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The recent amendments to the Section 162(m) regulations
largely follow the changes set forth in the proposed regulations
issued in 2011, clarifying two exceptions from the Section 162(m)
tax deductibility limit:
- The treatment of restricted stock units (RSUs) and certain
other forms of stock-based compensation under the transition rule
applicable to newly public companies; and
- The requirement under the "qualified performance-based
compensation" exception to set a per-employee limit applicable to
stock options and stock appreciation rights (SARs) under an equity
plan intended to comply with such exception.
RSU Reliance Period Clarification
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Generally, compensation paid by newly public companies under
plans or agreements in effect prior to the company's initial
public offering (IPO) (for which adequate disclosure is
provided in the IPO prospectus) must be "paid" during the reliance
period to be deemed performance-based compensation that does not
count against the annual $1 million deduction limitation.
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The reliance period ends on the earliest of: (a) the
first annual shareholders meeting at which directors are to be
elected that occurs after the third calendar year following the
year of the company’s IPO (or, if no IPO, the first calendar
year following the year in which the company becomes a public
company), (b) the issuance of all employer stock and other
compensation allocated under the plan or agreement, or (c) the
expiration or material modification of the plan or
agreement.
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Under a special equity award rule, stock options, SARs, and
restricted stock that are granted during the reliance period will
be deemed to be performance-based compensation (subject to meeting
all the other specific requirements) even if the equity awards are
exercised or vest after the end of the reliance period.
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The final regulations clarify that other forms of stock-based
compensation, most notably RSUs, do not qualify for the special
equity rule and must be settled during the reliance period.
However, this clarification does not apply to stock-based
compensation granted prior to April 1, 2015.
Practical
Advice
Public companies that
want to preserve both the flexibility of their pre-IPO equity
plans (e.g., evergreen increases to the share reserve) and the
tax deductibility of their equity award grants may want to
consider the following grant practices:
- Grant performance-based restricted
stock in lieu of performance-based RSUs during the reliance
period. Assuming all of the other requirements are
satisfied, the performance-based restricted stock will not
count against the annual $1 million deduction limitation
even if the vesting and income tax event occurs after the
end of the reliance period. Whether granting
restricted stock or RSUs, the tax consequences to the
employee generally will be the same (assuming the employee
does not make a Section 83(b) election to be taxed on the
restricted stock at grant and that the employee does elect
to defer the settlement of the RSUs).
- Grant only stock options during the
reliance period.
- Grant a lesser number of RSUs with
modified vesting schedules such that all or a portion of the
RSUs will be settled in stock during the reliance
period.
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Per-Employee Limit Clarification
- The final regulations retain the rule that using an aggregate
limit on the number of shares that could be granted under a
stockholder-approved plan will not meet the requirement for
establishing the maximum amount of compensation that may be
received by an individual covered employee.
- This clarification does not apply to stock options or SARs
granted prior to the proposed regulations' effective date of June
24, 2011. Further, the limit can be structured to include
all types of equity-based awards, other than stock options and
SARs.
Practical
Advice
Public
companies that want flexibility with their plans can have a
single limit for all equity grants or separate limits for
different classes of equity (e.g., separate limits for
appreciation-based awards such as stock options and SARs
versus full-value awards such as restricted stock and
RSUs). Set forth below are example plan provisions that
generally will comply with the final regulations subject to
the specific terms of the applicable plan:
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Single Limit
- No participant may be granted one or more awards
during any calendar year covering more than 10,000,000
shares in the aggregate.
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Seperate Limits
- Limits on Options. Subject to adjustment
pursuant to Section __, no key employee shall receive
options to purchase shares during any calendar year
covering in excess of 7,500,000 shares.
- Limits on SARs. Subject to adjustment pursuant
to Section __, no key employee shall receive awards of
SARs during any calendar year covering in excess of
7,500,000 shares.
- Limits on Stock Grants and Stock Units. Subject
to adjustment pursuant to Section __, no key employee
shall receive stock grants or stock units during any
calendar year covering, in the aggregate, in excess of
7,500,000
shares.
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If you would like additional information on the topic discussed
in this Compensation and Benefits Alert, please contact any member
of Orrick's Compensation
and Benefits Group. |
