It’s proxy season! As publicly traded companies prepare for the 2017 proxy season, we want to highlight several issues to keep in mind related to compliance with Section 162(m) of the Internal Revenue Code. As a reminder, Section 162(m) generally limits a public company’s tax deduction for compensation paid to the chief executive officer and its three other highest-paid officers (other than the chief financial officer) to $1 million per year. This deduction limitation does not apply to certain “qualified performance-based compensation” if certain requirements under Section 162(m) are satisfied. Highlighted below are several reminders for companies that rely on this exception.
Obtain Shareholder Reapproval Every Five Years
One requirement to meet the qualified performance-based compensation exception is that the material terms of the performance goal under which the compensation is to be paid must be approved by the company’s shareholders. The material terms include, for example, (a) the employees eligible to receive the compensation, (b) a description of the business criteria on which the performance goal will be based, and (c) either the maximum amount of compensation that could be paid to an employee, or the formula used to calculate the amount of compensation to be paid to the employee, upon attainment of the goals.
If a company satisfies this requirement by submitting for shareholder approval a laundry list of objective performance goals from which the compensation committee may select specific performance measures and set specific targets, then the material terms of the performance goals must be resubmitted for shareholder approval every five years (i.e., no later than the first shareholder meeting that occurs in the fifth year following the year in which shareholders previously approved the performance goals). Therefore, plans that were last approved by shareholders in 2012 will be up for reapproval in 2017.
Timely Establish Performance Goals and Goal Adjustments
In order for compensation to meet the qualified performance-based compensation exception, the compensation must be paid solely upon the attainment of one or more preestablished, objective performance goals. These goals must be established in writing no later than 90 days after the commencement of the period of service to which the performance goal relates, provided that the outcome is substantially uncertain at the time the goal is established. However, in no event can the goals be considered preestablished if they are established after 25% of the period of service has elapsed. This means that for an annual calendar year bonus plan, the performance goals must be established by March 31, 2017.
If qualified performance-based compensation may be adjusted for certain objective subsequent events, these adjustments must be established at the same time as the performance goals. For more information about performance goals, see our earlier post on Section 162(m).
Use Only Performance Goals Approved by Shareholders
Since the compensation committee cannot deviate from the performance goals approved by the shareholders when establishing qualified performance-based compensation, companies should ensure that the performance goals selected for specific awards are from the list of performance goals approved by the shareholders. If a company is resubmitting its plan for shareholder approval in 2017, now is a good time to confirm that the list of goals to be submitted to shareholders is sufficient to cover future awards.
Do Not Exceed Individual Limits
Companies should be careful to check plan limits when making awards to ensure that performance awards, stock options, and stock appreciation rights do not exceed the shareholder-approved plan limits.
Institutional Shareholder Services (ISS) indicated in its December 2016 FAQs that it will generally issue a favorable recommendation for plan proposals that seek approval for Section 162(m) purposes only (and do not seek additional shares for grants) if the compensation committee (or committee administering the plan) is 100% independent under ISS standards, unless the plan is being approved by the shareholders for the first time following the company’s IPO or spinoff, in which case the recommendation will be on a case-by-case basis.