The recent amendments to the Section 162(m) regulations largely follow the changes set forth in the proposed regulations issued in 2011, clarifying two exceptions from the Section 162(m) tax deductibility limit:
- The treatment of restricted stock units (RSUs) and certain other forms of stock-based compensation under the transition rule applicable to newly public companies; and
- The requirement under the "qualified performance-based compensation" exception to set a per-employee limit applicable to stock options and stock appreciation rights (SARs) under an equity plan intended to comply with such exception.
RSU Reliance Period Clarification
- Generally, compensation paid by newly public companies under
plans or agreements in effect prior to the company's initial
public offering (IPO) (for which adequate disclosure is
provided in the IPO prospectus) must be "paid" during the
reliance period to be deemed performance-based compensation that
does not count against the annual $1 million deduction
limitation.
- The reliance period ends on the earliest of: (a) the first annual shareholders meeting at which directors are to be elected that occurs after the third calendar year following the year of the company's IPO (or, if no IPO, the first calendar year following the year in which the company becomes a public company), (b) the issuance of all employer stock and other compensation allocated under the plan or agreement, or (c) the expiration or material modification of the plan or agreement.
- Under a special equity award rule, stock options, SARs, and restricted stock that are granted during the reliance period will be deemed to be performance-based compensation (subject to meeting all the other specific requirements) even if the equity awards are exercised or vest after the end of the reliance period.
- The final regulations clarify that other forms of stock-based compensation, most notably RSUs, do not qualify for the special equity rule and must be settled during the reliance period. However, this clarification does not apply to stock-based compensation granted prior to April 1, 2015.
Practical Advice
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Per-Employee Limit Clarification
- The final regulations retain the rule that using an aggregate limit on the number of shares that could be granted under a stockholder-approved plan will not meet the requirement for establishing the maximum amount of compensation that may be received by an individual covered employee.
- This clarification does not apply to stock options or SARs granted prior to the proposed regulations' effective date of June 24, 2011. Further, the limit can be structured to include all types of equity-based awards, other than stock options and SARs.
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