IRS Rules on Treatment of Dividends Under Section 162(m)

In a June 25, 2012 revenue ruling, the IRS issued guidance as to whether dividends and dividend equivalents related to restricted stock and restricted stock units (RSUs) that qualify as performance-based compensation for purposes of Internal Revenue Code Section 162(m) must separately qualify as performance-based.

Section 162(m) generally provides a deduction limit of $1 million per year for compensation paid by a publicly held corporation to a “covered employee” (i.e. the CEO and the three highest compensated officers other than the CEO and CFO).  The limitation does not apply to “qualified performance-based compensation,” which must be paid solely on account of the attainment of one or more pre-established, objective performance goals and satisfy other requirements set forth in regulations under Section 162(m).

Revenue Ruling 2012-19 provides two examples to address whether dividends and dividend equivalents payable with respect to performance-based restricted stock or RSUs also qualify as performance-based compensation.  In both examples, publicly held corporations maintain plans by which covered employees may be granted restricted stock or RSUs that vest upon the attainment of certain pre-established, objective performance goals and which qualify as performance-based compensation.

In the first example, the plan provides that dividends and dividend equivalents otherwise payable to the employee during the period from grant through vesting are accumulated and become payable to the employee only if the performance goals related to the restricted stock and RSUs are satisfied.  In the second example, the plan provides that the dividends and dividend equivalents are paid regardless of whether performance goals with respect to the restricted stock and RSUs are satisfied. 

The IRS held that the dividends and dividend equivalents are grants of compensation separate and apart from the related restricted stock and RSUs and must separately qualify as performance-based compensation to be excluded from the Section 162(m) limitation.  Accordingly, the dividends and dividend equivalents in the first example were held to qualify as performance-based compensation, while those in the second example were held not to qualify.

Public companies should consider a review of their Section 162(m) plan documents to determine whether any amendments are necessary in light of this revenue ruling.

Tags: IRS
  • Partner

    Mark Sims practices in the Business Representation & Transactions Group and works primarily in the federal income tax, business planning and healthcare areas. Mark's federal tax practice involves individual, corporate, S ...

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