Internal Revenue Code Section 162(m) limits the deduction that publicly held corporations may take for some of their executive salaries in excess of $1,000,000. This limitation applies to the salaries of the Chief Executive Officer and the four highest paid executives (other than the CEO). However, certain amounts paid to these executives, known as performance-based compensation, do not count toward the $1,000,000 deductibility limit.
In recently issued Revenue Ruling 2012-19, the Internal Revenue Service (IRS) provides guidance as to whether dividends and dividend equivalents relating to restricted stock and restricted stock units (RSUs) must separately satisfy the requirements of Internal Revenue Code Section 162(m)(4)(C) to be treated as performance-based compensation.
The revenue ruling examines the following two scenarios in its analysis:
- Scenario 1 - Corporation X, a publicly traded company, offers to key employees a plan under which the employees may be granted restricted common stock of X corporation or RSUs based on the common stock of X corporation. The plan provides that dividends and dividend equivalents payable from the period of grant through vesting are accumulated and become vested and payable only if the related performance goals are satisfied.
- Scenario 2 – Corporation Y maintains the same type of plan as Corporation X. Corporation Y’s plan provides for payment to an employee during the period from grant through vesting of dividends and dividend equivalents at the same time dividends are paid on the common stock of corporation Y regardless of whether the performance goals of the covered employees have been satisfied.
The regulations under Section 162(m) provide that qualified performance-based compensation must be paid solely on account of the attainment of one or more pre-established, objective performance goals. The regulations further provide that dividends and dividend equivalents made in connection with restricted stock and RSUs are not performance-based compensation unless they separately satisfy the performance goal requirements. Such performance goals may or may not be the same as the performance goals for the related stock-based compensation.
In the ruling, the IRS holds that because the employees of Corporation X have no rights to the dividends or dividend equivalents until the performance goals are met, they are not counted toward the $1,000,000 limitation under Section 162(m). Conversely, because the dividends and dividend equivalents under the Corporation Y plan are payable regardless of whether performance goals have been met, they are counted toward the $1,000,000 limitation of Section 162(m).
For more information on performance based compensation, please contact your Schneider Downs representative.
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