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CLIENT ALERT: Internal Revenue Service Issues Final Regulations under Internal Revenue Code Section 162(m)

May 2015
Manes Merrit

On March 31, 2015, the Internal Revenue Service (“IRS”) issued final regulations (the “Final Regulations”) under Internal Revenue Code (“Code”) Section 162(m) which clarify two important operational items regarding the deductibility of certain executive compensation.  While the Final Regulations do not substantively change the rules, the clarifications provide publicly traded companies with the opportunity to review their equity and incentive plans and procedures to ensure that compensation payable under the same is deductible by the company.


Code Section 162(m) imposes a $1,000,000 limit on the amounts that a public company can deduct for compensation paid to its chief executive officer and three highest compensated officers of the corporation (other than the CEO or CFO) in any taxable year.  This limitation on deductibility does not apply to performance-based compensation or remuneration that was paid in accordance with the Transition Rule (defined below) applicable to new public companies. 

The Final Regulations

The Final Regulations clarify that (i) per-employee limits on equity awards must be stated in the applicable equity compensation plan in order to qualify as performance-based compensation, and (ii) restricted stock units (“RSUs”) granted after April 1, 2015 must be settled or paid during the Transition Period (defined below) in order to satisfy the Transition Rule. 

Maximum Share Limit Clarification

In order to qualify as performance-based compensation, compensation must satisfy the following requirements:

  • The compensation is paid only upon attaining one or more pre-established, objective performance goals;
  • The performance goals are established by a compensation committee comprised of at least two outside directors (the “Compensation Committee”);
  • The material terms of the performance goals under which the compensation will be paid is disclosed to and approved by company shareholders before the compensation is paid; and
  • Prior to the payment of the compensation, the Compensation Committee certifies in writing that the performance goals were met.

Stock options and stock appreciation rights will qualify as performance-based compensation if:

  • The grant or award is made by the Compensation Committee;
  • The plan states the maximum number of shares an individual could obtain in a specified period; and
  • The amount of compensation the employee could receive is based solely on the increase in value of the stock after the date of grant.

The Final Regulations clarify that the requirement to state a per-employee limit on shares is separate and apart from the aggregate share limit required for securities laws purposes.  Although prior to this issuance of the Final Regulations, many plans specified per-employee limits as well as aggregate limits, some taxpayers argued that a literal reading of the prior Code Section 162(m) regulations would permit the aggregate shares limit to also serve as the per-employee limit.  The clarification under the Final Regulations now explicitly provides that the per-employee share limits are separate and distinct from the aggregate plan limit. 

The Final Regulations provide that the per-employee limit applies to compensation attributable to options and stock appreciation rights granted on or after June 24, 2011.

Transition Rule Clarification

Compensation is not required to be performance based to be exempt from the deduction limit under Code Section 162(m), if it satisfies the Transition Rule.  Under the Transition Rule, compensation paid by newly public companies under plans or agreements in effect prior to a corporation’s becoming publicly held (and, if the corporation becomes publicly held in connection with an IPO, if appropriate disclosure is made in SEC filings), will not be subject to the Code Section 162(m) deduction limit during a Transition Period, which lasts until the earliest of (i) the expiration or material modification of the plan or agreement; (ii) the issuance of all stock or other compensation under the plan or agreement; and (iii) the first shareholder meeting at which directors are to be elected that occurs after the third calendar year following the IPO or, if the privately held company becomes publicly held without an IPO, the first calendar year following the calendar year in which the  corporation becomes publicly held.

Two types of compensation are covered by the Transition Rule: any (i) compensation paid during the Transition Period; and (ii) compensation awarded during the Transition Period, even if settled after the Transition Period, with respect to the vesting of restricted stock and the exercise of stock options and stock appreciation rights. 

The Final Regulations clarified that the only compensation attributable to RSUs that is covered by the Transition Rule is compensation paid during the Transition Period.  Therefore, the Transition Rule would not apply to RSUs that were awarded but not paid during the Transition Period. 

However, the IRS provided limited relief by extending the Transition Rule to RSUs granted during a company’s Transition Period and prior to April 1, 2015. 


Public companies that rely on the performance-based compensation exception to the limitations of Code Section 162(m) should review their equity and incentive plans to confirm that such plans state per-employee maximum share limits.  This would also be an appropriate time to confirm that other procedural requirements of Code Section 162(m) to qualify payments as performance-based compensation are satisfied.

Newly public companies that are operating within the Transition Period should consider their grant processes with respect to RSUs in light of the Final Regulations.  Private companies that are contemplating going public should review their equity award programs to ensure such programs and any awards granted thereunder will receive the benefits of Transition Period rules, including making sure that any equity incentive plan is in place prior to the IPO and being aware that RSUs issued to covered employees during the Transition Period will be treated differently than stock options, stock appreciation rights, and restricted stock issued during such period.

If you have any questions regarding the recently issued Final Regulations, please contact the Olshan attorney with whom you regularly work or any member of the Employee Benefits practice listed below.

This publication is issued by Olshan Frome Wolosky LLP for informational purposes only and does not constitute legal advice or establish an attorney-client relationship.  To ensure compliance with requirements imposed by the IRS, we inform you that unless specifically indicated otherwise, any tax advice contained in this publication was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any tax-related matter addressed herein.  In some jurisdictions, this publication may be considered attorney advertising.
Copyright © 2015 Olshan Frome Wolosky LLP.  All Rights Reserved.

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