Code Section 162(m)
Code Section 162(m) provides that publicly held corporations cannot take a deduction for renumeration paid to the CEO and the next four highest paid officers of any renumeration in excess of $1,000,000 during a single tax year.
The term "publicly held corporation" means any corporation issuing any class of common equity securities required to be registered under section 12 of the Securities Exchange Act of 1934.
Code Section 162(m) applies to:
- the chief executive officer or an individual acting in such a capacity, and
- any employee whose total compensation is required to be reported to shareholders under the Securities Exchange Act of 1934 by reason of such employee being among the 4 highest compensated officers for the taxable year (other than the chief executive officer).
Renumeration generally includes all compensation for which the employer could take a deduction, including salary and benefits.
Renumeration does not include commissions, and does not include qualified performance based pay.
Qualified Performance-based Compensation
The 162(m) deduction limit does not apply to qualified performance-based compensation that meets four requirements:
Performance Goal Requirement
Qualified performance-based compensation must be paid solely on account of the attainment of one or more preestablished, objective performance goals.
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. Performance goals can be based on one or more business criteria that apply to the individual, a business unit, or the corporation as a whole. Such business criteria could include, for example, stock price, market share, sales, earnings per share, return on equity, or costs.
The terms of an objective formula or standard must preclude discretion to increase the amount of compensation payable that would otherwise be due upon attainment of the goal.
The performance goal under which compensation is paid must be established by a compensation committee comprised solely of two or more outside directors.
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 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).
Once the material terms of a performance goal are disclosed to and approved by shareholders, no additional disclosure or approval is required unless the compensation committee changes the material terms of the performance goal. If, however, the compensation committee has authority to change the targets under a performance goal after shareholder approval of the goal, material terms of the performance goal must be disclosed to and reapproved by shareholders no later than the first shareholder meeting that occurs in the fifth year following the year in which shareholders previously approved the performance goal.
Compensation Committee Certification
The compensation committee must certify in writing prior to payment of the compensation that the performance goals and any other material terms were in fact satisfied. For this purpose, approved minutes of the compensation committee meeting in which the certification is made are treated as a written certification. Certification by the compensation committee is not required for compensation that is attributable solely to the increase in the value of the stock of the publicly held corporation.
Covered Health Insurance Provider
Effective in 2013, PPACA adds a special rule to 162(m) that limits the deduction to $500,000 for any compensation paid to an officer, director, or employee of a "covered health insurance provider." See Code Section 162(m)(6).
- See Code Section 162 for the text of the Section. See also § 1.162-27.
- IRS Section 162(m) Audit Techniques
- See Rev Rul 2008-13 for guidance on performance-based compensation.
- Rev Rul 2008-32 (interim CEO is not outside director for purposes of setting performance-based compensation)
- Notice 2008-94 (guidance on Emergency Economic Stabilization Act of 2008)
- Emergency Economic Stabilization Act of 2008 (modifies 162(m))
- Memorandum AM 2009-006 (internal IRS memorandum on treatment of back-dated stock options under 162(m))