[Federal Register Volume 76, Number 122 (Friday, June 24, 2011)]
[Proposed Rules]
[Pages 37034-37037]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-15653]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-137125-08]
RIN 1545-BI65


Certain Employee Remuneration in Excess of $1,000,000 Under 
Internal Revenue Code Section 162(m)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to the

[[Page 37035]]

deduction limitation for certain employee remuneration in excess of 
$1,000,000 under the Internal Revenue Code (Code). The proposed 
regulations clarify that qualified performance-based compensation 
attributable to stock options and stock appreciation rights must 
specify the maximum number of shares with respect to which options or 
rights may be granted to each individual employee. The proposed 
regulations also clarify the application of the transition rule for 
taxpayers that are not publicly held corporations and then become 
publicly held corporations.

DATES: Written or electronic comments must be received by September 22, 
2011.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-137125-08), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
137125-08), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov/ (IRS REG-137125-08).

FOR FURTHER INFORMATION CONTACT: Concerning these proposed regulations, 
Ilya Enkishev at (202) 622-6030; concerning submissions of comments, 
and/or to request a public hearing, Richard Hurst at 
[email protected] or (202) 622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains a proposed amendment to 26 CFR part 1 under 
section 162(m) of the Code.
    Section 162(m) was added to the Code by section 3211(a) of the 
Omnibus Budget Reconciliation Act of 1993, Public Law 103-66. Proposed 
regulations under section 162(m) were published in the Federal Register 
on December 20, 1993 (58 FR 66310). Final regulations under section 
162(m) were published in the Federal Register on December 20, 1995 (TD 
8650) (60 FR 65534).
    The IRS and the Treasury Department have received questions 
regarding the requirement that a stock-based compensation plan must 
state the maximum number of shares with respect to which stock options 
or stock appreciation rights may be granted under the plan to any 
employee to qualify as performance-based compensation under section 
162(m). The IRS and the Treasury Department have also received 
questions regarding the application of the transition rule for 
taxpayers that are not publicly held corporations and then become 
publicly held corporations. These proposed amendments to Sec. Sec.  
1.162-27(e)(2), 1.162-27(e)(4), and 1.162-27(f)(1) are not intended to 
reflect substantive changes to the requirements in the current 
regulations, but rather to clarify the current language.

Explanation of Provisions

    1. Maximum number of shares with respect to which options or rights 
may be granted to each individual employee.
    Section 1.162-27(b) provides that section 162(m) precludes a 
deduction under chapter 1 of the Code by any publicly held corporation 
for compensation paid to any covered employee to the extent that the 
compensation for the taxable year exceeds $1,000,000. Section 1.162-
27(e)(1) provides that the deduction limit in Sec.  1.162-27(b) does 
not apply to qualified performance-based compensation. Section 1.162-
27(e)(1) further provides that qualified performance-based compensation 
is compensation that meets all of the requirements of Sec.  1.162-
27(e)(2) through (e)(5).
    Section 1.162-27(e)(2)(vi) sets forth special rules for 
performance-based compensation attributable to stock options and stock 
appreciation rights. This section provides that stock options and stock 
appreciation rights are deemed to satisfy the performance goal 
requirement in Sec.  1.162-27(e)(2) if: (1) The grant or award is made 
by the compensation committee; (2) the plan under which the option or 
right is granted states the maximum number of shares with respect to 
which options or rights may be granted during a specified period to any 
employee; and, (3) under the terms of the option or right, the amount 
of compensation the employee can receive is based solely on an increase 
in the value of the stock after the date of the grant or award.
    The legislative history for section 162(m) provides that ``[i]n the 
case of stock options, it is intended that the directors may retain 
discretion as to the exact number of options that are granted to an 
executive, provided that the maximum number of options that the 
individual executive may receive during a specified period is 
predetermined.'' H.R. Conf. Rep. No. 213, 103rd Cong., 1st Sess. 586-87 
(1993), reprinted in 1993 U.S.C.C.A.N. 1088, 1275-6.
    The preamble to the proposed 1993 Treasury Regulations (58 FR 
66310) under section 162(m) explains the reason for requiring an 
individual limit on the maximum number of shares for which options may 
be granted:

    Some have questioned why it would be necessary for the 
regulations to require an individual employee limit on the number of 
the shares for which options or stock appreciation rights may be 
granted, where shareholder approval of an aggregate limit is 
obtained for securities law purposes. The regulations follow the 
legislative history, which suggests that a per-employee limit be 
required under the terms of the plan. The IRS and the Treasury 
believe that a limit on the maximum number of shares for which 
individual employees may receive options or other rights is 
appropriate because it is consistent with the broader requirement 
that a performance goal include an objective formula for determining 
the maximum amount of compensation that an individual employee could 
receive if the performance goal were satisfied. A third party 
attempting to make this determination with respect to a stock option 
plan would need to know both the exercise price and the number of 
options that could be granted.

