Executive Compensation-IRS Provides Guidance On Whether Dividend And Dividend Equivalents On Restricted Stock And Restricted Stock Units Are Performance Based Compensation

In Revenue Ruling 2012-19, the Internal Revenue Service (the “IRS”) examined the question of whether dividends and dividend equivalents relating to restricted stock and restricted stock units (“RSUs”), which are qualified performance-based compensation under § 162(m)(4)(C) of the Internal Revenue Code (the “Code”), must separately satisfy the requirements under § 162(m)(4)(C) to be treated as qualified performance-based compensation (and therefore to be excluded from applicable remuneration for purposes of applying the Code § 162(m)(1) $1,000,000 limit on deductions).

The IRS posited the following facts. Corporation X and Corporation Y are publicly held corporations within the meaning of § 162(m)(2) of the Code. Both corporations maintain plans under which participating employees may be granted restricted common stock of the respective corporation or RSUs based upon the common stock of the respective corporation. The restricted stock and RSUs are qualified performance-based compensation.

The IRS then provided two situations. In Situation 1, Corporation X’s plan provides that dividends and dividend equivalents otherwise payable to an employee, during the period from grant to vesting with respect to 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 requirements of Treas. Reg. § 1.162-27(e) are met with respect to the grant of rights to dividends and dividend equivalents. In Situation 2, Corporation Y’s plan provides for payment to an employee, during the period from grant to vesting with respect to restricted stock and RSU awards granted to the employee, of dividends and dividend equivalents on the restricted stock and RSUs 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 said that, under Treas. Reg. § 1.162-27(e)(2)(iv), the dividends and dividend equivalents under Corporation X’s plan and under Corporation Y’s plan are grants of compensation that are separate and apart from the related restricted stock and RSU grants. Therefore, the grants of the dividends and dividend equivalents must separately satisfy the requirements of Treas. Reg. § 1.162-27(e) to be qualified performance-based compensation. In Situation 1, under Corporation X’s plan, participants’ rights to restricted stock and RSUs are subject to performance goals that meet the requirements of Treas. Reg. § 1.162-27(e). 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,
dividends and dividend equivalents under X’s plan are qualified performance-based compensation. In Situation 2, the dividends and dividend equivalents under Corporation Y’s plan fail to satisfy the requirements under § 162(m)(4)(C) and § 1.162-27(e) because 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.