Daily Rules, Proposed Rules, and Notices of the Federal Government
This document contains a proposed amendment to 26 CFR part 1 under section 162(m) of the Code.
Section 162(m) was added to the Code by section 3211(a) of the Omnibus Budget Reconciliation Act of 1993, Public Law 103-66. Proposed regulations under section 162(m) were published in the
The IRS and the Treasury Department have received questions regarding the requirement that a stock-based compensation plan must state the maximum number of shares with respect to which stock options or stock appreciation rights may be granted under the plan to any employee to qualify as performance-based compensation under section 162(m). The IRS and the Treasury Department have also received questions regarding the application of the transition rule for taxpayers that are not publicly held corporations and then become publicly held corporations. These proposed amendments to §§ 1.162-27(e)(2), 1.162-27(e)(4), and 1.162-27(f)(1) are not intended to reflect substantive changes to the requirements in the current regulations, but rather to clarify the current language.
Section 1.162-27(b) provides that section 162(m) precludes a deduction under chapter 1 of the Code by any publicly held corporation for compensation paid to any covered employee to the extent that the compensation for the taxable year exceeds $1,000,000. Section 1.162-27(e)(1) provides that the deduction limit in § 1.162-27(b) does not apply to qualified performance-based compensation. Section 1.162-27(e)(1) further provides that qualified performance-based compensation is compensation that meets all of the requirements of § 1.162-27(e)(2) through (e)(5).
Section 1.162-27(e)(2)(vi) sets forth special rules for performance-based compensation attributable to stock options and stock appreciation rights. This section provides that stock options and stock appreciation rights are deemed to satisfy the performance goal requirement in § 1.162-27(e)(2) if: (1) The grant or award is made by the compensation committee; (2) the plan under which the option or right is granted states the maximum number of shares with respect to which options or rights may be granted during a specified period to any employee; and, (3) under the terms of the option or right, the amount of compensation the employee can receive is based solely on an increase in the value of the stock after the date of the grant or award.
The legislative history for section 162(m) provides that “[i]n the case of stock options, it is intended that the directors may retain discretion as to the exact number of options that are granted to an executive, provided that the maximum number of options that the individual executive may receive during a specified period is predetermined.” H.R. Conf. Rep. No. 213, 103rd Cong., 1st Sess. 586-87 (1993), reprinted in 1993 U.S.C.C.A.N. 1088, 1275-6.
The preamble to the proposed 1993 Treasury Regulations (58 FR 66310) under section 162(m) explains the reason for requiring an individual limit on the maximum number of shares for which options may be granted:
Some have questioned why it would be necessary for the regulations to require an individual employee limit on the number of the shares for which options or stock appreciation rights may be granted, where shareholder approval of an aggregate limit is obtained for securities law purposes. The regulations follow the legislative history, which suggests that a per-employee limit be required under the terms of the plan. The IRS and the Treasury believe that a limit on the maximum number of shares for which individual employees may receive options or other rights is appropriate because it is consistent with the broader requirement that a performance goal include an objective formula for determining the maximum amount of compensation that an individual employee could receive if the performance goal were satisfied. A third party attempting to make this determination with respect to a stock option plan would need to know both the exercise price and the number of options that could be granted.
These proposed regulations clarify § 1.162-27(e)(2)(vi) by providing that the plan under which the option or right is granted must specify the maximum number of shares with respect to which options or rights may be granted to any individual employee during a specified period. Accordingly, if a plan states an aggregate maximum number of shares that may be granted but does not contain a specific per-employee limitation on the number of options that may be granted, then any compensation attributable to the stock options or rights granted under the plan is not qualified performance-based compensation under § 1.162-27(e)(2)(vi). A plan satisfies § 1.162-27(e)(2)(vi) where the terms of the plan specify that an individual employee may be granted options or rights to receive the maximum number of shares authorized under the plan during a specified period.
These proposed regulations also provide a related clarification of the shareholder approval requirement under § 1.162-27(e)(4). Specifically, § 1.162-27(e)(4)(iv) is clarified to provide that the requirement for description of the compensation in this section is satisfied where the maximum number of shares for which grants may be made to each individual employee during a specified period and the exercise price of those options is disclosed to the shareholders of the corporation.
Section 1.162-27(f)(1) of the current regulations provides that in the case of a corporation that was not a publicly held corporation and then becomes a publicly held corporation, the $1,000,000 deduction limit “does not apply to any remuneration paid pursuant to a compensation plan or agreement that existed during the period in which the corporation was not publicly held.” If a corporation becomes publicly held in connection with an initial public offering (IPO), then the relief provided in § 1.162-27(f)(1) applies only to the extent that the prospectus accompanying the IPO disclosed information concerning the existing compensation plans or agreements and satisfied all applicable securities laws.
Pursuant to § 1.162-27(f)(2), a corporation may rely on § 1.162-27(f)(1) until the earliest of: (i) The expiration of the plan or agreement; (ii) the material modification of the plan or agreement; (iii) the issuance of all employer stock and other compensation that has been allocated under the plan; or (iv) 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 IPO occurs or, in the case of a privately held corporation that becomes publicly held without an IPO, the first calendar year following the calendar year in which the corporation becomes publicly held. Section 1.162-27(f)(3) provides that the relief provided under § 1.162-27(f)(1) applies to any compensation received pursuant the exercise of a stock option or stock appreciation right, or the substantial vesting of restricted property, granted under a plan or agreement described in § 1.162-27(f)(1) if the grant occurs on or before the earliest of the events specified in § 1.162-27(f)(2).
Practitioners have asked whether compensation payable under a restricted stock unit arrangement or a phantom stock arrangement is eligible for the relief provided in § 1.162-27(f)(3). A restricted stock unit is a right to an amount based on the value of the employer's stock, and which is payable in cash, shares of the stock, or other property (as defined in § 1.83-3(e)), following the satisfaction of a specified vesting condition. Compensation payable under a phantom stock arrangement is compensation that is paid at a future date in cash or in property based on the value of the employer's stock.
The preamble to the final 1994 Treasury Regulations (60 FR 65534) under section 162(m) specifically addressed the types of compensation covered under § 1.162-27(f)(3):
Commentators have asked that the relief provided in the 1994 amendments for stock options, stock appreciation rights, and restricted property be extended even further to cover other stock-based compensation and deferred compensation in general. After careful consideration of the comments received, the IRS and Treasury have concluded that there is not adequate justification for a further expansion of the 1994 expansion of the prior regulatory transition relief for previously approved plans and agreements, or the other similar relief provisions added in 1994.
These regulations under section 162(m) are proposed to apply to taxable years ending on or after the date of publication of the Treasury decision adopting these rules as final regulation in the
It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this regulation has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.
Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are timely submitted to the IRS. The IRS and the Treasury Department specifically request comments on the clarity of the proposed rules and how they can be made easier to understand. All comments will be available for public inspection and copying. A public hearing will be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the
The principal author of these proposed regulations is Ilya Enkishev, Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.
Income taxes, Reporting and recordkeeping requirements.
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
26 U.S.C. 7805 * * *.
(e) * * *
(2) * * *
(vi) * * *
(vii) * * *
(4) * * *
(f) * * *
(j) * * *
(2) * * *
(vi) The clarifications to paragraphs (e)(2)(vi)(A), (e)(2)(vii)