Section 1.162-27(h)(3)(i) of the final regulations provides that, under 
a transition rule that applies to plans or agreements approved by 
shareholders before December 20, 1993, a stock option plan was treated 
as satisfying the requirement to state a maximum number of shares for 
which an option could be granted to any employee over a specified 
period if the plan that was approved by the shareholders provided for 
an aggregate limit (consistent with SEC Rule 16b-3(b)) on the shares of 
employer stock for which awards could be made under the plan. This rule 
was available only during a limited reliance period specified in Sec.  
1.162-27(h)(3)(i).
    These proposed regulations clarify Sec.  1.162-27(e)(2)(vi) by 
providing that the plan under which the option or right is granted must 
specify the maximum number of shares with respect to which options or 
rights may be granted to any individual employee during a specified 
period. Accordingly, if a plan states an aggregate maximum number of 
shares that may be granted but does not contain a specific per-employee 
limitation on the number of options that may be granted, then any 
compensation attributable to the stock options or rights granted under 
the plan is not qualified performance-based compensation under Sec.  
1.162-27(e)(2)(vi). A plan satisfies Sec.  1.162-27(e)(2)(vi) where the 
terms of the plan specify that an individual employee may be granted 
options or rights to receive the maximum number of shares authorized 
under the plan during a specified period. Example 9 of Sec.  1.162-
27(e)(2)(vii) of the regulations has been modified to illustrate these 
principles.

[[Page 37036]]

    These proposed regulations also provide a related clarification of 
the shareholder approval requirement under Sec.  1.162-27(e)(4). 
Specifically, Sec.  1.162-27(e)(4)(iv) is clarified to provide that the 
requirement for description of the compensation in this section is 
satisfied where the maximum number of shares for which grants may be 
made to each individual employee during a specified period and the 
exercise price of those options is disclosed to the shareholders of the 
corporation.
    2. Compensation payable under restricted stock units paid by 
companies that become publicly held.
    Section 1.162-27(f)(1) of the current regulations provides that in 
the case of a corporation that was not a publicly held corporation and 
then becomes a publicly held corporation, the $1,000,000 deduction 
limit ``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.'' If a corporation becomes 
publicly held in connection with an initial public offering (IPO), then 
the relief provided in Sec.  1.162-27(f)(1) applies only to the extent 
that the prospectus accompanying the IPO disclosed information 
concerning the existing compensation plans or agreements and satisfied 
all applicable securities laws.
    Pursuant to Sec.  1.162-27(f)(2), a corporation may rely on Sec.  
1.162-27(f)(1) until the earliest of: (i) The expiration of the plan or 
agreement; (ii) the material modification of the plan or agreement; 
(iii) the issuance of all employer stock and 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 IPO occurs or, in the case of a privately held corporation that 
becomes publicly held without an IPO, the first calendar year following 
the calendar year in which the corporation becomes publicly held. 
Section 1.162-27(f)(3) provides that the relief provided under Sec.  
1.162-27(f)(1) applies to any compensation received pursuant 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 Sec.  1.162-27(f)(1) if the grant occurs on or 
before the earliest of the events specified in Sec.  1.162-27(f)(2).
    Practitioners have asked whether compensation payable under a 
restricted stock unit arrangement or a phantom stock arrangement is 
eligible for the relief provided in Sec.  1.162-27(f)(3). A restricted 
stock unit is a right to an amount based on the value of the employer's 
stock, and which is payable in cash, shares of the stock, or other 
property (as defined in Sec.  1.83-3(e)), following the satisfaction of 
a specified vesting condition. Compensation payable under a phantom 
stock arrangement is compensation that is paid at a future date in cash 
or in property based on the value of the employer's stock.
    The preamble to the final 1994 Treasury Regulations (60 FR 65534) 
under section 162(m) specifically addressed the types of compensation 
covered under Sec.  1.162-27(f)(3):

    Commentators have asked that the relief provided in the 1994 
amendments for stock options, stock appreciation rights, and 
restricted property be extended even further to cover other stock-
based compensation and deferred compensation in general. After 
careful consideration of the comments received, the IRS and Treasury 
have concluded that there is not adequate justification for a 
further expansion of the 1994 expansion of the prior regulatory 
transition relief for previously approved plans and agreements, or 
the other similar relief provisions added in 1994.

Accordingly, only compensation attributable to stock options, stock 
appreciation rights, and restricted property is covered under Sec.  
1.162-27(f)(3). The proposed regulations clarify that the general rule 
of Sec.  1.162-27(f)(1) applies to all compensation other than 
compensation specifically identified in Sec.  1.162-27(f)(3).

Proposed Effective/Applicability Date

    These regulations under section 162(m) are proposed to apply to 
taxable years ending on or after the date of publication of the 
Treasury decision adopting these rules as final regulation in the 
Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
the regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this regulation has 
been 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 these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are timely submitted to the 
IRS. The IRS and the Treasury Department specifically request comments 
on the clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying. A public hearing will be scheduled if requested in writing by 
any person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place for the public hearing 
will be published in the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Ilya 
Enkishev, Office of the Division Counsel/Associate Chief Counsel (Tax 
Exempt and Government Entities). However, other personnel from the IRS 
and the Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *.

