Public employers may need to amend executive compensation agreements and plans prior to Dec. 31, 2009, to preserve the deductibility of performance-based compensation.
In Revenue Ruling 2008-13 (the “Ruling”), the IRS confirmed its earlier position that a plan or agreement that provides for payment following an executive’s termination without cause, for good reason or upon retirement will not qualify as deductible performance-based compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”), regardless of whether the performance goals are satisfied.
As a result, this compensation will not be deductible if it exceeds the $1 million deduction limit. The Ruling provides relief for certain existing plans, as discussed in more detail in this advisory. Public companies should evaluate their plans as soon as possible to determine compliance.
Code Section 162(a)(1) provides employers with a tax deduction for reasonable compensation for services. The Code caps the allowable deduction in any year at $1 million for compensation payable to a “covered employee” of a public company. A covered employee is defined as the public company’s chief executive officer and its three other most highly compensated officers whose compensation is required to be disclosed to shareholders under the Securities Exchange Act of 1934. The deduction limit does not apply to performance-based compensation provided that it is paid solely upon attainment of one or more pre-established, objective performance goals.
Revenue Ruling 2008-13
The Ruling clarifies that compensation will not fail to be qualified deductible performance-based compensation merely because the compensation is payable upon death, disability or change of ownership or control, even if the performance goals are not obtained. However, compensation that is payable upon an executive’s involuntarily termination, voluntary termination or retirement will not constitute performance-based compensation under any circumstances, regardless of whether the performance goals are fulfilled. Compensation payable under such an arrangement that exceeds $1 million in the taxable year will not be deductible.
Relief for existing plans
The Ruling provides employers relief in certain limited circumstances. Existing plans with payments triggered by termination without cause, with good reason or upon retirement will not be subject to the holding in the Ruling, provided that (a) the performance period for the compensation began on or before Jan. 1, 2009, or (b) the employment agreement that established the terms of the compensation arrangement was in place on Feb. 21, 2008 (without respect to future renewals or extensions, including renewals or extensions that occur automatically absent further action of one or more of the parties to the contract).
Public companies should review their outstanding compensation agreements and plans with covered employees to determine whether such arrangements may require amendment in light of the Ruling. Employers will need to act quickly to amend such arrangements to comply with the Ruling for performance periods beginning on or after Jan. 1, 2010.