does not resign for good reason, is not performance-based compensation, and, therefore, is not exempt from the deduction limit in section 162(m).
This ruling is contrary to previous PLRs issued by the IRS (PLR 199949014 and 200613012) and, like PLRs generally, is technically applicable only to the taxpayer who requested the ruling. Moreover, pursuant to another section of the Code, a PLR may not be used or cited as precedent. Nevertheless, PLRs do tend to indicate the IRS’s current thinking about the matters at issue.
The IRS may reverse the new PLR or the IRS may announce that it will only take the position set forth in the PLR on a prospective basis. Particularly because this ruling contradicts prior rulings and because of the amount of protest this ruling has generated, the IRS may take one of those steps in this case.
In the meantime, you should review your company’s compensation and benefi t programs for its executives. Any arrangement that purports to provide performance-based compensation but also provides that, if the executive’s employment is terminated by the company for any reason other than cause or if the executive resigns for good reason, the executive shall become 100% vested in his or her awards, may not be entitled to exemption from the section 162(m) limit.
Comment: Members of our fi rm listened to a webcast on February 14 during which the IRS offi cial who signed the PLR, Ken Griffi n, Associate General Counsel in the IRS’s Executive Compensation Branch, spoke, giving his personal opinions. Mr. Griffi n said the IRS has heard the concerns expressed about the PLR, is “actively working [on] the issue,” and hopes to publish guidance by the end of February. Although Mr. Griffi n did not get into specifi cs regarding the nature of the guidance, he did say (somewhat cryptically) that if it is similar to the draft of the guidance that he has reviewed, it will address the concerns raised by the ruling. He advised companies not to engage in drastic measures at this time simply because of the ruling, but instead, to wait until the guidance is issued.