[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