Articles Posted in Executive Compensation

Under section 6039 of the Internal Revenue Code (the “Code”) and IRS rules, a corporation is required to provide a report to an employee of: (1) any transfer it makes to the employee, during the 2011 calendar year, of a share of stock pursuant to the employee’s exercise of an “incentive stock option” ( within the meaning of section 422(b) of the Code), or (2) any record the corporation (or its agent) makes, during the 2011 calendar year, of a transfer of the legal title of a share of stock acquired by the employee, under an employee stock purchase plan, pursuant to his or her exercise of an option described in section 423(c) of the Code (that is, an option for which the exercise price is either less than 100% of the stock’s value on the option grant date, or is not fixed or determinable on such date).

The report to the employee is provided on Form 3921 for a transfer described in (1) above, and on Form 3922 for a record described in (2) above. One Form 3921 or Form 3922, as applicable, is required for each separate transfer of stock or title. The due date for furnishing these Forms to employees is January 31, 2012. The corporation must file the Forms with the IRS at a later date (generally, unless extended, by April 2, 2012 if filed electronically (check rules to see when electronic filing is required or permitted), or by February 28, 2012 if filed on paper).

In Rev. Rul. 2011-29, the Internal Revenue Service (the “IRS”) reviewed the question of whether certain bonuses, which are payable by an accrual basis taxpayer for a tax year, can meet the “fact of liability” requirement for that year, even though the amount or recipient of any particular bonus is unknown until the next year. The “fact of liability” requirement is found in Treas. Reg. Sec. 1.461-1(a)(2)(i), promulgated under section 461 of the Internal Revenue Code (the “Code”). In addition to the fact of liability requirement, that Treas. Reg. Sec. also contains an “amount of liability requirement” and an “economic performance requirement”. The Revenue Ruling does not consider the latter two requirements.

The bonuses at issue work as follows. The employer pays bonuses to a group of employees, for services rendered during a taxable year, pursuant to a program that defines the terms and conditions under which the bonuses are paid for that year. The employer communicates the general terms of the bonus program to employees when they become eligible to participate. The total amount of bonuses payable under the program to all employees as a group is determinable either (1) through a formula that is fixed prior to the end of the taxable year, or (2) through other corporate action, such as a resolution of the employer’s board of directors or compensation committee, made before the end of the taxable year, that fixes the bonuses payable to the employees as a group. To be eligible for a bonus, an employee must perform services during the taxable year and be employed on the date that the bonus is actually paid. Under the program, bonuses are paid after the end of the taxable year in which the employee performed the services, but before the 15th day of the 3rd calendar month after the close of that year. Any bonus amount allocable to an employee who is not employed on the date on which bonuses are actually paid is reallocated among other eligible employees.

According to the Revenue Ruling, the “fact of liability” is established when: (a) the event fixing the liability, whether that be the required performance or other event, occurs, or (b) payment is unconditionally due. Here, the employer’s liability to pay a total amount of bonuses to the group of eligible employees is fixed at the end of the tax year in which the services are rendered. Any bonus allocable to an employee, who is not employed on the date on which bonuses are actually paid, is reallocated to other eligible employees. Thus, the total amount of bonuses the employer pays to its group of eligible employees is not reduced by the departure of an employee before actual payment. As such, the “fact of liability” for the total amount of bonuses is established by the end of the tax year in which the services are rendered. This obtains, even though the identity of the ultimate recipients and the amount, if any, each employee will receive cannot be determined prior to the end of that year.

The IRS has issued Notice 2010-80. This notice modifies certain provisions of Notice 2008-113 and Notice 2010-6, dealing with the correction of failures to comply with Section 409A of the Internal Revenue Code (the “Code”), by:

• Clarifying that the types of plans eligible for relief under Notice 2010-6 include a nonqualified plan linked to a qualified plan or another nonqualified plan, provided that the linkage does not affect the time and form of payments under the plans;

• Expanding the types of plans eligible for relief under Notice 2010-6 to include certain stock rights that were intended to comply with the requirements of Code Section 409A(a) (rather than be exempt from the requirements of Section 409A(a));

The Internal Revenue Service (“IRS”) has issued Forms 3921 and 3922 (both information returns), to be used by corporations to report certain transfers of stock to employees. According to IRS Instructions, Forms 3921 and 3922 are required to be filed for such stock transfers occurring after 2009. The filing of these information returns is required by section 6039 of the Internal Revenue Code (the “Code”), as amended by the Tax Relief and Health Care Act of 2006. Form 3921 is to be used to report a corporation’s transfer of stock pursuant to an employee’s exercise of an incentive stock option described in section 422(b) of the Code. Form 3922 is to be used to report a transfer of stock by an employee where the stock was acquired pursuant to the exercise of an option described in Section 423(c) of the Code (that is, an option granted under an employee stock purchase plan, where the exercise price is less than 100% of the value of the stock on the date of grant, or is not fixed or determinable on the date of grant).

