On March 30, 2015, the Department of the Treasury issued final regulations relating to the deduction limitation for certain employee remuneration in excess of $1 million (80 FR 16970). Like the proposed regulations (76 FR 37034), the final regulations address:

The final regulations generally adopt the proposed regulations with some modifications as a result of comments received.

Code Section 162(m) prohibits publicly held corporations from deducting more than $1 million per year in remuneration paid to each of certain covered employees (26 U.S.C. § 162(m)). A covered employee is any individual who, on the last day of the taxable year, is the principal/chief executive officer (PEO/CEO) or one of the three highest compensated officers (other than the PEO/CEO and principal/chief financial officer). Code Section 162(m)'s deduction limitation does not apply to qualified performance-based compensation, which is compensation that meets certain requirements under Treasury Regulation Section 1.162-27(e) or to compensation paid by newly public companies according to a transition rule.

For more information on Code Section 162(m), see Practice Note, Section 162(m): Limit on Compensation.

For a grant of stock options or stock appreciation rights (SARs) to qualify as performance-based compensation under Code Section 162(m), the plan under which the grant is made must state the "maximum number of shares with respect to which options or SARs may be granted during a specified period to any individual employee." The proposed regulations explained that if a plan document sets out the maximum number of shares that may be granted under the plan but does not include the maximum number of stock options or SARs that may be granted to any individual employee during a specified period, then the stock options and SARs will not be qualified performance-based compensation.

In response to commenters, the final regulations clarify that plans may satisfy the per-employee limit requirement by specifying the aggregate maximum number of shares with respect to which stock options, SARs, restricted stock, RSUs or other equity-based awards may be granted to any individual employee during a specified period.

The clarifications apply to amounts attributable to stock options and SARs that are granted on or after June 24, 2011 (the date of publication of the proposed regulations).

Remuneration paid under a compensation plan or agreement that exists during a period that the corporation is not publicly held is excluded from the Code Section 162(m) limit. If a non-publicly held corporation becomes publicly held, the limit does not apply during a transition period which ends when the first of certain events occurs (see Practice Note, Section 162(m): Limit on Compensation: Newly Public Companies).

Consistent with the proposed regulations, the final regulations provide that this relief applies to any compensation received from stock options, SARs or restricted stock if the option, SAR or restricted stock was granted before the end of the transition period, regardless of when it is exercised or vests, as applicable. The exception does not, however, apply to other forms of equity compensation such as RSUs or phantom stock. The effect is that RSUs and phantom stock granted during the transition period are eligible for transition relief only if paid before the transition period expires.

The good news is that this clarification only applies to compensation otherwise deductible under an equity-based award that is granted on or after April 1, 2015.

The final regulations provide important clarifications to the Code Section 162(m) deduction limitation. To maximize deductibility, publicly held corporations, and companies that become publicly held should be aware of these regulations and structure their plans and awards with these clarifications in mind.