[Federal Register Volume 59, Number 231 (Friday, December 2, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-29536]
[[Page Unknown]]
[Federal Register: December 2, 1994]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[EE-61-93]
RIN 1545-AS23
Disallowance of Deductions for Employee Remuneration in Excess of
$1,000,000
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Amendments to proposed regulations.
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SUMMARY: This document contains amendments to the proposed regulations
under section 162(m) of the Internal Revenue Code of 1986 (Code),
relating to the disallowance of deductions for employee remuneration in
excess of $1,000,000. The proposed regulations, as amended, will
provide guidance to taxpayers who must comply with section 162(m),
which was added to the Code by the Omnibus Budget Reconciliation Act of
1993.
DATES: Written comments with regard to the amendments to the proposed
regulations and requests for a public hearing must be received by March
2, 1995.
ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (EE-61-93), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be delivered to:
CC:DOM:CORP:T:R (EE-61-93), Courier's Desk, Internal Revenue Service,
1111 Constitution Avenue, NW, Washington, DC 20224.
FOR FURTHER INFORMATION CONTACT: Robert Misner or Charles T. Deliee at
(202)-622-6060 (not a toll free call).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to the proposed Income Tax
Regulations (26 CFR Part 1) under section 162(m) of the Internal
Revenue Code (Code). The proposed regulations were published in the
Federal Register on December 20, 1993, at 58 FR 66310, with a
correction published in the Federal Register on February 14, 1994, at
59 FR 5370. Additional guidance was provided under Notice 94-2, 1994-2
I.R.B. 25, and Notice 94-68, 1994-26 I.R.B. 1. In Notice 94-2, the IRS
provided transition relief relating to the requirement that a
performance goal based on a period of service be ``preestablished.'' In
Notice 94-68, the IRS announced that the final regulations would
provide similar relief on a permanent basis. Notice 94-68 also extended
the transition period during which a corporation can treat
disinterested directors as outside directors until the first meeting of
shareholders at which directors are to be elected that occurs on or
after January 1, 1995. Section 1.162-27(h)(2) of the proposed
regulations defines a disinterested director as a director who is
disinterested within the meaning of Rule 16b-3(c)(2)(i) under the
Securities Exchange Act of 1934 (including the provisions of Rule 16b-
3(d)(3), as in effect on April 30, 1991). Under Sec. 1.162-27(h)(2),
the transition rule for disinterested directors originally was
scheduled to expire upon the first meeting of shareholders at which
directors were to be elected that occurred after July 1, 1994.
These amendments provide guidance on the definition of the term
``outside director.'' The amendments also extend the transition relief
provided in Notice 94-68 until the first meeting of shareholders at
which directors are to be elected that occurs on or after January 1,
1996. Thus, corporations can treat disinterested directors as outside
directors until that first meeting of shareholders. Other modifications
are also included that reflect a number of the comments received on the
December 1993 proposed regulations. The IRS and Treasury will continue
to consider comments previously received on the December 1993 proposed
regulations on issues other than those addressed by these amendments.
The December 1993 proposed regulations, as amended by these
amendments, are generally intended to address broad issues that are
important to most taxpayers in complying with section 162(m) and, thus,
are not comprehensive. To the extent that an issue is not covered by
the proposed regulations, as amended, taxpayers should follow a
reasonable, good faith interpretation of the statutory provisions.
Overview of Amendments
Definition of Publicly Held Corporation
Section 1.162-27(c)(1)(ii) of the proposed regulations defines a
publicly held corporation to include an affiliated group of
corporations, as defined in section 1504 of the Code (determined
without regard to section 1504(b)). Because a subsidiary that is itself
publicly held is subject to reporting requirements of the Securities
and Exchange Commission (SEC), Sec. 1.162-27(c)(1)(ii) is amended to
make clear that any publicly held subsidiary is excluded from the
affiliated group of its parent. Such a publicly held subsidiary, and
its subsidiaries (if any), are separately subject to section 162(m) and
may comprise one or more separate affiliated groups of corporations.
Thus, for example, if 85 percent of the stock of a subsidiary (S1)
is owned by a parent (P) that is publicly held, and 15 percent is
publicly traded, S1 is not considered a member of P's affiliated group
for purposes of section 162(m). In this case, S1 is treated as a
separate publicly held corporation. If, in turn, S1 owns, for example,
100 percent of the stock of another corporation, S2, then S2 is
considered a member of S1's affiliated group, and not a member of P's
affiliated group. Conversely, P (and, for example, a 100 percent
subsidiary of P) are not considered members of S1's affiliated group.
Thus, if P and S1 both pay compensation to the same covered employee,
the compensation paid to the employee by each is not aggregated with
the compensation paid to the employee by the other.
Definition of Compensation Committee
Section 1.162-27(c)(4) provides that a compensation committee must
have the authority to establish and administer a ``performance-based
compensation arrangement described in paragraph (e)(2).'' In order to
clarify that, for example, the entire board of directors may establish
a plan, this section is amended to state more narrowly that a
compensation committee must have the authority to establish and
administer ``performance goals described in paragraph (e)(2).''
Preestablished Performance Goal
Section 1.162-27(e)(2)(i) and Example 1 under Sec. 1.162-
27(e)(2)(vii) are amended to conform to the definition of
``preestablished'' provided in Notice 94-68. As amended, Sec. 1.162-
27(e)(2)(i) now provides that a performance goal is considered
preestablished if it is established in writing by the compensation
committee not later than 90 days after the commencement of the period
of service to which the performance goal relates, provided that the
outcome is substantially uncertain. However, in no event will a
performance goal be considered preestablished if it is established
after 25 percent of the period of service (as scheduled in good faith
at the time the goal is established) has elapsed.
The ``Substantially Uncertain'' Requirement
Commentators have requested additional guidance as to when a
performance goal is ``substantially uncertain.'' While this
determination remains essentially factual in nature, two examples have
been added to the proposed regulations under Sec. 1.162-27(e)(2)(vii).
Under new Example 2, it is concluded that a performance goal based on a
percentage of total sales is not substantially uncertain because some
sales are a virtual certainty. New Example 3, however, illustrates that
a performance goal based on corporate profitability is substantially
uncertain, even for companies with a history of profitability.
Awards Based on a Percentage of Salary
Commentators have raised the question whether a compensation
formula based on a percentage of salary or base pay involves
impermissible discretion to increase the amount payable under the
formula upon attainment of the goal because, by increasing salary, the
amount payable may be increased after the goal has been established.
Section 1.162-27(e)(2)(iii) has been amended to provide that, if the
terms of an objective formula or standard fail to preclude discretion
merely because the amount of compensation to be paid upon the
attainment of the performance goal is based, in whole or in part, on a
percentage of salary or base pay, the objective formula or standard
will not be considered discretionary (and thus Sec. 1.162-27(e)(2)(iii)
will not be violated) if the maximum dollar amount to be paid is fixed
at the time the performance goal is established.
