Client Alert

New IRS Position on Section 162(m) Performance-Based Compensation for Top Executives to be Applied on a Prospective Basis

February 22, 2008

Yesterday, the Internal Revenue Service announced in Revenue Ruling 2008-13 that it would apply on a prospective basis only the new IRS position on Section 162(m) performance-based compensation for top executives. The new IRS position was the subject of our client alert earlier this week.

As described in our earlier client alert, the new IRS position is that employment contracts and plans generally do not satisfy the Section 162(m) performance-based compensation requirements where the contracts or plans provide for a deemed satisfaction of performance goals in the event that the executive is involuntarily terminated by the company without cause or the employee quits for good reason or retires. The IRS position is that the existence of such a plan or contract provision results in a disallowed deduction for amounts in excess of $1 million payable to a top executive even if the top executive continues to work for the company and receives a bonus upon attainment of the performance goals.

Revenue Ruling 2008-13 represents the first formal IRS pronouncement on this point. Our earlier client alert was based on an IRS private letter ruling to the same effect. Chadbourne & Parke joined a number of other law firms in asking the IRS to delay the effective date of the new IRS position.

As predicted in our earlier client alert, the IRS has now announced that the new rule will apply prospectively only and does not apply to compensation payable for performance periods beginning on or before January 1, 2009. This generally means that it will not apply until 2010 for calendar year taxpayers. There is even further transition relief for payments made pursuant to employment agreements in effect now, although such additional transition relief is not available for compensation paid in respect of subsequent contract extension periods, including automatic roll-over periods.

This latest IRS pronouncement eliminates the immediate concern companies had about the possible need to address the deduction disallowance issue in preparing financial statements for 2007 and 2008. Companies now have some additional time to consider how to address the issues presented by this new IRS position, including possibly amending plans and renegotiating employment contracts.