Final Rules Clarify Performance-Based Pay Exception Under Section 162(m)

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By Mary Hughes

March 30—The IRS issued final regulations confirming that stock-based compensation plans must provide a limit on the maximum number of shares for which individual employees may receive options and that only compensation specifically identified in the regulations is available for special transition relief in the case of newly public companies.

Issued March 30, the final rules (T.D. 9716; RIN 1545-BI65) adopt the proposed regulations (REG-137125-08) with minor modifications.

Tax code Section 162(m) limits the deduction for compensation paid to any covered employee of a public company to $1 million for the taxable year. An exception to the $1 million cap applies to performance-based compensation.

The final rules add an additional example to the regulations and clarify (1) that a plan must specify the maximum number of shares that may be granted to each individual employee during a specified period, and (2) that, under the transition rule for companies that become publicly held, compensation attributable to restricted stock units during the transition period must be paid, rather than merely granted, to be eligible for the exception.

All Equity Awards

The final rules clarify that a plan will satisfy the performance-based plan exception under Section 162(m) if it specifies the maximum number of shares with respect to which any type of equity-based compensation may be granted to any individual employee during a specified period.

The proposed rules had specified stock options and stock appreciation rights, “which are the two types of equity-based awards described” in the regulations, the Internal Revenue Service said.

Extending the clarification to all types of equity awards “is not intended as a substantive change,” the IRS said.

Newly Public Companies

The rules in general provide that the Section 162(m) deduction limit doesn't apply to compensation paid “pursuant to a plan that existed during the period in which the corporation was not publicly held.”

For companies that go public through an initial public offering, the final rules clarify the extent of the exemption from Section 162(m) for compensatory arrangements that existed during the time the company was privately held.

The proposed rules made it clear that compensation payable under a restricted stock unit would be eligible for transition relief only “if it is paid, and not merely granted, before the earliest of the events” enumerated in the regulations. The final rules adopt this clarification without change.

The final rules grant additional time for their application to RSUs paid by companies that are newly public. The final rules will apply to RSUs granted on or after the date the rules are published in the Federal Register, scheduled for March 31.

The rules will apply to compensation attributable to equity awards granted on or after June 24, 2011.

To contact the reporter on this story: Mary Hughes in Washington at

To contact the editor responsible for this story: Sue Doyle at

Text of T.D. 9716 is in TaxCore.