Of course, a formula or standard based on salary or base pay might
fail to meet the requirements of Sec. 1.162-27(e)(2)(iii) for reasons
other than the fact that the formula or standard is based on salary or
base pay. If that is the case, the relief described in the preceding
paragraph will not prevent the performance goal from failing to meet
the requirements of Sec. 1.162-27(e)(2). A conforming amendment has
been made to Sec. 1.162-27(e)(4)(i) to provide that, when the amount to
be paid is based on a percentage of salary or base pay, the material
terms of a performance goal that must be disclosed to shareholders
include the maximum dollar amount that could be paid.
Earnings on Deferred Performance-Based Compensation
In the case of a deferral of a payment of compensation beyond the
date on which it would otherwise be payable, Sec. 1.162-
27(e)(2)(iii)(B) provides that an increase in the amount of the
compensation is not treated as an increase in the amount payable under
the performance goal if the increase in compensation is based on a
reasonable rate of interest. (Of course, this rule assumes there is no
constructive receipt of the compensation at the time it is deferred.)
Commentators have asked whether this deferral rule also applies to
increases in compensation that are determined on reasonable bases other
than by reference to a rate of interest. The purpose of the rule is
generally to permit a reasonable adjustment in the amount of
compensation to account for the delay in payment. Consequently, the
rule is amended to permit the adjustment to be based on the actual rate
of return on a predetermined investment (including any decrease as well
as any increase in the value of an investment) during the deferral
period (whether or not assets associated with the amount originally
owed are actually invested therein). New Examples 14, 15, and 16 have
been added to illustrate the application of this rule.
Impact of Corporate Transactions on Performance Goals
Section 1.162-27(e)(2)(vi) provides that compensation attributable
to a stock option or stock appreciation right does not fail to be
performance-based to the extent that a change in the grant or award is
made to reflect changes in corporate capitalization. In response to
commentators' suggestions that this relief for changes in corporate
capitalization be expanded, the current provision has been expanded to
apply to all stock-based compensation, not only to stock options and
stock appreciation rights. Thus, the provision has been moved to new
Sec. 1.162-27(e)(2)(iii)(C). In addition, new Example 13 in Sec. 1.162-
27(e)(2)(vii) indicates that the adjustment of a performance goal to
reflect a change in accounting standards will not be considered an
exercise of impermissible discretion, provided that the adjustment is
made pursuant to the terms of the plan or arrangement.
Clarification of Rule Viewing All Plans and Agreements in the Aggregate
Section 1.162-27(e)(2)(iv) provides that all plans, arrangements,
and agreements that provide for compensation to an employee will be
taken into account for purposes of determining whether, under the facts
and circumstances, compensation is only nominally or partially
contingent on attainment of a performance goal. Compensation is only
nominally or partially contingent on attainment of a performance goal
if the employee will receive all or part of the compensation regardless
of whether the performance goal is attained. Section 1.162-27(e)(2)(v)
provides that the determination of whether compensation satisfies the
requirements of Sec. 1.162-27(e)(2), and thus is performance-based, is
made on a grant-by-grant basis.
In order to clarify how these two provisions apply and work
together, the sequence of the two provisions has been reversed and
minor revisions have been made. These changes are intended to clarify
that the grant-by-grant rule is the general rule under which
compensation arrangements are tested for purposes of determining
whether they are performance-based. Thus, whether a compensation
arrangement is performance-based is generally determined without regard
to other compensation arrangements. The changes make clear that the
aggregation rule requiring all plans, arrangements, and agreements
providing compensation to an employee to be taken into account is a
limited exception to the general grant-by-grant rule, and applies only
for the purpose of determining whether the employee would receive,
regardless of whether the performance goal is attained, compensation
that purports to be performance-based. Thus, for example, if payment
under a nonperformance-based compensation arrangement is contingent
upon the failure to attain a performance goal under an otherwise
performance-based arrangement, neither arrangement provides for
compensation that is performance-based.
The amendments also provide that, if a plan providing for
performance-based restricted stock also provides for the payment of
dividends on the stock prior to the attainment of the performance goal,
the restricted stock and the dividends will be considered separate
grants, and the payment of dividends will not ``taint'' the
performance-based character of the restricted stock.
Outside Directors
Under Sec. 1.162-27(e)(3)(i)(D), an outside director is one who
does not receive remuneration, either directly or indirectly, in any
capacity other than as a director. Remuneration for this purpose
includes any payment in exchange for goods or services. Remuneration is
deemed to be paid to a director if it is paid to the director
personally, to an entity in which the director has a beneficial
ownership interest of greater than 50 percent, or (if more than de
minimis remuneration) to an entity by which the director is employed or
in which the director has a beneficial ownership interest of at least
five percent but not more than 50 percent. See Sec. 1.162-27(e)(3)(ii).
Remuneration is de minimis for this purpose if, during the publicly
held corporation's preceding taxable year, payments to the entity did
not exceed the lesser of $60,000 or five percent of the entity's gross
income for the entity's taxable year ending with or within the publicly
held corporation's taxable year. See Sec. 1.162-27(e)(3)(iii).
Commentators have asserted that the $60,000 limit of the de minimis
rule may be unrealistically low in cases where goods or certain types
of services are purchased from entities that employ their directors.
Thus, under the proposed amendments, the $60,000 de minimis limit
applies only if the payment to the entity employing the director is
remuneration for personal services or if the director is a five-
percent-or-more owner of the entity. In addition, the proposed
amendments clarify that a director of an entity will not be considered
employed or self-employed by that entity solely on account of services
as a director of the entity.
Under new Sec. 1.162-27(e)(3)(iv), remuneration is not for personal
services unless two requirements are satisfied. First, the remuneration
must be paid to an entity for personal or professional services,
consisting of legal, accounting, investment banking, and management
consulting services (and other similar services that may be specified
by the Commissioner in revenue rulings, notices, or other guidance
published in the Internal Revenue Bulletin), performed for the publicly
held corporation. For this purpose, remuneration for personal services
that are incidental to the purchase of goods or nonpersonal services
are not taken into account. Second, the director must perform
significant services (whether or not as an employee) for the
corporation, division, or similar organization (within the entity) that
actually provides the personal services described above to the publicly
held corporation, or more than 50 percent of the entity's gross
revenues must be derived from the personal-service-providing
organization.
New Examples 5, 6, and 7 are added to Sec. 1.162-27(e)(3)(ix) to
clarify the revised rules on de minimis remuneration. Other clarifying
amendments have been made to the outside director rules. New
Sec. 1.162-27(e)(3)(v) clarifies the definition of the term ``entity.''
Section 1.162-27(e)(3)(ii)(A) and new Examples 3 and 4 under
Sec. 1.162-27(e)(3)(ix) make clear that directors are not outside
directors if they receive any indirect personal remuneration from the
publicly held corporation.
