On March 31, 2015, the IRS published final regulations related to performance-based compensation that is exempt from the $1 million compensation limit for covered employees of publicly held corporations.
Publicly held corporations cannot claim a tax deduction for compensation paid in excess of $1 million to covered employees. Covered employees include the CEO and the three next-highest-compensated officers of the corporation other than the CFO. Compensation paid on a commission basis, paid for performance-based goals, or paid under a binding contract in effect on Feb. 17, 1993, might be deductible even if annual compensation for the covered employee exceeds $1 million.
The new regulations modify the requirements that must be met for stock options and stock appreciation rights (SARs) to qualify for the performance-based exception. Under the previous regulations, stock options or SARs could satisfy the performance-based exception if the plan stated the maximum number of shares available under the plan. The new regulations require the plan to state the maximum number of shares available to each individual employee. The new rules also clarify that the plan can set an overall limit for each individual employee’s receipt of stock options, SARs, restricted stock, restricted stock units, and other equity-based awards without separately stating the maximum number of shares available as stock options or SARs. This rule is effective for all equity awards granted on or after June 24, 2011.
Additionally, the final regulations clarify the rules for applying the $1 million limit for private companies that become public. Generally, compensation from stock options, SARs, and restricted stock granted before the company was public is not subject to the $1 million limit through the earliest of one of the following dates, assuming appropriate disclosures are included in the prospectus for the initial public offering:
- The expiration of the plan or agreement
- The material modification of the plan or agreement
- The issuance of all employer stock and other compensation that has been allocated under the plan
- The first meeting of shareholders at which directors are to be elected that occurs after the close of the third calendar year following the calendar year in which the initial public offering occurs or, in the case of a privately held corporation that becomes publicly held without an initial public offering, the first calendar year following the calendar year in which the corporation becomes publicly held
Under the final regulations, compensation from restricted stock units, phantom stock plans, or any equity-based compensation plans other than those noted above must be paid, not granted, prior to the earliest of the dates outlined. This change is effective for equity compensation granted after March 31, 2015.