Feb 22, 2008

IRS Issues Formal Guidance on Code Section 162(m)

Yesterday the IRS issued Revenue Ruling 2008-13, addressing the Internal Revenue Code Section 162(m) (“162(m)”) issue that we have recently highlighted in client alerts.

As a brief reminder, on January 25, 2008, the IRS issued a Private Letter Ruling in which it changed its longstanding position on the deductibility of performance-based compensation which becomes payable upon certain terminations of employment. We questioned how this change would impact public companies’ existing compensation arrangements and their financial reporting obligations.

In Revenue Ruling 2008-13, the IRS has now confirmed its change in position on 162(m). A payment of performance-based compensation to an executive will not be exempt from the $1 million compensation limit if it might become payable, regardless of achievement of the performance goal, upon the executive’s termination without cause, termination for good reason, or retirement. The IRS has provided a grandfathering provision protecting those arrangements whose performance period begins on or before January 1, 2009, and those employment contracts in effect on February 21, 2008. However, if any such arrangement or employment contract is amended, modified, or renewed (even if such renewal is automatic, e.g. an evergreen provision), the grandfathering protection may be lost. In addition, any arrangement adopted after February 21, 2008, will need to comply with the new requirements.

The full effects of this change in IRS position remain to be seen, and we expect that further guidance will likely be issued. We will continue to update our clients when more information becomes available. In the meantime, we recommend that all public companies have their executive compensation arrangements reviewed to determine which, if any, provisions need to be amended and the deadline for such an amendment. In addition, public companies should work closely with their accounting and auditing professionals to determine what, if any, financial accounting and reporting impact any change or failure to change may have.

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