Ruling Discusses Whether Dividend Equivalents Affect $1 Million Compensation Cap. (Parker's Federal Tax Bulletin: July 15, 2012)

Where the rights to dividend and dividend equivalents of performance-based restricted stock or restricted stock units do not vest, and become payable solely on account of the attainment of preestablished performance goals, these amounts are not qualified performance-based compensation and are therefore included in determining applicable employee compensation for purposes of applying the $1 million cap on deductible compensation for a publicly held company. Rev. Rul. 2012-19.

The facts in Rev. Rul. 2012-19 deal with two publicly held corporations both in different situations. Both corporations maintain plans under which participating employees may be granted restricted common stock of the respective corporation or restricted stock units (RSUs) based on the common stock of the respective corporation. The restricted stock and RSUs granted under the plans vest upon the attainment of certain preestablished, objective performance goals and otherwise meet the applicable requirements of being deductible. Accordingly, the compensation received due to the vesting of the restricted stock and the vesting and payment of the RSUs is qualified performance-based compensation that is excluded from the applicable employee remuneration to which the deduction limitation under Code Sec. 162(m) applies.

In the first situation, Corporation X's plan provides that dividends and dividend equivalents otherwise payable to an employee during the period from grant through vesting with respect to performance-based restricted stock and RSU awards granted to the employee are accumulated and become vested and payable only if the related performance goals with respect to the restricted stock and RSUs are satisfied. All other applicable requirements are met with respect to the grant of rights to dividends and dividend equivalents.

In the second situation, Corporation Y's plan provides for payment to an employee during the period from grant to vesting of dividends and dividend equivalents with respect to performance-based restricted stock and RSU awards granted to the employee at the same time dividends are paid on common stock of Corporation Y regardless of whether the performance goals established with respect to the restricted stock and RSUs are satisfied.

The IRS was asked to rule on whether dividends and dividend equivalents relating to restricted stock and RSUs that are performance-based compensation must separately satisfy the requirements under Code Sec. 162(m)(4)(C) to be treated as performance-based compensation. Code Sec. 162(m)(4)(C) provides that applicable employee remuneration does not include compensation payable solely on account of the attainment of one or more performance goals, but only if (1) the performance goals are determined by a compensation committee of the board of directors of the taxpayer that is comprised solely of two or more outside directors, (2) the material terms under which the remuneration is to be paid, including the performance goals, are disclosed to shareholders and approved by a majority of the vote in a separate shareholder vote before payment of such remuneration, and (3) before any payment of such compensation, the compensation committee certifies that the performance goals and other material terms were in fact satisfied.

The IRS ruled that, with respect to Corporation X, dividends and dividend equivalents paid under X's plan are qualified-performance based compensation and therefore are excluded from applicable employee remuneration for purposes of applying the $1 million limitation on deductibility. Under Corporation X's plan, the IRS stated, participants' rights to restricted stock and RSUs are subject to performance goals that meet the applicable requirements in Reg. Sec. 1.162-27(e) and are excluded from applicable remuneration for purposes of applying the excess compensation deduction limitation. Under the same plan, participants' rights to dividends and dividend equivalents vest and become payable only if the same performance goals that apply to the related grants of restricted stock and RSUs are satisfied. Therefore, the IRS concluded, dividends and dividend equivalents under X's plan are also excluded from applicable remuneration for purposes of applying the excess compensation deduction limitation.

However, the IRS ruled that in the second situation, with respect to Corporation Y, dividends and dividend equivalents paid under Y's plan are not qualified-performance based compensation and therefore are included in applicable employee remuneration for purposes of applying the $1 million limitation on deductibility. According to the IRS, the rights to these amounts do not vest and become payable solely on account of the attainment of preestablished performance goals. Thus, these amounts are not qualified performance-based compensation, regardless of whether the performance goals are met with respect to the related restricted stock and RSUs.

For a discussion of the $1 million cap on deductible compensation for publicly held companies, see Parker Tax ¶91,101.

Parker Tax Publishing Staff Writers

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