Section 1.162-27(e)(3)(ii)(A) further provides that remuneration
described in that section is considered paid when actually paid (and
throughout the remainder of that taxable year of the publicly held
corporation) and, if earlier, throughout the period when a contract or
agreement to pay remuneration is outstanding. New Example 4 illustrates
this rule. By contrast, Sec. 1.162-27(e)(3)(ii)(B) and (C) are amended
to provide that remuneration described in those sections is considered
paid when it is actually paid or, if earlier, when the publicly held
corporation becomes liable to pay it. Thus, for example, if a publicly
held corporation becomes liable in 1998 to pay more than de minimis
remuneration to an entity, but agrees with the entity to defer payment
of that remuneration until 1999, the remuneration would be taken into
account for purposes of Sec. 1.162-27(e)(3)(ii)(B) and (C) only in 1998
when the corporation became liable to pay it. Also, under Sec. 1.162-
27(e)(3)(iii), the five percent de minimis rule is amended to focus on
the entity's gross revenue instead of its gross income. Finally, in
order to clarify the application of the outside director rules to
affiliated groups, new Sec. 1.162-27(e)(3)(viii) provides that the
outside directors of the publicly held member of an affiliated group
are treated as the outside directors of all members of the affiliated
group.
``Key Employees'' as a Description of a Class of Eligible Employees
Section 1.162-27(e)(4)(ii) provides a nonexclusive list of classes
of employees that constitute sufficient disclosure of employees
eligible to receive performance-based compensation. The proposed
regulations are amended to add ``key employees'' to the list.
Shareholder Approval
Under Sec. 1.162-27(e)(4)(i), the material terms of the performance
goal under which compensation is to be paid must be disclosed to and
subsequently approved by shareholders. The proposed amendments make
explicit the requirement that disclosure and shareholder approval must
occur before the compensation is paid. Of course, disclosure and
shareholder approval need not occur during the period within which the
compensation committee is required to establish the performance goal.
Under Sec. 1.162-27(e)(4)(vii), the material terms of a performance
goal are considered approved by shareholders if, in a separate vote,
affirmative votes are cast by a majority of the voting shares. In order
to reflect the fact that certain shares may have more than one vote,
and to properly deal with abstentions, that section is amended to
provide that the material terms of a performance goal are considered
approved by shareholders if, in a separate vote, a majority of the
votes cast on the issue (including abstentions to the extent
abstentions are counted as voting under applicable state law) are cast
in favor of approval.
In addition, in order to clarify the application of the shareholder
approval requirements to affiliated groups, new Sec. 1.162-
27(e)(4)(viii) provides that the shareholders of the publicly held
member of an affiliated group are treated as the shareholders of all
members of the affiliated group. For example, if one of the five
covered employees of an affiliated group is an employee of a wholly-
owned subsidiary of a publicly held parent corporation, the
shareholders of the parent would be required to approve the
performance-based compensation of that covered employee along with that
of the four covered employees who are employees of the publicly held
parent.
Private to Public Exception
Under Sec. 1.162-27(f), the $1 million deduction limit does not
apply to any compensation plan or agreement that existed during a
period in which a corporation was not publicly held, to the extent that
the prospectus accompanying the initial public offering disclosed
information concerning those plans or agreements that satisfied all
applicable securities laws then in effect. Several commentators have
asked whether the exemption should apply in perpetuity to plans or
agreements that existed before the corporation became public. Other
comments have suggested that the exemption be extended to corporations
that are spun off from publicly held corporations.
The IRS and Treasury believe that abuse could occur if the
``private to public'' exemption from the normally applicable rules were
of unlimited duration. Accordingly, new Sec. 1.162-27(f)(2) provides
that the exemption will apply for the duration of a reliance period
that lasts until the earliest of the expiration or material
modification of the plan or agreement; the issuance of all employer
stock or other compensation that has been allocated under the plan; or
the first meeting of shareholders at which directors are elected that
occurs after the close of the third calendar year following the
calendar year in which the initial public offering occurs. A taxpayer
may rely on this exemption for any compensation received pursuant to
the exercise of a stock option or stock appreciation right, or the
substantial vesting of restricted property, if the grant (as opposed to
the exercise or the substantial vesting) occurs before the close of the
reliance period.
The IRS and Treasury have decided that the ``private to public''
exemption should not apply to a subsidiary of a publicly held
corporation, where the subsidiary has been spun off or has otherwise
become a separate publicly held corporation. This is because those
subsidiary corporations are considered to be publicly held before the
spinoff under the affiliated group rule of Sec. 1.162-27(c)(ii).
However, the IRS and Treasury recognize that it may be difficult to
obtain shareholder approval of otherwise performance-based compensation
in some of these situations.
Accordingly, new Sec. 1.162-27(f)(3) provides alternative rules for
satisfying the requirements for performance-based compensation in the
context of a spinoff or similar situations. The first alternative
prescribes the method for applying the existing rules to satisfy the
performance-based compensation requirements for compensation paid after
a spinoff (or similar transaction) pursuant to a plan or arrangement
established before the spinoff (or similar transaction). The second
alternative provides relief from the shareholder approval requirement
during a transition period that ends with the first regularly scheduled
meeting of the shareholders of the new publicly held corporation that
occurs more than 12 months after the date on which the corporation
becomes a separate publicly held corporation. This alternative may be
necessary where shareholder approval of compensation is not obtained
before the spinoff.
Earnings on Deferred Compensation Payable Under a Binding Written
Contract
Section 1.162-27(h)(1)(iii)(B) is amended to conform to changes
made to Sec. 1.162-27(e)(2)(iii)(B) (with respect to permissible
increases in the amount of compensation where payment of compensation
has been deferred).
Special Transition Rule for Outside Directors
Section 1.162-27(h)(2) is amended to extend the transition relief
for the treatment of disinterested directors (as defined in Sec. 1.162-
27(h)(2)) as outside directors until the first meeting of shareholders
at which directors are to be elected that occurs on or after January 1,
1996. Thus, for example, if disinterested directors establish a bonus
plan (that satisfies the performance-based compensation requirements of
Sec. 1.162-27(e)(2)) for 1996 before that first shareholders meeting,
and the plan is approved by shareholders at that meeting, payments
under the plan will satisfy the performance-based-compensation
requirements if the compensation committee comprised of the new outside
directors certifies that the performance goals have been satisfied
prior to payment of the bonuses.
Special Transition Rule for Previously-Approved Plans
The proposed amendments modify Sec. 1.162-27(h)(3)(i) to clarify
that, in order for a plan to qualify under the special transition rule
for previously-approved plans, the disinterested directors need only
administer the plan (and need not also establish it).
