IRS changes its position on performance-based compensation for $1 million compensation limit.

• Author: Adkins, G. Edgar, Jr.

Under Sec. 162(m), a public company may not deduct compensation paid to certain employees in excess of $1 million. However, compensation that qualifies as performance-based compensation is not subject to the $1 million limit. In Rev. Rul. 2008-13, the IRS ruled that an incentive plan is not performance-based compensation because it allows payments upon involuntary termination without cause by the employer, voluntary termination by the employee with good reason, or voluntary retirement regardless of whether the performance goals are met. Thus, all payments under the plan are subject to the $1 million limit, including payments made when the performance criteria have been met.

According to the IRS, the payment provisions run afoul of Rags. Sec. 1.162-27(e)(2)(v), which provides generally that compensation is not performance based if an employee would receive all or part of the compensation regardless of whether the performance goal is attained. The regulation makes specific exceptions to this general rule for payments made upon death, disability, or a change in control.

The revenue ruling and a recent similar letter ruling (200804004) are a surprise to many employers bemuse they run contrary to two prior rulings (Letter Rulings 199949014 and 200613012). In those rulings, the IRS held that compensation was still performance based even though...