Return to NASPP Blog
The NASPP Blog

Section 162(m) and Negative Discretion, Part 2

Subscribe to the NASPP Blog

November 27, 2018 | Barbara Baksa

Section 162(m) and Negative Discretion, Part 2

Back in September, I blogged that one unresolved question on the new Section 162(m) is whether performance awards that are subject to negative discretion can be eligible for the grandfather provision.  This is a key question because performance awards that are grandfathered remain fully deductible for the granting corporation. Considering the size of performance awards typically issued to executives, this could be a substantial tax savings for many companies.

Quick Reminder

The term “negative discretion” refers to a provision in an award that allows the company’s board to discretionarily reduce the payout the executive would otherwise be entitled to under the award.  Where awards include this discretion, it’s not clear that the executive has a legally binding right to the compensation. This is a problem because, for an award to be grandfathered, the executive’s legally binding right to the compensation paid under it must have been established as of November 2, 2017.

What Did Stephen Tackney Say?

Not surprisingly, this was a hot topic at this year’s NASPP Conference and it was addressed in all of the sessions that featured IRS representative Stephen Tackney. Stephen explained that the crux of the grandfather provision is whether the company could get out of paying amounts that it had contracted to pay as of November 2, 2017. If the company can’t get out of paying those amounts, the amounts should be subject to the old Section 162(m) rules because the decision to pay them was made under those rules.

But when it comes to amounts that the company could legally get out of paying, if the company chooses to go ahead and pay those amounts anyway, that is viewed as a new decision to pay a new amount. Thus, the payment is subject to new Section 162(m).

The Burden of Proof

Stephen further noted that the burden of proving that compensation is grandfathered (and, thus, deductible) lies squarely on the shoulders of the taxpayer (the company, in this case). Companies that want to claim the performance awards are grandfathered must be prepared to prove that the executive’s legally binding right existed as of November 2, 2017.

Catherine Creech of EY, who was one of Stephen’s copanelists, pointed out that companies need to prove this not only to the IRS, but also to their auditors (since an award’s deductibility affects the DTAs recorded for it). 

Proving that Negative Discretion and a Legally Binding Right Can Coexist

Proving that the presence of negative discretion in the terms of an award doesn’t negate (excuse my pun) an executive’s legally binding right is a matter of state law.  I think a challenge here is that what a company is legally obligated to pay might differ from what a company feels it is obligated to pay as a practical matter. Where an executive has achieved the performance targets, many companies would not feel comfortable refusing to pay out the award simply because the payment wouldn’t be deductible, even if the terms of the award might give them the legal right to do so (and that arguably is not the intent of most negative discretion provisions). Refusing to pay the award in this situation would likely make an executive feel cheated—that’s not the incentive the award was intended to provide.

In his blog on, Mike Melbinger of Winston & Strawn notes that some of the areas of state law to consider when determining whether a legally binding right to compensation exists include “doctrines of contractual interpretation and enforcement such as the implied covenant of good faith and fair dealing, promissory estoppel and detrimental reliance, and a requirement to interpret contracts so as to avoid illusory promises.”

Mike also suggests reviewing the specific facts and circumstances of each award, including whether negative discretion has ever been exercised in the past, whether the award agreement imposes any limits on said discretion, and the communications made to executives as to the goals and targets that must be achieved to earn the award.

- Barbara

About Us

The National Association of Stock Plan Professionals is the largest and oldest professional association for the stock and executive compensation community, with over two decades of leadership providing expert resources, education and other benefits for our more than 6,000 members across 32 affiliated chapters.


P.O. Box 21639 Concord, CA 94521-0639 Telephone: (925) 685-9271 Fax: (925) 930-9284

©NASPP 2019, All Rights Reserved.