Reliance Period for Special Transition Rule for Previously-Approved
Plans
Section 1.162-27(h)(3)(ii) provides that the reliance period that
applies to the transition rule for previously-approved plans under
Sec. 1.162-27(h)(3)(i) ends upon the earliest of the expiration or
material modification of the plan or agreement, the issuance of all
employer stock or other compensation that has been allocated under the
plan, or the first meeting of shareholders at which directors are to be
elected that occurs after December 31, 1996. Questions have been raised
as to whether, under this provision, and under the example provided,
the deductions attributable to stock options, stock appreciation
rights, and restricted property must be taken within the paragraph
(h)(3)(ii) reliance period in order to take advantage of the transition
relief. This was not the intention of the IRS or Treasury. Accordingly,
this provision and the related example are amended to provide that
stock options, stock appreciation rights, and restricted property need
only be granted before the end of the reliance period.
Proposed Effective Date
Except as otherwise provided, these amendments are proposed to be
effective for any payment that would be deductible for taxable years
beginning on or after January 1, 1994. Later effective dates are
proposed for several of the amendments under Sec. 1.162-27(i)(2).
Special Analysis
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. It also has
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C.
chapter 6) do not apply to these regulations, and, therefore, a
Regulatory Flexibility Analysis is not required. Pursuant to section
7805(f) of the Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Requests for Public Hearing
Before adopting these amendments to the proposed regulations,
consideration will be given to any written comments that are submitted
timely (preferably 8 copies) to the Commissioner of Internal Revenue.
All comments will be available for public inspection and copying. A
public hearing may be held upon written request to the Commissioner by
any person who has submitted written comments. If a public hearing is
held, notice of the time and place will be published in the Federal
Register.
Drafting information
The principal authors of the amendments to the proposed regulations
are Charles T. Deliee and Robert Misner, Office of the Associate Chief
Counsel (Employee Benefits and Exempt Organizations), IRS. However,
other personnel from IRS and the Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Amendments to the Proposed Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority for part 1 continues to read as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.162-27, as proposed to be added on December 20,
1993 at 58 FR 66313, is amended as follows:
1. Paragraph (c)(1)(ii) is amended by adding two sentences after
the first sentence.
2. Paragraph (c)(4) is revised.
3. Paragraph (e)(2) is amended as follows:
a. In paragraph (e)(2)(i), the second sentence is removed and two
new sentences are added in its place.
b. Paragraph (e)(2)(iii) is amended as follows:
i. A new sentence is added at the end of paragraph (e)(2)(iii)(A).
ii. Paragraph (e)(2)(iii)(B) is revised.
iii. Paragraph (e)(2)(iii)(C) is added.
c. Paragraphs (e)(2)(iv) and (v) are revised.
d. Paragraph (e)(2)(vi)(C) is removed.
e. Paragraph (e)(2)(vii) is amended as follows:
i. The first sentence of Example 1 is revised.
ii. Example 2 through Example 10 are redesignated as Example 4
through Example 12, respectively.
iii. New Examples 2 and 3 are added.
iv. The second sentence of newly designated Example 6 is revised.
v. Examples 13, 14, 15, and 16 are added.
4. Paragraph (e)(3) is amended as follows:
a. Paragraphs (e)(3)(i)(D), (e)(3)(ii), and (e)(3)(iii) are
revised.
b. Paragraph (e)(3)(vi) is redesignated as paragraph (e)(3)(ix);
Example 2 is revised; and Examples 3, 4, 5, 6, and 7 are added.
c. Paragraphs (e)(3)(iv) and (e)(3)(v) are redesignated as
paragraphs (e)(3)(vi) and (e)(3)(vii) respectively.
d. New paragraphs (e)(3)(iv), (e)(3)(v) and (e)(3)(viii) are added.
5. Paragraph (e)(4) is amended as follow:
a. Paragraph (e)(4)(i) is revised.
b. The last sentence of (e)(4)(ii) is revised.
c. Paragraph (e)(4)(vii) is revised.
d. Paragraph (e)(4)(viii) is redesignated as paragraph (e)(4)(ix).
e. New paragraph (e)(4)(viii) is added.
6. The heading for paragraph (f) is revised, the text of paragraph
(f) following the heading is designated as paragraph (f)(1) and
revised, and paragraphs (f)(2) through (5) are added.
7. The last sentence of paragraph (h)(1)(iii)(B) is revised.
8. The first sentence of paragraph (h)(2) is revised.
9. Paragraph (h)(3) is amended as follows:
a. Paragraph (h)(3)(i) is revised.
b. Paragraph (h)(3)(ii)(B) is revised.
c. Paragraph (h)(3)(iii) is redesignated as paragraph (h)(3)(iv)
and the Example is revised.
d. New paragraph (h)(3)(iii) is added.
10. Paragraph (i) is amended as follows:
a. The text of paragraph (i) following the heading is designated as
paragraph (i)(1).
b. A paragraph heading is added for newly designated paragraph
(i)(1).
c. Paragraph (i)(2) is added.
The revisions and additions read as follows:
Sec. 1.162-27 Certain employee remuneration in excess of $1,000,000.
* * * * *
(c) * * * (1) * * *
(ii) Affiliated groups. * * * However, an affiliated group of
corporations does not include any subsidiary that is itself a publicly
held corporation. Such a publicly held subsidiary, and its subsidiaries
(if any), are separately subject to this section. * * *
* * * * *
(4) Compensation Committee. The compensation committee means the
committee of directors (including any subcommittee of directors) of the
publicly held corporation that has the authority to establish and
administer performance goals described in paragraph (e)(2) of this
section, and to certify that performance goals are attained, as
described in paragraph (e)(5) of this section. A committee of directors
is not treated as failing to have the authority to establish
performance goals merely because the goals are ratified by the board of
directors of the publicly held corporation or, if applicable, any other
committee of the board of directors. See paragraph (e)(3) of this
section for rules concerning the composition of the compensation
committee.
* * * * *
(e) * * *
(2) * * * (i) * * * A performance goal is considered preestablished
if it is established in writing by the compensation committee not later
than 90 days after the commencement of the period of service to which
the performance goal relates, provided that the outcome is
substantially uncertain at the time the compensation committee actually
establishes the goal. However, in no event will a performance goal be
considered to be preestablished if it is established after 25 percent
of the period of service (as scheduled in good faith at the time the
goal is established) has elapsed. * * *
* * * * *
(iii) * * * (A) * * * If the terms of an objective formula or
standard fail to preclude discretion to increase the amount of
compensation merely because the amount of compensation to be paid upon
attainment of the performance goal is based, in whole or in part, on a
percentage of salary or base pay, the objective formula or standard
will not be considered discretionary for purposes of this paragraph
(e)(2)(iii) if the maximum dollar amount to be paid is fixed at the
time the performance goal is established.
