Under the Tax Cuts and Jobs Act of 2017 (the “Act”), Congress broadened the $1 million deduction limitation under Code Section 162(m) for a public company’s top executives by, among other things, broadening the scope of who are “covered employees” and by eliminating the performance-based compensation exception. Prior to the changes made by the Act, in order for compensation payable to a covered employee in excess of $1 million to be deductible under Code Section 162(m), the company’s compensation committee had to certify that the performance goals were met following the end of the performance period and before any payouts were made. Any misstep would disqualify the compensation awards. Beginning in 2018, there is no particular tax benefit for companies to follow the certification procedures, as any compensation over $1 million will not be deductible if paid to a covered employee. Notwithstanding the foregoing, the Act grandfathered some incentive compensation… Continue Reading
The Tax Cuts and Jobs Act of 2017 amended Section 83 of the Internal Revenue Code by adding a new Section 83(i) (“Code Section 83(i)”), which allows certain employees of privately-held corporations to defer the recognition of income (for up to five years) attributable to the vesting or receipt of certain qualified company stock transferred to such employees upon the exercise of stock options or the settlement of restricted stock units. On December 7, 2018, the IRS released Notice 2018-97, which provides initial guidance on certain aspects of Code Section 83(i). In particular, the notice provides guidance on (i) the application of the requirement in Code Section 83(i)(2)(C)(i)(II) that equity grants be made to at least 80 percent of all employees who provide services to the corporation in the United States, (ii) the application of tax withholdings on the deferred income related to the qualified company stock, and (iii) the… Continue Reading
Granting “incentive stock options” qualifying under Section 422 of the Internal Revenue Code (“ISOs”) can often result in more favorable tax treatment to the recipient, provided that the recipient holds the option and the optioned shares for the required period of time. When granting ISOs, it is important to make sure that the plan document and administrative procedures only permit such options to be granted to eligible recipients. For purposes of ISOs, eligible recipients are limited to employees of a granting corporation (or its subsidiaries that are corporations). Independent contractors, non-employee directors, and employees of entities that are not corporations for tax purposes are ineligible to receive ISOs.
The following post is a general summary of the changes to the Internal Revenue Code made by the recently enacted Tax Cuts and Jobs Act (the “Act”) that affect employee compensation and benefits: Executive Compensation Updates Loss of Deduction for Compensation in Excess of $1 Million Currently, Section 162(m) of the Internal Revenue Code limits the ability of publicly held corporations to deduct annual compensation paid to a “covered employee” in excess of $1 million, with an exception to this limit for certain performance-based compensation. Beginning on and after January 1, 2018, the Act amends Code Section 162(m) to eliminate the exception for “qualified performance-based compensation” (which includes stock options, stock appreciation rights, and compensation paid upon the attainment of pre-established performance goals) and commissions. There is limited grandfathering relief available under the Act that preserves the deductibility of existing arrangements that pay out after 2017, provided the “written binding… Continue Reading
Delaware Supreme Court Adopts Fairness Standard of Review for Discretionary Equity Compensation for Directors
On December 13, 2017, the Delaware Supreme Court held that discretionary equity compensation grants to directors are subject to an “entire fairness” standard of review, rather than the more deferential “business judgment” rule, even if the equity incentive plan has been adopted and approved by the company’s stockholders. Specifically, the Delaware Supreme Court held that when stockholders have approved an equity incentive plan that gives the company’s directors discretion to grant themselves awards within general parameters, the directors will be required to prove the fairness of their awards to the corporation and will not be able to rely on the business judgment rule unless (i) the directors submit specific compensation decisions related to equity grants to themselves for approval by fully informed, un-coerced, and disinterested stockholders, or (ii) the plan is self-executing (i.e., the plan grants awards to directors over time based on fixed criteria, with the specific amounts and… Continue Reading
On June 23, 2017, the IRS Office of Chief Counsel issued Chief Counsel Memorandum Number 201725027 (the “Memorandum”) addressing the application of Section 409A of the Internal Revenue Code (“Section 409A”) to certain back-to-back arrangements. The taxpayer in the Memorandum managed investment funds, including the funds of a foreign corporation, with whom the taxpayer had entered into an arrangement to defer some of its management and/or performance fees from the foreign corporation (referred to as an “ultimate service recipient plan” or “USR plan”). The taxpayer also sponsored a deferred compensation arrangement for its investment professional employees (referred to as an “immediate service recipient plan” or “ISR Plan”). While the deferral elections and payment triggers of the USR Plan and ISR Plan were coordinated, the USR Plan provided that payment would be made to the taxpayer under the USR Plan even when amounts were forfeited by a participant under the ISR… Continue Reading
A former CEO of a marketing company has agreed to settle charges by the U.S. Securities and Exchange Commission (the “SEC”) that his executive perks were not properly disclosed to the company’s shareholders. According to the SEC’s order, annual filings disclosed that the company’s CEO and chairman received an annual perquisite allowance of $500,000 in addition to other benefits. However, the SEC’s investigation discovered that the company paid for the CEO’s personal use of private airplanes as well as charitable donations in his name, yacht and sports car expenses, cosmetic surgery, jewelry, medical expenses for family members, pet care, and a wide range of other perks that the company failed to properly disclose. The SEC alleged the CEO improperly obtained an additional $11.285 million in perks beyond his disclosed benefits and the $500,000 annual allowance. The CEO has since resigned and returned $11.285 million to the company. The CEO consented… Continue Reading
In a recent Delaware Court of Chancery case, stockholders brought suit against a company’s directors alleging breach of fiduciary duty for awarding themselves “grossly excessive compensation.” The excessive compensation in question included equity grants issued pursuant to the company’s equity incentive plan. The terms of the stockholder-approved plan provided limits on the number of shares that the company could issue as stock options, restricted stock, and restricted stock units and on the number of shares the company could award to employees and directors. The court held that the specific equity awards could be reviewed pursuant to the business judgment rule, which is the standard used to review executive compensation approved by a disinterested committee rather than a more stringent standard required for “self-dealing.” In applying the business judgment rule, the court found that it was critical that the director-specific limits set forth in the plan differed from the limits that… Continue Reading
Directors, officers, and other persons who directly or indirectly hold common stock worth close to or more than $80.8 million (the threshold amount for 2017) should consult legal counsel before acquiring any more shares to determine if compliance with the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act“), is required prior to completing any additional acquisitions. In recent years, the Federal Trade Commission and the U.S. Department of Justice have more aggressively enforced the HSR Act, including inadvertent failures to file that occur when an insider of a company with significant equity value acquires a small number of shares-whether through a restricted stock grant, shares issued as director compensation, the exercise of a stock option, open market purchases, or otherwise. For example, in January 2017, the agencies imposed a fine of $780,000 on an individual who was a founder, officer, and director of a company for his… Continue Reading
The SEC recently published Compliance and Disclosure Interpretations (“C&DIs“) relating to the CEO pay ratio disclosure rule. This disclosure rule under Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires a public company to disclose the ratio between its CEO’s annual compensation and the median annual compensation of all other employees. The new C&DIs include guidance on the selection of an appropriate alternative compensation measure and clarify that if an alternative compensation measure is utilized to determine the median employee, the time period utilized does not have to be a full annual period. Moreover, the time period utilized does not have to include the date on which the employee population was determined. View our prior post on the SEC’s adoption of the CEO pay ratio disclosure rule here. View the full text of the C&DIs here.