PLR 200019010: Executive pay limit after an acquisition and officer resignations

Plain-English summary

A company being acquired asked who would count as a covered employee under the executive compensation deduction limit in section 162(m). The IRS ruled that, assuming the acquired company had no required SEC summary compensation table for its final fiscal year or short tax year, its officers would not be covered employees for those years. It also ruled that officers of either company who resigned their officer roles before year-end, with no foreseeable intent to resume them, would not be covered employees for the resignation year. The ruling therefore excluded compensation to those resigning officers from the section 162(m) limit for that year, even if they continued as employees.

Ruling snapshot

• Question: Did the acquisition or pre-year-end officer resignations make the affected executives covered employees under section 162(m)?
• Outcome: Approved, subject to the stated SEC filing and resignation conditions.
• Key authorities: IRC § 162(m); Treas. Reg. § 1.162-27(c)(2).

Full text (IRS public release)

INTERNAL REVENUE SERVICE

Number: 200019010
Release Date: 5/12/2000
Index No.: 162.36-02

CC:EBEO:4-PLR-116447-99

February 8, 2000

Target =

Acquiring =

Sub =

date a =

date b =

date c =

date d =

year e =

year f =

This is in reply to a request for rulings concerning the deduction limitation of section 162(m) of the Internal Revenue Code. The facts, as presented by Target, are as follows.

Target reports income on a fiscal year basis. Acquiring reports income on a calendar year basis.
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On date a, Acquiring formed Sub. Sub was formed for the sole purpose of acquiring the stock of Target and did not otherwise engage in any active trade or business. On date b, Target and Acquiring entered into a merger agreement, and on date d the acquisition occurred.

According to Target, it will not be required to file any reports or statements with the Securities Exchange Commission (SEC) that disclose executive compensation that would be due to be filed with the SEC after Target ceases to be a reporting entity as a result of the merger. Accordingly, there will be no "Summary Compensation Table" for Target which would disclose the compensation of the CEO and the four highest paid officers, either for Target’s year ending date c, or for the subsequent short tax year ending on date d.

Target also contends that none of its employees will be included in the year e "Summary Compensation Table" to be filed with the SEC by Acquiring. Most of the Target executives will continue to be employees of Target, but some will become employees of Acquiring or other of its subsidiaries during the year e and year f tax years.

Several of the corporate officers of Target and Acquiring have resigned in year e, or intend to resign their positions as officers and all of their duties as such in a later year. These individuals may continue to perform services as employees of Target or Acquiring, or another company in the Acquiring controlled group for the remainder of the year of resignation and possibly in future years. Thus, the resignation from their positions as officers does not necessarily equate to separation from service as employees. These officers may, however, be listed pursuant to the executive compensation disclosure rules under the Securities Exchange Act as chief executive officer or one of the highest compensated officers for the resignation year.

Section 162(a)(1) of the Code allows as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered.

Section 162(m)(1) of the Code provides that in the case of any publicly held corporation, no deduction is allowed for applicable employee remuneration with respect to any covered employee to the extent that the amount of the remuneration for the taxable year exceeds $1,000,000.

Section 162(m)(3) of the Code defines "covered employee" to mean any employee of the taxpayer if as of the close of the taxable year, such employee is the chief executive officer of the taxpayer or is an individual acting in such capacity, or the total compensation of such employee for the taxable year is required to be reported to 3

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shareholders under the Securities Exchange Act of 1934 by reason of such employee being among the 4 highest compensated officers for the taxable year (other than the chief executive officer).

Section 1.162-27(c)(2) of the Income Tax Regulations provides the general rule for who is a covered employee. Under the regulations, a covered employee means any individual who, on the last day of the taxable year, is (A) the chief executive officer of the corporation or is acting in such capacity; or (B) among the four highest compensated officers (other than the chief executive officer). Whether an individual is the chief executive officer or one of the four highest compensated officers is determined pursuant to the executive compensation disclosure rules under the Exchange Act.

In the notice of proposed rulemaking containing the proposed regulations under section 162(m), the preamble contains the following language concerning the identification of "covered employee":

The regulations clarify which employees are "covered employees" for purposes of section 162(m). The legislative history to section 162(m) provides that "covered employees" are defined by reference to the SEC rules governing executive compensation disclosure under the Exchange Act. Under the regulations, an individual generally is a "covered employee" if the individual’s compensation is reported on the "summary compensation table" under the SEC’s executive compensation disclosure rules, as set forth in Item 402 of Regulation S-K, 17 CFR 229.402, under the Exchange Act. However, the regulations specifically provide that, in order to be a "covered employee" for section 162(m) purposes, an individual must be employed as an executive officer on the last day of the taxable year. Thus, only those employees who appear on the "summary compensation table" and who are also employed on the last day of the taxable year are "covered employees."

Therefore, based on the facts as outlined above, we rule as follows:

1. Assuming that no summary compensation table is required to be filed by Target with the SEC for the fiscal year ending on date c or for the short taxable year ending on date d, for purposes of section 162(m) of the Code, Target’s officers will not be "covered employees" with respect to the fiscal year ending on date c or for the short taxable year ending on date d.

2. For purposes of section 162(m) of the Code, officers of Target and Acquiring who resign their positions as officers before the last day of the taxable year with no intent to resume their duties as officers at any time in the foreseeable future will not be "covered employees" with respect to the resignation year. Accordingly, no compensation to these officers with 4

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respect to the resignation year will be subject to the section 162(m) deduction limitation.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent. Except as specifically ruled above, no opinion is expressed as to the federal tax consequences of the transaction described above under any other provisions of the Code.

Sincerely yours,

_______
ROBERT B. MISNER
Assistant Chief, Branch 4
Office of the Associate
Chief Counsel
(Employee Benefits and
Exempt Organizations)