(B) If compensation is payable upon or after the attainment of a
performance goal, and a change is made to accelerate the payment of
compensation to an earlier date after the attainment of the goal, the
change will be treated as an increase in the amount of compensation,
unless the amount of compensation paid is discounted to reasonably
reflect the time value of money. If compensation is payable upon or
after the attainment of a performance goal, and a change is made to
defer the payment of compensation to a later date, any amount paid in
excess of the amount that was originally owed to the employee will not
be treated as an increase in the amount of compensation if the
additional amount is based either on a reasonable rate of interest or
on one or more predetermined actual investments (whether or not assets
associated with the amount originally owed are actually invested
therein) such that the amount payable by the employer at the later date
will be based on the actual rate of return of a specific investment
(including any decrease as well as any increase in the value of an
investment). If compensation is payable in the form of property, a
change in the timing of the transfer of that property after the
attainment of the goal will not be treated as an increase in the amount
of compensation for purposes of this paragraph (e)(2)(iii). Thus, for
example, if the terms of a stock grant provide for stock to be
transferred after the attainment of a performance goal and the transfer
of the stock also is subject to a vesting schedule, a change in the
vesting schedule that either accelerates or defers the transfer of
stock will not be treated as an increase in the amount of compensation
payable under the performance goal.
(C) Compensation attributable to a stock option, stock appreciation
right, or other stock-based compensation does not fail to satisfy the
requirements of this paragraph (e)(2) to the extent that a change in
the grant or award is made to reflect a change in corporate
capitalization, such as a stock split or dividend, or a corporate
transaction, such as any merger of a corporation into another
corporation, any consolidation of two or more corporations into another
corporation, any separation of a corporation (including a spinoff or
other distribution of stock or property by a corporation), any
reorganization of a corporation (whether or not such reorganization
comes within the definition of such term in section 368), or any
partial or complete liquidation by a corporation.
(iv) Grant-by-grant determination. The determination of whether
compensation satisfies the requirements of this paragraph (e)(2)
generally shall be made on a grant-by-grant basis. Thus, for example,
whether compensation attributable to a stock option grant satisfies the
requirements of this paragraph (e)(2) generally is determined on the
basis of the particular grant made and without regard to the terms of
any other option grant, or other grant of compensation, to the same or
another employee. In addition, whether a restricted stock grant
satisfies the requirements of this paragraph (e)(2) is determined
without regard to whether dividends on the restricted stock are payable
prior to the attainment of the performance goal.
(v) Compensation contingent upon attainment of performance goal.
Compensation does not satisfy the requirements of this paragraph (e)(2)
if the facts and circumstances indicate that the employee would receive
all or part of the compensation regardless of whether the performance
goal is attained. Thus, if the payment of compensation under a grant or
award is only nominally or partially contingent on attaining a
performance goal, none of the compensation payable under the grant or
award will be considered performance-based. For example, if an employee
is entitled to a bonus under either of two arrangements, where payment
under a nonperformance-based arrangement is contingent upon the failure
to attain the performance goals under an otherwise performance-based
arrangement, then neither arrangement provides for compensation that
satisfies the requirements of this paragraph (e)(2). Compensation does
not fail to be qualified performance-based compensation merely because
the plan allows the compensation to be payable upon death, disability,
or change of ownership or control, although compensation actually paid
on account of those events prior to the attainment of the performance
goal would not satisfy the requirements of this paragraph (e)(2). As an
exception to the general rule set forth in the first sentence of
paragraph (e)(2)(iv) of this section, the facts-and-circumstances
determination referred to in the first sentence of this paragraph
(e)(2)(v) is made taking into account all plans, arrangements, and
agreements that provide for compensation to the employee.
* * * * *
(vii) * * *
Example 1. No later than 90 days after the start of a fiscal
year, but while the outcome is substantially uncertain, Corporation
S establishes a bonus plan under which A, the chief executive
officer, will receive a cash bonus of $500,000, if year-end
corporate sales are increased by at least 5 percent. * * *
Example 2. The facts are the same as in Example 1, except that
the bonus is based on a percentage of the Corporation's total sales
for the fiscal year. Because Corporation S is virtually certain to
have some sales for the fiscal year, the outcome of the performance
goal is not substantially uncertain, and therefore the bonus does
not meet the requirements of this paragraph (e)(2).
Example 3. The facts are the same as in Example 1, except that
the bonus is based on a percentage of the Corporation's total
profits for the fiscal year. Although some sales are virtually
certain for virtually all public companies, it is substantially
uncertain whether a company will have profits for a specified future
period even if the company has a history of profitability.
Therefore, the bonus will meet the requirements of this paragraph
(e)(2).
* * * * *
Example 6. * * * If both the earnings-per-share goal and the
stock-price goal are preestablished, the compensation committee's
discretion to choose to pay a bonus under either of the two goals
does not cause any bonus paid under the plan to fail to meet the
requirement of this paragraph (e)(2) because each goal independently
meets the requirements of this paragraph (e)(2). * * *
* * * * *
Example 13. Corporation W adopts a plan under which a bonus will
be paid to the CEO only if there is a 10% increase in earnings per
share during the performance period. The plan provides that earnings
per share will be calculated without regard to any change in
accounting standards that may be required by the Financial
Accounting Standards Board after the goal is established. After the
goal is established, such a change in accounting standards occurs.
Corporation W's reported earnings, for purposes of determining
earnings per share under the plan, are adjusted pursuant to this
plan provision to factor out this change in standards. This
adjustment will not be considered an exercise of impermissible
discretion because it is made pursuant to the plan provision.
Example 14. Corporation X adopts a performance-based incentive
pay plan with a four-year performance period. Bonuses under the plan
are scheduled to be paid in the first year after the end of the
performance period (year 5). However, in the second year of the
performance period, the compensation committee determines that any
bonuses payable in year 5 will instead, for bona fide business
reasons, be paid in year 10. The compensation committee also
determines that any compensation that would have been payable in
year 5 will be adjusted to reflect the delay in payment. The
adjustment will be based on the greater of the future rate of return
of a specified mutual fund that invests in blue chip stocks or of a
specified venture capital investment over the five-year deferral
period. Each of these investments, considered by itself, is a
predetermined actual investment because it is based on the future
rate of return of an actual investment. However, the adjustment in
this case is not based on predetermined actual investments within
the meaning of paragraph (e)(2)(iii)(B) of this section because the
amount payable by Corporation X in year 10 will be based on the
greater of the two investment returns and, thus, will not be based
on the actual rate of return on either specific investment.
Example 15. The facts are the same as in Example 14, except that
the increase will be based on the rate of return of Moody's Average
Corporate Bond Yield over the five-year deferral period. Because
this index reflects a reasonable rate of interest, the increase in
the compensation payable that is based on the index's rate of return
is not considered an impermissible increase in the amount of
compensation payable under the formula.
Example 16. The facts are the same as in Example 14, except that
the increase will be based on the rate of return for the Standard &
Poor's 500 Index. This index does not measure interest rates and
thus does not represent a reasonable rate of interest. In addition,
this index does not represent an actual investment. Therefore, any
additional compensation payable based on the rate of return of this
index will result in an impermissible increase in the amount payable
under the formula. If, in contrast, the increase were based on the
rate of return of an existing mutual fund that is invested in a
manner that seeks to approximate the Standard & Poor's 500 Index,
the increase would be based on a predetermined actual investment
within the meaning of paragraph (e)(2)(iii)(B) of this section and
thus would not result in an impermissible increase in the amount
payable under the formula.
