Section 162(m), Material Modifications, and Acceleration of Vesting
November 12, 2018
When listening to a webcast, it pays to stick around until the very end. The last question asked during the NASPP’s webcast “Navigating Equity Plan and Award Changes After the TCJA and IRS Notice 2018-68” turned out to be interesting.
Section 162(m) and Material Modifications
The question relates to material modifications of equity grants. This is an important issue right now because equity grants that are exempt from Section 162(m) under the grandfather provision in the Tax Cuts and Jobs Act lose their exempt status if they are materially modified after November 2, 2017. (If you have no idea what I’m talking about, crawl out from the rock you are living under and read my October 16 blog entry “Getting Ready to Comply with the New Section 162(m).”)
The webcast listener asked whether acceleration of vesting of an equity grant is considered a material modification.
What Does Notice 2018-68 Say?
IRS Notice 2018-68 provides some initial guidance on application of the grandfather provision. The only thing the notice says on this is that an acceleration of payment of compensation is considered a material modification unless the payment is reduced to reflect the time value of money. I had assumed this would apply to acceleration of vesting of equity awards. As it turns out, however, the answer to the question during the webcast, which was given by Ilya Enkishev, who also happens to be the primary author of Notice 2018-68, was a little more nuanced.
What Was the Answer?
Enkishev addressed the question in the context of stock options specifically. He noted that acceleration of vesting allows the employee to exercise the option earlier and that this is clearly a benefit to the option holder, but it isn’t clear that this benefit is material. He said that the IRS hopes to address this question in future guidance.
Catherine Creech of EY, who was also a panelist on the webcast, pointed out that there is guidance in the existing regulations on Section 162(m), in the context of the now eliminated performance-based compensation exemption, that acceleration of vesting isn’t a modification.
It is helpful to know that the IRS is thinking that acceleration of vesting might not be material for stock options, but I wouldn’t take it to the bank until actual guidance is issued. Whenever IRS representatives present, they are always careful to point out that the opinions they are expressing are their own and not necessarily that of the organization. Moreover, it’s not clear how this would apply to other types of equity compensation, e.g., RSUs, where the vesting event typically triggers a payout, so that accelerating vesting likely also has the effect of accelerating the payout.
If you want to listen to the question and response, it starts at about 1:26:08 in the recording. The transcript will be posted in the next couple of weeks.