IRS increases scrutiny of performance-based plans under sec. 162(m).

• Author: Slivanya, James D.

Sec. 162(m) governs the deductibility of certain excessive employee compensation. In recent months the IRS has issued Rev. Rul. 2008-13 and Rev. Rul. 2008-32, providing for additional clarification related to certain components of the performance-based compensation rules contained within Sec. 162(m)(4)(C) and Regs. Sec. 1.162-27(e). Corporations not paying careful attention to the application of these recent rulings can be subject to unexpected negative results.

What Is Sec. 162(m)?

Sec. 162(m) disallows a tax deduction to corporations for compensation paid to any "covered employee" in excess of $1 million for the tax year. This section applies only to publicly held corporations registered under Section 12 of the Securities Exchange Act of 1934. As interpreted by Notice 2007-49, issued in June 2007, a covered employee under Sec. 162(m)(3) refers to a publicly held corporation's chief executive officer, or an individual acting in that capacity, and the three other highest-paid officers whose compensation must be reported to shareholders under SEC regulations, but not including the chief financial officer (unless the CFO was also acting as the CEO or the CFO held another position that was among the top three highest-paid officers other than the CEO).

Commissions based on income generated from individual performance and other performance-based compensation are excepted from the $1 million limitation. Specifically, performance-based compensation is excluded for purposes of Sec. 162(m) if:

* The compensation is payable upon the realization of one or more performance goals (Sec. 162(m)(4)(C));

* The performance goals are determined by a compensation committee of the corporation's board of directors, which is composed solely of two or more outside directors (Sec. 162(m)(4)(C)(i));

* The material terms under which the compensation is paid, including performance goals, are disclosed to shareholders and approved by a majority in a separate shareholder vote before the compensation is actually paid (Sec. 162(m)(4)(C)(ii)); and

* Before payment of the compensation, the compensation committee confirms or certifies that the performance goals and any other material terms were in fact satisfied (Sec. 162(m)(4)(C)(iii)).

Rev. Rul. 2008-13

Rev. Rul. 2008-13, issued on February 21, 2008, affirms the IRS's position in Letter Ruling 200804004 that compensation will not qualify as performance based under Sec. 162(m) if all or part of the compensation can be paid...