(3) * * * (i) * * *
(D) Does not receive remuneration from the publicly held
corporation, either directly or indirectly, in any capacity other than
as a director. For this purpose, remuneration includes any payment in
exchange for goods or services.
(ii) Remuneration received. For purposes of this paragraph (e)(3),
remuneration is received, directly or indirectly, by a director in each
of the following circumstances:
(A) If remuneration is paid, directly or indirectly, to the
director personally or to an entity in which the director has a
beneficial ownership interest of greater than 50 percent. For this
purpose, remuneration is considered paid when actually paid (and
throughout the remainder of that taxable year of the corporation) and,
if earlier, throughout the period when a contract or agreement to pay
remuneration is outstanding.
(B) If remuneration, other than de minimis remuneration, was paid
by the publicly held corporation in its preceding taxable year to an
entity in which the director has a beneficial ownership interest of at
least 5 percent but not more than 50 percent. For this purpose,
remuneration is considered paid when actually paid or, if earlier, when
the publicly held corporation becomes liable to pay it.
(C) If remuneration, other than de minimis remuneration, was paid
by the publicly held corporation in its preceding taxable year to an
entity by which the director is employed or self-employed other than as
a director. For this purpose, remuneration is considered paid when
actually paid or, if earlier, when the publicly held corporation
becomes liable to pay it.
(iii) De minimis remuneration--(A) In general. For purposes of
paragraphs (e)(3)(ii)(B) and (C) of this section, remuneration that was
paid by the publicly held corporation in its preceding taxable year to
an entity is de minimis if payments to the entity did not exceed 5
percent of the gross revenue of the entity for its taxable year ending
with or within that preceding taxable year of the publicly held
corporation.
(B) Remuneration for personal services and substantial owners.
Notwithstanding paragraph (e)(3)(iii)(A) of this section, remuneration
in excess of $60,000 is not de minimis if the remuneration is paid to
an entity described in paragraph (e)(3)(ii)(B) of this section, or is
paid for personal services to an entity described in paragraph
(e)(3)(ii)(C) of this section.
(iv) Remuneration for personal services. For purposes of paragraph
(e)(3)(iii)(B) of this section, remuneration from a publicly held
corporation is for personal services if--
(A) The remuneration is paid to an entity for personal or
professional services, consisting of legal, accounting, investment
banking, and management consulting services (and other similar services
that may be specified by the Commissioner in revenue rulings, notices,
or other guidance published in the Internal Revenue Bulletin),
performed for the publicly held corporation, and the remuneration is
not for services that are incidental to the purchase of goods or to the
purchase of services that are not personal services; and
(B) The director performs significant services (whether or not as
an employee) for the corporation, division, or similar organization
(within the entity) that actually provides the services described in
paragraph (e)(3)(iv)(A) of this section to the publicly held
corporation, or more than 50 percent of the entity's gross revenues
(for the entity's preceding taxable year) are derived from that
corporation, subsidiary, or similar organization.
(v) Entity defined. For purposes of this paragraph (e)(3), the term
entity means an organization that is a sole proprietorship, trust,
estate, partnership, or corporation. The term entity also includes an
affiliated group of corporations as defined in section 1504 (determined
without regard to section 1504(b)) and a group of organizations that
would be an affiliated group but for the fact that one or more of the
organizations are not incorporated. However, the aggregation rules
referred to in the preceding sentence do not apply for purposes of
determining whether a director has a beneficial ownership interest of
at least 5 percent or greater than 50 percent.
* * * * *
(viii) Members of affiliated groups. For purposes of this paragraph
(e)(3), the outside directors of the publicly held member of an
affiliated group are treated as the outside directors of all members of
the affiliated group.
(ix) * * *
Example 2. Corporation Z, a calendar-year taxpayer, uses the
services of a law firm by which B is employed, but in which B has a
less-than-5-percent ownership interest. The law firm reports income
on a July 1 to June 30 basis. Corporation Z appoints B to serve on
its compensation committee for calendar year 1998 after determining
that, in calendar year 1997, it did not become liable to the law
firm for remuneration exceeding the lesser of $60,000 or five
percent of the law firm's gross revenue (calculated for the year
ending June 30, 1997). On October 1, 1998, Corporation Z becomes
liable to pay remuneration of $50,000 to the law firm on June 30,
1999. For the year ending June 30, 1998, the law firm's gross
revenue was less than $1 million. Thus, in calendar year 1999, B is
not an outside director. However, B may satisfy the requirements for
an outside director in calendar year 2000, if, in calendar year
1999, Corporation Z does not become liable to the law firm for
additional remuneration. This is because the remuneration actually
paid on June 30, 1999 was considered paid on October 1, 1998 under
paragraph (e)(3)(ii)(C) of this section.
Example 3. Corporation Z, a publicly held corporation, purchases
goods from Corporation A. D, an executive and less-than-5-percent
owner of Corporation A, sits on the board of directors of
Corporation Z and on its compensation committee. For 1997,
Corporation Z obtains representations to the effect that D is not
eligible for any commission for D's sales to Corporation Z and that,
for purposes of determining D's compensation for 1997, Corporation
A's sales to Corporation Z are not otherwise treated differently
than sales to other customers of Corporation A (including its
affiliates, if any) or are irrelevant. In addition, Corporation Z
has no reason to believe that these representations are inaccurate
or that it is otherwise paying remuneration indirectly to D
personally. Thus, in 1997, no remuneration is considered paid by
Corporation Z indirectly to D personally under paragraph
(e)(3)(ii)(A) of this section.
Example 4. (i) Corporation W, a publicly held corporation,
purchases goods from Corporation T. C, an executive and less-than-5-
percent owner of Corporation T, sits on the board of directors of
Corporation W and on its compensation committee. Corporation T
develops a new product and agrees on January 1, 1998 to pay C a
bonus of $500,000 if Corporation W contracts to purchase the
product. Even if Corporation W purchases the new product, sales to
Corporation W will represent less than 5 percent of Corporation T's
gross revenues. In 1999, Corporation W contracts to purchase the new
product and, in 2000, C receives the $500,000 bonus from Corporation
T. In 1998, 1999, and 2000, Corporation W does not obtain any
representations relating to indirect remuneration to C personally
(such as the representations described in Example 3).
(ii) Thus, in 1998, 1999, and 2000, remuneration is considered
paid by Corporation W indirectly to C personally under paragraph
(e)(3)(ii)(A) of this section. Accordingly, in 1998, 1999, and 2000,
C is not an outside director of Corporation W. The result would have
been the same if Corporation W had obtained appropriate
representations but nevertheless had reason to believe that it was
paying remuneration indirectly to C personally.
