On February 21, 2008, the IRS issued Rev. Rul. 2008-13, which provides guidance relating to the performance-based compensation exception to the $1.0 million deduction limitation under Section 162(m) of the Internal Revenue Code. Rev. Rul 2008-13 formally adopts the surprising position taken by the IRS in PLR 200804004, issued earlier this year. Rev. Rul. 2008-13 holds that an arrangement will not satisfy the Section 162(m) performance-based compensation exception if the payment will be made without regard to the performance goals upon a “covered employee’s” (i.e., named executive officers) termination of employment (for reasons other than the executive’s death or disability) or retirement.

The IRS deferred the effective date of Rev. Rul. 2008-13 to allow companies to make changes to their executive compensation plans and arrangements. Specifically, Rev. Rul. 2008-13 will not apply to compensation that otherwise qualifies for the Section 162(m) performance-based compensation exception if either (1) the performance period for the compensation begins on or before Jan. 1, 2009, or (2) the compensation is paid in accordance with an employment agreement in effect Feb. 21, 2008 (but the ruling will be applied to the extension or renewal of such agreements, including any subsequent auto-renewal periods).

In addition to the obvious tax consequences of Rev. Rul. 2008-13, companies will need to consider the financial accounting implications under FIN 48. Prior to this ruling, it was generally believed that companies could rely upon two previous IRS rulings to support the “more likely than not” standard under FIN 48. However, upon the effective date of Rev. Rul. 2008-13, companies can no longer rely upon the more likely than not standard if they do not modify their affected arrangements to remove any provisions allowing Section 162(m) covered employees to receive payments of performance compensation upon their termination of employment (other than for death or disability) or their retirement, as described in Rev. Rul. 2008-13.