July 10, 2012
Dividends and Section 162(m)
On June 21, 2012, the IRS issued Rev. Rul. 2012-19 to clarify the treatment of dividends paid on awards that satisfy the requirements to be considered performance-based compensation under Section 162(m). For today’s blog entry, I summarize this ruling.
Background on Section 162(m) (That You Probably Already Know But I Feel Compelled to Include Anyway, Just in Case)
Section 162(m) limits the tax deduction companies can claim for compensation paid to specified executive officers to $1 million per year. Performance-based compensation, as defined under the code and associated regulations, is exempt from this limitation. There are numerous conditions that must be met for awards to be considered performance-based, including that the awards must be payable only upon achievement of performance targets and cannot be paid out prior to certification (by the compensation committee) that the targets have been satisfied.
Treatment of Dividends Under Section 162(m)
Under the ruling, the dividends (and dividend equivalents) are viewed as separate awards–thus, they don’t taint the status of the underlying awards even if they will be paid to award holders before the performance conditions have been met (or will be paid even if the conditions aren’t met). But the dividends or equivalents themselves are considered performance-based compensation only if they also meet the requirements for this treatment under Section 162(m)–i.e., if they will be paid only upon attainment of performance targets and meet the other requirements specified under Section 162(m).
The easiest way to ensure that the dividends/equivalents will be considered performance-based under Section 162(m) is to pay them out only when the underlying award is paid out. If the award is forfeited, the dividends/equivalents accrued on it are forfeited as well. This is also a best practice for accounting purposes and from a shareholder-optics standpoint (ISS specifically identifies paying dividends on unvested performance awards as a “problematic pay practice”–see my December 15, 2010 blog entry, “ISS Policy Updates“).
Interestingly–in a grotesque-but-can’t-look-away sense–the ruling says that the dividends/equivalents don’t have to be subject to the same performance criteria as the underlying award–you could have one set of goals for the award and different goals for the dividends. That seems like a disaster just waiting to happen–a mess from both an administrative and participant education standpoint (as if your executives really need another set of goals to focus on, in addition to the award goals and the cash bonus plan goals). But now that the IRS has suggested it, I fear there is a compensation consultant already trying to design a plan that incorporates this feature. Just say “No!”
No Deduction for Dividends Paid on a Current Basis
Where the dividends will be paid out prior to satisfaction of the performance conditions–i.e., where they are paid to award holders at the same time they are paid to shareholders–the dividends are not considered performance-based compensation and are subject to the limit on the company’s tax deduction under Section 162(m).
This is just one more nail in the coffin for paying out dividends on a current basis. Even if the dividend payments aren’t that significant, I imagine trying to separate them from the original award for purposes of computing the company’s tax deduction will be a challenge. I have a headache just thinking about it.
No Surprises
My sense, from reading Mike Melbinger’s blog on CompensationStandards.com (“Code Sec. 162(m), RSUs, Dividends and Dividend Equivalents,” July 2, 2012) and the Skadden memo we posted on this, is that this is pretty much what everyone was doing anyway. It certainly seemed like common sense to me–if there is such a thing when it comes to the tax code. So, just like last month’s “Section 83 Update” (June 12, 2012), I’m a little surprised that the IRS doesn’t have anything more important to worry about. I’m sure this will be discussed at the IRS and Treasury Speak panel at the NASPP Conference–it will be interesting to hear why the IRS felt the need to issue this ruling.
NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.
- Register for the 20th Annual NASPP Conference in New Orleans.
- Register for the NASPP’s newly updated and expanded online program, “Tackling Equity Compensation Issues Related to Mergers & Acquisitions.” The course starts this Thursday, July 12.
- Register for the NASPP’s newest online program, “Proxy Statements 101 for Stock Plan Professionals.” Don’t wait–the early-bird rate is only available until July 20.
- Complete the Compliance-O-Meter quiz on Divorce.
- Check out the NASPP’s Facebook and Twitter pages.
- Renew your NASPP membership for 2012 (if you aren’t an NASPP member, join today).
- Don’t miss the Silicon Valley chapter all-day conference this Wednesday, July 11. Robyn Shutak and I will be presenting on life events and equity compensation, with Liz Stoudt of Radford–we hope to see you there!
- Chapter meetings are also being held in Chicago, Los Angeles, NY/NJ, and Philadelphia. I’ll be speaking at the NY/NJ and Philadelphia meetings–be sure to stop by and say hello!
– Barbara