In general, a covered employee is the publicly-held corporation’s Chief Executive Officer and the four other highest compensated officers of the corporation. Often this foursome includes the CFO. Under Section 162(m)(4)(C),
applicable employee remuneration does not include any compensation payable solely based on the attainment of one or more performance goals. Furthermore, the tax code — specifically Reg. Sec. 1.162-27(e)(1) — provides that “qualified performance based compensation” (deductible without regard to the $1 million cap generally applicable to a covered employee’s compensation) is compensation that meets the requirements of another section, namely, Reg. Sec. 1.162-27(e)(2) through (5).
In this regard, one subsection (Reg. Sec. 1.162-27(e)(2)(v)) provides that compensation does not satisfy the requirements of a previous subsection (Reg. Sec. 1.162-27(e)(2)) if “the facts indicate that the executive would receive all or part of the compensation regardless of whether the performance goal is attained.”
Moreover, the regulations also provide that if the payment of compensation is only “nominally or partially” contingent on attaining a performance goal, none of the compensation payable under a grant or award will be considered performance based.
On the other hand, the regulations provide that compensation does not fail to be qualified performance based compensation merely because the plan allows the compensation to be payable upon death, disability, or a change of ownership or control, a so-called “permissible payment event”*.
With these principles in mind, the ruling observes (as did the I.R.S. letter on which the ruling is based) that a covered employee’s termination “without cause” or “for good reason” is not listed as a permissible payment event under Reg. Sec. 1.162-27(e)(2)(v). More important, termination without cause may occur, or a good reason may arise, as a result of Mr. E’s poor performance and his failure to meet the performance goal.
Accordingly, the ruling concludes that the compensation is not remuneration payable solely on account of attainment of performance goals, and therefore, the compensation payable under the bonus plan is applicable employee remuneration to which the provisions of Sec. 162(m) are fully and unremittingly applicable. (Note that compensation may become payable as a result of events and circumstances that do not entail the attainment of performance goals, and which are not considered permissible payment events.)
A similar conclusion was reached with respect to the second scenario described in the ruling. An executive’s “voluntary retirement” is not listed as a permissible payment event. Moreover, because retirement is a voluntary action within the control of the covered employee, the compensation payable as a result of the action is not remuneration payable solely on account of the attainment of one or more performance goals. As a result, in each case, the cash award did not constitute qualified performance based compensation and, therefore, X Corp. was denied a tax deduction in the manner provided for in Sec. 162(m)(1).
It appears that many (if not most) corporations have adopted incentive plans for their covered employees that parallel the plan addressed in Rev. Rul. 2008-13. As a result, to ease the sting of the ruling’s conclusions, the I.R.S. provides for a generous transition rule. Thus, the holdings of Rev. Rul. 2008-13 will not be applied to disallow a corporate deduction for cases that are similar to the two scenarios if: (1) the “performance period” for such compensation begins on or before January 1, 2009; or (2) the compensation is paid pursuant to the terms of an employment contract “as in effect” on February 21, 2008.
This issue may well become the subject of litigation. Judging by the nature of the protests lodged by the legal community, it would appear that attorneys firmly believes that the case to be made against the I.R.S.’s conception of the parameters of performance based compensation is a compelling one. Indeed, it seems safe to say that the debate will not end merely because the I.R.S. has chosen to “formalize” its views with respect to this matter through the issuance of a revenue ruling.
Contributor Robert Willens, founder and principle of Robert Willens LLC, writes a regular tax column for CFO.com.
*Compensation actually paid on account of these permissible payment events prior to the attainment of the performance goals does not satisfy the requirements of Reg. Sec. 1.162-27(e)(2) and, therefore, constitutes applicable employee remuneration.