IRS Revenue Ruling 2008-13 changed one of the exceptions to the $1million limit under Section 162(m) of the Internal Revenue Code (the "Code") on the deductibility of bonus pay by public companies, and generally requires that bonus plans be amended before the start of 2010 to reflect this change.
By way of background, Section 162(m)(1) of the Code provides that, in the case of any publicly held corporation, no deduction is allowed for the compensation of any "covered employee" (generally, the chief executive officer or one of the 3 other highest paid executive officers other than the chief financial officer), to the extent that the employee's compensation for the year in question exceeds $1,000,000. However, Section 162(m)(4)(C) of the Code and Section 1.162-27(e)(1) of the Treasury regulations provide that this limit does not apply to qualified performance-based compensation. Under the Treasury regulations, to be qualified performance-based compensation, several requirements must be satisfied. One such requirement is found in Treasury regulation Section 1.162-27(e)(2)(i), under which qualified performance-based compensation must be paid solely on account of the attainment of one or more preestablished, objective performance goals. Treasury regulation Section 1.162-27(e)(2)(v) states that compensation is not performance-based 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. It further states that compensation does not fail to be qualified performance-based compensation merely because the plan in question allows the compensation to be payable upon the employee's death, disability, or change of control, although compensation actually paid on account of one of those events, prior to the attainment of the performance goal, would not be qualified performance-based compensation.
In Revenue Ruling 2008-13, the IRS considered the case in which a plan, agreement or contract (a "Plan") of a public company, under which compensation is paid to a covered employee, provides that the compensation will be paid (1) upon attainment of a performance goal or (2) without regard to whether the performance goal is attained, if (a) the covered employee's employment is involuntarily terminated by the employer without cause, or (b) the covered employee resigns from employment for good reason, or retires. The IRS ruled that compensation paid under this Plan is not qualified performance-based compensation, since it could be paid even if the performance goals are not met. The Ruling affirmed the IRS's position taken in a 2008 private letter ruling, which reversed the IRS's position in some earlier private letter rulings. This Ruling requires that any Plan of a public company, such as a bonus plan, which contains the language in (2) (or similar language) must be amended to remove such language, otherwise all compensation payable under the Plan to covered employees will be subject to the $1 million dollar limit on deductions under Section 162(m).
Fortunately, the IRS gave employers a period of time to make this amendment. Revenue Ruling 2008-13 stated that the Ruling will not be applied to disallow a deduction for any compensation which otherwise satisfies the requirements for being qualified performance-based compensation, and which is paid under a Plan that has language similar to that in (2) above, if either:
--the performance period (i.e., the period of service to which the performance goal applicable
to such compensation relates) for the compensation begins on or before January 1, 2009; or
--the compensation is paid pursuant to the terms of an employment contract as in effect on February 21, 2008, unless that contract has been renewed or extended after that date.
Thus, except for the case of an employment contract referred to above, the final performance period to which the Ruling will not apply is the performance period starting on January 1, 2009. If an employer's Plan has a calendar year performance period, it may still avoid the adverse effect of Revenue Ruling 2008-13 by amending its Plan to remove the proscribed language prior to the end of 2009.