IRS Provides Some Limited Transition Relief for RSUs

By NAPA Net Staff • 4/22/2015 • 0 Comments

The IRS has just issued final regulations of interest to advisors that work with executive benefit plans.

The regulations have implications for the use of restricted stock units and other similar awards, such as performance shares and phantom stock (collectively, RSUs) in equity compensation plans. While substantially similar to the proposed regulations issued by the IRS in June 2011, the final regulations make two important clarifications to the Section 162(m) limit. 

By way of background, McGuireWoods explains that Section 162(m) generally limits the deduction that public companies may take for the annual compensation paid to their CEOs and three other most highly compensated officers (excluding the CFO) to $1 million each. There are several exemptions to this deduction limit, including for:

  • “performance-based compensation” awards (which include stock options and stock appreciation rights (SARs), provided the shareholder-approved arrangement authorizing such awards states the maximum number of shares as to which options or SARs may be granted during a specified period to any employee); and 
  • compensation (whether or not performance-based) payable during a transition period for newly public companies under an arrangement that was in effect before the company became public. 
For options and SARs be exempt, the shareholder-approved arrangement must state the maximum number of shares as to which options or SARs may be granted during a specified period to any individual employee (rather than relying on the maximum number of shares authorized under a share reserve to satisfy this requirement). McGuireWoods notes that, as a practical matter, virtually all companies have already been observing this requirement, although the IRS had granted relief for options and SARs granted prior to the proposed regulations’ publication date. These clarifications apply to compensation attributable to stock options and SARs that are granted on or after June 24, 2011, according to Meridian Compensation Partners LLC

Additionally, under a transition rule for newly public companies, restricted stock, options and SARs qualify for exemption if granted before the end of the applicable transition period, even if they vest or are exercised after the end of such period. McGuireWoods explains that since RSUs are economically similar to restricted stock, there was a question whether such units granted before the end of the transition period might be exempt as well, even if paid after the end of such period. The analysis explains that the new clarification states that restricted stock units and other similar awards, such as performance shares and phantom stock (collectively, RSUs), granted before the end of the transition period will be exempt only if they are also paid out before the end of such period. 

McGuireWoods notes that the final regulations depart from the proposed regulations by stating that the clarification applies only to RSUs granted on or after April 1, 2015. The proposed regulations had stated that the clarification would apply to RSUs paid out after the effective date of the regulations, even if granted before then. Newly public companies intending to take advantage of the Section 162(m) transition relief may want to review their current grant practices to ensure that they do not run afoul of the final regulations. 

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