Finalized regulations on compensation and performance-based pay

The IRS issued final regulations on March 31, 2015 on Section 162(m).  These regulations were proposed back in 2011, and were intended to clarify a few areas of §162(m) but not make substantive changes. Section 162(m)(1) allows for a $1,000,000 deduction for compensation to covered employees. It goes on to define covered employees in §162(m)(3) as the CEO and the three other highest compensated officers, other than the CEO. Most of the final regulations followed the proposed regulations, only with slight points of clarification or reasoning why some suggestions were incorporated or left out.

The final regulations clarify two exceptions to the §162(m) deduction limitation:

• a per-employee maximum number of shares under qualified performance-based compensation with respect to stock options and stock appreciation rights (SARs)
• a provision for newly public companies during the time of their transition

Maximum Number of Shares
Under §162(m), there is an exception for qualified performance-based compensation. A stock option or SAR qualifies for this exception without a specific performance goal requirement according to the finalized regulations. The regulations go on to outline a few other specifics that are important to note:

• Per-employee limit reporting may be satisfied by reporting "an aggregate maximum number" of all equity-based shares, to include: stock options, SARs, restricted stock, restricted stock units, and other awards granted to that employee in the specified period of time. This may be reported instead of just stock options and SARs. 

• The final regulations also clarify the price at which the shares will be granted must be stated and thus, any compensation amount would be solely based on a change in stock value.

• As stated in the proposed regulation, these changes take effect for any qualified performance-based compensation plans put into place on or after June 24, 2011.

Newly Public Companies
As §162(m), specifically only applies to publicly held corporations, these final regulations help define and clarify exceptions to the deduction limitation of §162 during the transition of a previously private corporation, primarily:

• Compensation under a restricted stock unit (RSU) or a phantom stock arrangement only qualifies for the exception if it is paid out before the end of the transition period. This was a clarification to §1.162-27(f)(1) which excepted "any remuneration paid pursuant to a compensation plan or agreement that existed during the period in which the corporation was not publicly held," but did not define when that remuneration had to be paid.

• The particular events that signal the end of the transition period are outlined in §1.162-27(f)(2) and include items, such as: expiration of plan or agreement, material modification to plan or agreement, and first meeting of shareholders at which directors are elected after IPO, among others.

• This clarification applies to any RSU granted on or after April 1, 2015

In Review
As most of these items were already outline in the proposed regulations, there should not be drastic changes for any corporation. However, it is always important to review executive compensation plans, especially for those corporations who are considering an IPO, to ensure that all regulations are followed.

Will Double Taxation Finally Be Eliminated?

Senators Marco Rubio (FL) and Mark Lee (UT) laid out a new tax reform plan last week that would eliminate the double taxation that many shareholders and business owners feel on the dollars that they earn. Additionally, this would reduce the tax paid by both corporations and individuals who are the owners of pass-through entities.

What are the major changes for corporations?

1. Full Expensing for All Businesses - Under the current MACRS and Section 179 provisions along with "Bonus Depreciation," corporations are allowed a number of different ways to expense off capital investments into their businesses. This proposal requires immediate expensing of all capital investments into a business. This means that in years where a corporation has large capital expenditure, their tax liability will be greatly reduced. However, the benefit of the capital investment is only felt in the year of initial investment. 
2. Change in Taxation of Business Income - The current Section 11 provisions for corporate taxation create a ballooned structure based on the income earned by the corporation. In C Corporations, tax gets paid on dollars earned at both the entity level and at the individual level once the shareholders have been paid out in dividends. In any pass-through entity, the income earned is subject to the tax bracket of the individual taxpayer which could be as high as 39.6%. Under this new proposal, all C Corps would be taxed at 25% regardless of the amount of income earned. Additionally, income from pass-through corporations would not be taxed any higher than 25%.
3. Elimination of Loop Holes - There are currently many provisions in the corporate tax code that help some companies and hurt others. This proposal will eliminate those and not renew any that currently exist.
4. Elimination of Tax Paid on Income Earned Abroad - Currently, US headquartered corporations are taxed on all dollars earned, regardless of where. Under this new proposal, dollars would only be taxed in the country where they were earned, eliminating the barrier that currently exists for many US based companies that are wanting to expand abroad.
5. For Your Shareholders: Elimination of Tax on Dividends and Capital Gains on Stock - Currently shareholders in a C Corp are taxed on their dividends and capital gains on any stock they own in the corporations. This means every dollar earned by the corporation is taxed at the entity level and again at the personal level. This proposal eliminates dividend and capital gains tax, which effectively eliminates double taxation.

This proposal puts forth a few additional items. First, it removes the advantage of carrying financing through debt by eliminating the ability to deduct interest. The proposal includes some exceptions for financial institutions to allow for a continued recognition of interest as it is integral to this business. Additionally, plan also addresses the need to reform the overall health care system with the potential to change the current structure for corporate contributions.

What is the purpose behind this proposal?
Senators Rubio and Lee propose that this new plan will help to stimulate growth in domestic businesses as well as give the US better positioning in the global marketplace. Additionally, this will simplify tax preparation and filing for both individuals and corporations.