In Private Letter Ruling 201024045, the IRS ruled that the amounts of salary waived by certain governmental employees are not includible in their gross incomes. Specifically, legislation (“Statute A”) was passed which allowed the employees to voluntarily waive a statutorily specified amount of salary on a monthly basis. The waivers are irrevocable and must be filed by an employee by a specified date prior to the day on which the employee is paid. The employees have no claim to the waived amounts in the future.

The Ruling cites Code Sections 61 and 451, Treas. Reg. Sec. 1.451-1(a) and Revenue Rulings 66-167 (holding that fees or commissions are not includible in the gross income of the executor of an estate, where he effectively waives his right to receive such fees or commissions within a reasonable time after commencing to serve as the executor, and all his other actions with respect to the estate are consistent with an intention to render gratuitous service). Then, without any analysis, the Ruling concludes that the amounts of salary waived by the employees pursuant to Statute A are not includible in their gross incomes.

Note: I always thought that, as a general matter, you cannot turn your back on income without being taxed. Since there is no analysis in the Ruling, it is unkown how the thinking behind this Ruling could be applied to analogous waivers of salary, fees and commissions.

The IRS has issued Notice 2010-6, which contains procedures for voluntarily correcting many types of failures to comply with the document requirements that apply to nonqualified deferred compensation plans under Section 409A of the Internal Revenue Code. The Notice provides:

–clarification that certain language commonly included in plan documents will not cause a document failure;

— relief which permits correction of certain document failures without current income inclusion or additional taxes under Section 409A, so long as, in certain cases, the corrected plan provision does not affect the operation of the plan within one year following the date of correction;

This item is of interest because it illustrates how issues involving section 409A can arise.

IRS Notice 2009-92 (the “Notice”) provides guidance for a financial institution (a “TARP Recipient”), which has received financial assistance under the Troubled Asset Relief Program (“TARP”), on how to comply with section 409A of the Internal Revenue Code (the “Code”) when amending its nonqualified deferred compensation plan to comply with an advisory opinion of the Office of the Special Master for TARP Executive Compensation (the “Special Master”).

In October, 2008, the Treasury Department established TARP under the Emergency Economic Stabilization Act of 2008 (“EESA”). Under an interim final rule published by the Treasury Department on June 15, 2009, a TARP Recipient may request an advisory opinion from the Special Master as to whether a compensation structure is consistent with TARP, EESA, and the public interest. Also, the Special Master may render such an advisory opinion at his own initiative. The advisory opinion is not binding on the TARP Recipient who receives it, but the TARP Recipient may rely on the advisory opinion as to whether the covered compensation structure discussed in the opinion meets the consistency requirement.

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).

In Chief Counsel Advice Memorandum 200935029 (8/28/2009), the IRS was reviewing a “salary advance program.” Under this program, an employee would receive a salary advance, apparently as a loan. However, the employee was permitted to apply the amount otherwise due him or her, under a nonqualified deferred compensation plan (the “Plan”) upon termination of employment, to offset and eliminate the loan balance.

The IRS said that the doctrine of constructive receipt applies to the “salary advances” to employees. Accordingly, an employee would be required to include the amount available as a salary advance in gross income in the earliest open tax year in which the advance was available (even if not taken), and this amount would be subject to income tax withholding at such time as a constructive payment.

The IRS continued by saying that, even if there was no constructive receipt, salary advances which an employee is expected to earn through future services are taxed as compensation, and are therefore included in gross income, at the time of receipt. The IRS conceded that an (unspecified) employment tax exception would apply to an employee, so that any advance would not be subject to employment tax. Further, if there is no constructive receipt, the salary advance program causes the Plan to violate IRC Section 409A, due to the permitted off-set feature described above. Apparently, the IRS felt that this offset, which is a pre-employment termination use of amounts deferred under the Plan, causes an acceleration of the payment of deferred compensation by the Plan, and this acceleration violates Section 409A.

I just received an email from my Congressman, Gary Ackerman, telling me that the House of Representatives has now passed the Corporate and Financial Institution Compensation Fairness Act, H.R. 3269. This Act would require that any public company with assets greater than $1 billion must hold an advisory shareholder vote on the compensation packages of the company’s top executives at least once per year. It would also empower federal regulators to limit inappropriate or imprudently risky executive compensation packages. Acccording to the email, the Act is intended to help end the now all-too-familiar practice of executives taking excessive risk at the expense of their shareholders and, ultimately, the American taxpayer.