Example 5. Corporation R, a publicly held corporation, purchases
utility service from Corporation Q, a public utility. The chief
executive officer, and less-than-5-percent owner, of Corporation Q
is a director of Corporation R. Corporation R pays Corporation Q
more than $60,000 per year for the utility service, but less than 5
percent of Corporation Q's gross revenues. Because utility services
are not personal services, the fees paid are not subject to the
$60,000 de minimis rule for remuneration for personal services
within the meaning of paragraph (e)(3)(iii)(B) of this section.
Thus, the chief executive officer qualifies as an outside director
of Corporation R, unless disqualified on some other basis.
Example 6. Corporation A, a publicly held corporation, purchases
management consulting services from Division S of Conglomerate P.
The chief financial officer of Division S is a director of
Corporation A. Corporation A pays more than $60,000 per year for the
management consulting services, but less than 5 percent of
Conglomerate P's gross revenues. Because management consulting
services are personal services within the meaning of paragraph
(e)(3)(iv)(A) of this section, and the chief financial officer
performs significant services for Division S, the fees paid are
subject to the $60,000 de minimis rule as remuneration for personal
services. Thus, the chief financial officer does not qualify as an
outside director of Corporation A.
Example 7. The facts are the same as in Example 6, except that
the chief executive officer, and less-than-5-percent owner, of the
parent company of Conglomerate P is a director of Corporation A and
does not perform significant services for Division S. If the gross
revenues of Division S do not constitute more than 50 percent of the
gross revenues of Conglomerate P for P's preceding taxable year, the
chief executive officer will qualify as an outside director of
Corporation A, unless disqualified on some other basis.
(4) Shareholder approval requirement--(i) General rule. The
material terms of the performance goal under which the compensation is
to be paid must be disclosed to and subsequently approved by the
shareholders of the publicly held corporation before the compensation
is paid. The requirements of this paragraph (e)(4) are not satisfied if
the compensation would be paid regardless of whether the material terms
are approved by shareholders. The material terms include the employees
eligible to receive compensation; a description of the business
criteria on which the performance goal is based; and either the maximum
amount of compensation that could be paid to any employee or the
formula used to calculate the amount of compensation to be paid to the
employee if the performance goal is attained (except that, in the case
of a formula based, in whole or in part, on a percentage of salary or
base pay, the maximum dollar amount of compensation that could be paid
to the employee must be disclosed).
(ii) * * * A general description of the class of eligible employees
by title or class is sufficient, such as the chief executive officer
and vice presidents, or all salaried employees, all executive officers,
or all key employees.
* * * * *
(vii) Shareholder vote. For purposes of this paragraph (e)(4), the
material terms of a performance goal are approved by shareholders if,
in a separate vote, a majority of the votes cast on the issue
(including abstentions to the extent abstentions are counted as voting
under applicable state law) are cast in favor of approval.
(viii) Members of affiliated group. For purposes of this paragraph
(e)(4), the shareholders of the publicly held member of the affiliated
group are treated as the shareholders of all members of the affiliated
group.
* * * * *
(f) Companies that become publicly held, spinoffs, and similar
transactions--(1) In general. In the case of a corporation that was not
a publicly held corporation and then becomes a publicly held
corporation, the deduction limit of paragraph (b) of this section does
not apply to any remuneration paid pursuant to a compensation plan or
agreement that existed during the period in which the corporation was
not publicly held, to the extent that the prospectus accompanying the
initial public offering disclosed information concerning those plans or
agreements that satisfied all applicable securities laws then in
effect. In accordance with paragraph (c)(1)(ii) of this section, a
corporation that is a member of an affiliated group that includes a
publicly held corporation is considered publicly held and, therefore,
cannot rely on this paragraph (f)(1).
(2) Reliance period. Paragraph (f)(1) of this section may be relied
upon until the earliest of--
(i) The expiration of the plan or agreement;
(ii) The material modification of the plan or agreement, within the
meaning of paragraph (h)(1)(iii) of this section;
(iii) The issuance of all employer stock or other compensation that
has been allocated under the plan; or
(iv) The first meeting of shareholders at which directors are to be
elected that occurs after the close of the third calendar year
following the calendar year in which the initial public offering
occurs.
(3) Stock-based compensation. Paragraph (f)(1) of this section will
apply to any compensation received pursuant to the exercise of a stock
option or stock appreciation right, or the substantial vesting of
restricted property, granted under a plan or agreement described in
paragraph (f)(1) of this section if the grant occurs before the
earliest of the dates specified in paragraph (f)(2) of this section.
(4) Subsidiaries that become separate publicly held corporations--
(i) In general. If a subsidiary that is a member of the affiliated
group described in paragraph (c)(1)(ii) of this section becomes a
separate publicly held corporation (whether by spinoff or otherwise),
any remuneration paid to covered employees of the new publicly held
corporation will satisfy the exception for performance-based
compensation described in paragraph (e) of this section if the
conditions in either paragraph (f)(4)(ii) or (iii) of this section are
satisfied.
(ii) Prior establishment and approval. The remuneration satisfies
the requirements for performance-based compensation set forth in
paragraphs (e)(2), (3), and (4) of this section (by application of
paragraphs (e)(3)(viii) and (e)(4)(viii) of this section) before the
corporation becomes a separate publicly held corporation, and the
certification required by paragraph (e)(5) of this section is made by
the compensation committee of the new publicly held corporation (but if
the performance goals are attained before the corporation becomes a
separate publicly held corporation, the certification may be made
before it becomes a separate publicly held corporation by the
compensation committee referred to in paragraph (e)(3)(viii) of this
section). Thus, this paragraph (f)(4)(ii) requires that the outside
directors and shareholders (within the meaning of paragraphs
(e)(3)(viii) and (e)(4)(viii) of this section) of the corporation
before it becomes a separate publicly held corporation establish and
approve, respectively, the performance-based compensation for the
covered employees of the new publicly held corporation in accordance
with paragraphs (e)(3) and (4) of this section.
(iii) Transition period. The remuneration satisfies all of the
requirements of paragraphs (e)(2), (3), and (5) of this section. The
outside directors (within the meaning of paragraph (e)(3)(viii) of this
section) of the corporation before it becomes a separate publicly held
corporation, or the outside directors of the new publicly held
corporation, may establish and administer the performance goals for the
covered employees of the new publicly held corporation for purposes of
satisfying the requirements of paragraphs (e)(2) and (3) of this
section. The certification required by paragraph (e)(5) of this section
must be made by the compensation committee of the new publicly held
corporation. However, a taxpayer may rely on this paragraph (f)(4)(iii)
to satisfy the requirements of paragraph (e) of this section only for
compensation paid, or stock options, stock appreciation rights, or
restricted property granted, prior to the first regularly scheduled
meeting of the shareholders of the new publicly held corporation that
occurs more than 12 months after the date the corporation becomes a
separate publicly held corporation. Compensation paid, or stock
options, stock appreciation rights, or restricted property granted, on
or after the date of that meeting of shareholders must satisfy all
requirements of paragraph (e) of this section, including the
shareholder approval requirement of paragraph (e)(4) of this section,
in order to satisfy the requirements for performance-based
compensation.
