Check Your Parachute

The IRS provided temporary relief from its new, tougher stance on qualifying performance-based compensation exempt from the general $1 million deductibility limit on executive pay. In Revenue Ruling 2008-13, the Service officially adopted a controversial holding from an earlier private letter ruling but said the treatment will not be applied to plans like the one described, as long as they otherwise satisfy requirements for qualified performance-based compensation and have “performance periods” that begin on or before Jan. 1, 2009, or for contracts in effect on Feb. 21, 2008, the date of the revenue ruling.

The grace period and grandfather provisions were among the requests of 90 law firms in a letter to IRS officials for guidance in dealing with the “unexpected development” of the Service’s position in private letter ruling 200804004, released Jan. 25, 2008. Otherwise, the law firms said, “numerous” companies’ financial accounting would be affected, current awards disrupted and proxy disclosures thrown into uncertainty.

IRC § 162(m) limits the deductibility of pay for CEOs and the top four most highly compensated executives of publicly held corporations but allows an exception for performance-based compensation. Subsection (m)(4)(C) and related regulations require such compensation to be paid solely on account of attainment of one or more performance goals during a certain period of service—for example, an earnings-per-share target met by a certain date—and sets conditions of their corporate review and approval.

Treas. Reg. § 1.162-27(e)(2)(v) directs that compensation is not performance-based if the employee would receive the compensation regardless of whether the goal is met. A compensation plan, however, can include provisions allowing payment upon the employee’s death or disability or a change of ownership or control, although if the performance goal has not yet been met when the payment is made, the compensation would not be considered performance-based.

In the revenue ruling and private letter ruling, the IRS analyzed a company’s employment agreement with an executive that provided for performance-based incentive awards but also allowed vesting of those awards if the employment were terminated by the company without “cause” or by the executive for “good reason.” Because those events aren’t specifically included in Treas. Reg. § 1.162-27(e)(2)(v), the compensation wasn’t performance based, the Service concluded. Likewise, it said in the revenue ruling, a plan wouldn’t qualify in which an award would be paid to the employee even if the goal were not attained, or if the employee died, voluntarily retired or became disabled, or if the company had a change of control or ownership, since retirement also isn’t included in the regulation subsection.

In response, the law firms wrote that many companies had based their plans partly on two previous private letter rulings going back more than eight years (200613012 and 199949014) with similar facts but contrary holdings to the one released in January. The one released in 1999 specifically included severance provisions like those of the recent ruling. While a private letter ruling applies only to the taxpayer requesting it, the law firms noted that the rulings are a source of “substantial authority” for treatment of an item.


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