The leading association for the stock and executive compensation profession
Join a professional community 6,000+ members strong
Continue your investment in your professional development and community
Our member care center is here to assist you
Country-specific guidance for stock plan design and administration
Connect with a chapter in your area
Learn more about and engage your peers
Attend an NASPP event for unbeatable professional development and networking
Ask, find and provide answers to burning industry questions
Professional development to keep you at the top of your game
Expert industry perspectives and guidance for your daily work
Enrich you career and discover new opportunities
Be there for the 27th annual event Sept. 16-19, 2019 in New Orleans!
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.
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.
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).
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 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 CompensationStandards.com, 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.
Six Reasons Why Section 83(i) Is a Trap
One of the many challenges private companies face when offering stock compensation to their employees is that, whether in the form of stock options or awards, the grants may be subject to tax be...Read More
IRS Notice 2018-97 Provides Guidance on Section 83(i)
On December 7, the IRS issued Notice 201...Read More
Ten Things to Know About Qualified Equity Grants
On December 7, the IRS issued Notice 2018-97<...Read More
Section 162(m), Material Modifications, and Acceleration of Vesting
When listening to a webcast, it pays to stick around until the very end. The last question asked during the NASPP’s webcast “Read More
New Section 162(m): Who’s Covered?
For today’s blog entry, I look at how the Tax Cuts and Jobs Act changes who is subject to Section 162(m).
Prior to the TCJA, a maximum of four executives w...Read More