(5) Example. The following example illustrates the application of
paragraph (f)(4)(ii) of this section:
Example. Corporation P, which is publicly held, decides to spin
off Corporation S, a wholly owned subsidiary of Corporation P. After
the spinoff, Corporation S will be a separate publicly held
corporation. Before the spinoff, the compensation committee of
Corporation P, pursuant to paragraph (e)(3)(viii) of this section,
establishes a bonus plan for the executives of Corporation S that
provides for bonuses payable after the spinoff and that satisfies
the requirements of paragraph (e)(2) of this section. If, pursuant
to paragraph (e)(4)(viii) of this section, the shareholders of
Corporation P approve the plan prior to the spinoff, that approval
will satisfy the requirements of paragraph (e)(4) of this section
with respect to compensation paid pursuant to the bonus plan after
the spinoff. However, the compensation committee of Corporation S
will be required to certify that the goals are satisfied prior to
the payment of the bonuses in order for the bonuses to be considered
performance-based compensation.
* * * * *
(h) *** (1) ***
(iii) ***
(B) *** If the contract is modified to defer the payment of
compensation, any compensation paid in excess of the amount that was
originally payable to the employee under the contract will not be
treated as a material modification if the additional amount is based on
either a reasonable rate of interest or one or more predetermined
actual investments (whether or not assets associated with the amount
originally owed are actually invested therein) such that the amount
payable by the employer at the later date will be based on the actual
rate of return of a specific investment (including any decrease as well
as any increase in the value of an investment).
* * * * *
(2) Special transition rule for outside directors. A director who
is a disinterested director is treated as satisfying the requirements
of an outside director under paragraph (e)(3) of this section until the
first meeting of shareholders at which directors are to be elected that
occurs on or after January 1, 1996. ***
(3) *** (i) In general. Any compensation paid under a plan or
agreement approved by shareholders before December 20, 1993, is treated
as satisfying the requirements of paragraphs (e) (3) and (4) of this
section, provided that the directors administering the plan or
agreement are disinterested directors and the plan was approved by
shareholders in a manner consistent with Rule 16b-3(b), 17 CFR 240.16b-
3(b), under the Exchange Act or Rule 16b-3(a) (17 CFR 240.16b-3(a) as
contained in 17 CFR Part 240 to End, revised April 1, 1990). In
addition, for purposes of satisfying the requirements of paragraph
(e)(2)(vi) of this section, a plan or agreement is treated as stating a
maximum number of shares with respect to which an option or right may
be granted to any employee if the plan or agreement that was approved
by the shareholders provided for an aggregate limit, consistent with
Rule 16b-3(b), 17 CFR 250.16b-3(b), on the shares of employer stock
with respect to which awards may be made under the plan or agreement.
(ii) ***
(B) The issuance of all employer stock or other compensation that
has been allocated under the plan; or
* * * * *
(iii) Stock-based compensation. This paragraph (h)(3) will apply to
any compensation received pursuant to the exercise of a stock option or
stock appreciation right, or the substantial vesting of restricted
property, granted under a plan or agreement described in paragraph
(h)(3)(i) of this section if the grant occurs before the earliest of
the dates specified in paragraph (h)(3)(ii) of this section.
(iv) ***
Example. Corporation Z adopted a stock option plan in 1991.
Pursuant to Rule 16b-3 under the Exchange Act, the stock option plan
has been administered by disinterested directors and was approved by
Corporation Z shareholders. Under the terms of the plan, shareholder
approval is not required again until 2001. In addition, the terms of
the stock option plan include an aggregate limit on the number of
shares available under the plan. Option grants under the Corporation
Z plan are made with an exercise price equal to or greater than the
fair market value of Corporation Z stock. Compensation attributable
to the exercise of options that are granted under the plan before
the earliest of the dates specified in paragraph (h)(3)(ii) of this
section will be treated as satisfying the requirements of paragraph
(e) of this section for qualified performance-based compensation,
regardless of when the options are exercised.
(i) Effective date--(1) In general. ***
(2) Delayed effective date for certain provisions--(i) Date on
which remuneration is considered paid. Notwithstanding paragraph (i)(1)
of this section, the rules in the second sentence of each of paragraphs
(e)(3)(ii) (A), (B), and (C) of this section for determining the date
or dates on which remuneration is considered paid to a director are
effective for taxable years beginning on or after January 1, 1995.
Prior to those taxable years, taxpayers must follow the rules in
paragraphs (e)(3)(ii) (A), (B), and (C) of this section or another
reasonable, good faith interpretation of section 162(m) with respect to
the date or dates on which remuneration is considered paid to a
director.
(ii) Separate treatment of publicly held subsidiaries.
Notwithstanding paragraph (i)(1) of this section, the rule in paragraph
(c)(1)(ii) of this section that treats publicly held subsidiaries as
separately subject to section 162(m) is effective as of the first
regularly scheduled meeting of the shareholders of the publicly held
subsidiary that occurs more than 12 months after December 2, 1994. The
rule for stock-based compensation set forth in paragraph (f)(3) of this
section will apply for this purpose, except that the grant must occur
before the shareholder meeting specified in this paragraph (i)(2)(ii).
Taxpayers may choose to rely on the rule referred to in the first
sentence of this paragraph (i)(2)(ii) for the period prior to the
effective date of the rule.
(iii) Subsidiaries that become separate publicly held corporations.
Notwithstanding paragraph (i)(1) of this section, if a subsidiary of a
publicly held corporation becomes a separate publicly held corporation
as described in paragraph (f)(4)(i) of this section, then, for the
duration of the reliance period described in paragraph (f)(2) of this
section, the rules of paragraph (f)(4) of this section do not apply to
remuneration paid to covered employees of that new publicly held
corporation pursuant to a plan or agreement that existed prior to
December 2, 1994 provided that the treatment of that remuneration as
performance-based is in accordance with a reasonable, good faith
interpretation of section 162(m). However, if remuneration is paid to
covered employees of that new publicly held corporation pursuant to a
plan or agreement that existed prior to December 2, 1994, but that
remuneration is not performance-based under a reasonable, good faith
interpretation of section 162(m), then the rules of paragraph (f)(4) of
this section apply as of the first regularly scheduled meeting of
shareholders that occurs more than 12 months after December 2, 1994.
The rule for stock-based compensation set forth in paragraph (f)(3) of
this section will apply for purposes of this paragraph (i)(2)(iii),
except that the grant must occur before the shareholder meeting
specified in the preceding sentence if the remuneration is not
performance-based under a reasonable, good faith interpretation of
section 162(m). Taxpayers may choose to rely on the rules of paragraph
(f)(4) of this section for the period prior to the applicable effective
date referred to in the first or second sentence of this paragraph
(i)(2)(iii).
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 94-29536 Filed 12-1-94; 8:45 am]
BILLING CODE 4830-01-U