    Par. 2. Section 1.162-27 paragraphs (e)(2)(vi)(A), (e)(2)(vii) 
Example 9, (e)(4)(iv) and (f)(3) are revised and paragraph (j)(2)(vi) 
is added to read as follows:


Sec.  1.162-27  Certain employee remuneration in excess of $1,000,000.

* * * * *
    (e) * * *
    (2) * * *
    (vi) * * *
    (A) In general. Compensation attributable to a stock option or a 
stock appreciation right is deemed to satisfy the requirements of this 
paragraph (e)(2) if the grant or award is made by the compensation 
committee; the plan under which the option or right is granted states 
the maximum number of shares with respect to which options or rights 
may be granted during a specified

[[Page 37037]]

period to any individual employee; and, under the terms of the option 
or right, the amount of compensation the employee could receive is 
based solely on an increase in the value of the stock after the date of 
the grant or award. Conversely, if the amount of compensation the 
employee will receive under the grant or award is not based solely on 
an increase in the value of the stock after the date of grant or award 
(for example, in the case of restricted stock, or an option that is 
granted with an exercise price that is less than the fair market value 
of the stock as of the date of grant), none of the compensation 
attributable to the grant or award is qualified performance-based 
compensation because it does not satisfy the requirement of this 
paragraph (e)(2)(vi)(A). Whether a stock option grant is based solely 
on an increase in the value of the stock after the date of grant is 
determined without regard to any dividend equivalent that may be 
payable, provided that payment of the dividend equivalent is not made 
contingent on the exercise of the option. The rule that the 
compensation attributable to a stock option or stock appreciation right 
must be based solely on an increase in the value of the stock after the 
date of grant or award does not apply if the grant or award is made on 
account of, or if the vesting or exercisability of the grant or award 
is contingent on, the attainment of a performance goal that satisfies 
the requirements of this paragraph (e)(2).
* * * * *
    (vii) * * *

    Example 9. Corporation V establishes a stock option plan for 
salaried employees. The terms of the stock option plan specify that 
no individual salaried employee shall receive options for more than 
100,000 shares over any 3-year period. The compensation committee 
grants options for 50,000 shares to each of several salaried 
employees. The exercise price of each option is equal to or greater 
than the fair market value at the time of each grant. Compensation 
attributable to the exercise of the options satisfies the 
requirements of this paragraph (e)(2). If, however, the terms of the 
options provide that the exercise price is less than fair market 
value at the date of grant, no compensation attributable to the 
exercise of those options satisfies the requirements of this 
paragraph (e)(2) unless issuance or exercise of the options was 
contingent upon the attainment of a preestablished performance goal 
that satisfies this paragraph (e)(2). If, however, the terms of the 
plan also provide that Corporation V could grant options to purchase 
no more than 900,000 shares over any 3-year period, but did not 
provide a limitation on the number of shares that any individual 
employee could purchase, then no compensation attributable to the 
exercise of those options satisfies the requirements of paragraph 
(e)(2)(vi) of this section.
* * * * *
    (4) * * *
    (iv) Description of compensation. Disclosure as to the compensation 
payable under a performance goal must be specific enough so that 
shareholders can determine the maximum amount of compensation that 
could be paid to any individual employee during a specified period. If 
the terms of the performance goal do not provide for a maximum dollar 
amount, the disclosure must include the formula under which the 
compensation would be calculated. Thus, if compensation attributable to 
the exercise of stock options is equal to the difference in the 
exercise price and the current value of the stock, then disclosure of 
the maximum number of shares for which grants may be made to any 
individual employee during a specified period and the exercise price of 
those options (for example, fair market value on date of grant) would 
satisfy the requirements of this paragraph (e)(4)(iv). In that case, 
shareholders could calculate the maximum amount of compensation that 
would be attributable to the exercise of options on the basis of their 
assumptions as to the future stock price.
* * * * *
    (f) * * *
    (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)(2) of this section if the grant occurs on or before the 
earliest of the event specified in paragraph (f)(2) of this section. 
This paragraph does not apply to any form of stock-based compensation 
other than the forms listed in the immediately preceding sentence. 
Thus, for example, compensation payable under a restricted stock unit 
arrangement or a phantom stock arrangement must be paid, rather than 
merely granted, on or before the occurrence of the earliest of the 
events specified in paragraph (f)(2) of this section in order for 
paragraph (f)(1) to apply.
* * * * *
    (j) * * *
    (2) * * *
    (vi) The clarifications to paragraphs (e)(2)(vi)(A), (e)(2)(vii) 
Example 9, and (e)(4)(iv) of this section apply on or after June 24, 
2011. The modification to paragraph (f)(3) of this section applies on 
or after the date of publication of the Treasury decision adopting 
these rules as final regulations in the Federal Register.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2011-15653 Filed 6-23-11; 8:45 am]
BILLING CODE 4830-01-P