PLR 200216001: Executives not covered by the section 162(m) deduction limit

Plain-English summary

A company acquired a target in a tax-free merger and asked how the section 162(m) compensation deduction limit applied to the target's executives. The target did not have to file a summary compensation table for its short year ending with the merger, and the executives would not appear in the acquiring company's table for that year. The IRS ruled that the target's officers were not covered employees for the merger year. It also ruled that two groups of executives who resigned their officer positions were not covered employees for the respective years, so compensation paid to them in those years was not subject to the section 162(m) deduction limit.

Ruling snapshot

• Question: Were the target's officers covered employees subject to the section 162(m) compensation deduction limit?
• Outcome: Approved: the described compensation was not subject to the limitation
• Key authorities: IRC § 162(m); Treas. Reg. § 1.162-27(c)(2)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200216001
Washington, DC 20224
Release Date: 4/19/2002
Index Number: 162.36-02
Person to Contact:

Telephone Number:

Refer Reply To:
CC:TEGE:EB:EC-PLR-131766-01
Date:
October 17, 2001

Target
=

Acquiring = .

Date A
=

Year 1
=

Year 2
=

Executive Group 1 =

Executive Group 2 =

This is in reply to your letter dated June 1, 2001, requesting rulings concerning the deduction limitation of section 162(m) of the Internal Revenue Code. The facts, as represented by Acquiring, are as follows.

On Date A, Target merged with a wholly-owned subsidiary of Acquiring so that Target became a wholly-owned subsidiary of Acquiring. Target’s final separate consolidated tax year ended on Date A. It has been represented that the Merger qualified as a tax-free reorganization.

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Acquiring represents that Target was not required to file any reports or statements with the Securities and Exchange Commission (SEC) that disclose executive compensation under Item 402 of Regulation S-K for its short year that ends with the Merger. Target did not file a “Summary Compensation Table” disclosing the compensation of Target’s CEO and Target’s four highest paid officers for the short year ending with the Merger.

Acquiring represents that none of the Target executives will be included in the Summary Compensation Table for Year 1 (the year of the Merger) to be filed by Acquiring. Thus, the compensation paid and deducted by Target in its short taxable year ending with the Merger will never be reported on a “Summary Compensation Table” filed by either Acquiring or Target.

Executive Group 1 resigned as officers in Year 1. Executive Group 2 resigned in Year 2. Those individuals who resign their position as officers may continue to perform services as consultants to Target, or as employees of Acquiring or another company in the Acquiring controlled group for the remainder of the year of resignation and possibly in future years. Resignation from their position as officers does not necessarily equate to separation from service as consultants or employees. Members of Executive Group 1 and 2 may be listed pursuant to the executive compensation disclosure rules under the Securities Exchange Act of 1934 (Exchange Act) as the chief executive officer or one of the highest compensated officers for Year 1 and Year 2, respectively.

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 shall be 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 shareholders under the Exchange Act 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

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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 submitted, we rule as follows:

1. For purposes of section 162(m) of the Code, Target’s officers will not be “covered employees” with respect to year of the Merger because no Summary Compensation Table is required to be filed by Target with the SEC for the year of the Merger and those officers will not be listed on any Summary Compensation Table filed by Acquiring for the year of the Merger.

2. For purposes of section 162(m) of the Code, members of Executive Group 1 and Executive Group 2 will not be “covered employees” with respect to Year 1 and Year 2, respectively. Accordingly, no compensation paid to members of Executive Group 1 or Executive Group 2 with respect to Year 1 and Year 2, respectively, will be subject to the section 162(m) deduction limitation.

Except as specifically ruled above, no opinion is expressed as to the federal tax consequences of the transaction described above under any other provision of the Code. Specifically, no opinion was requested and none is given regarding the federal tax consequences of the Merger. This ruling is directed only to the taxpayer who

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requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to the taxpayer.

Sincerely yours,

ROBERT B. MISNER
Assistant Chief
Executive Compensation Branch
Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and Government
Entities)

Enclosure:
Copy for 6110 purposes