A recent IRS Chief Counsel Memorandum indicates that smaller reporting companies must treat their CFO as a covered employee under Section 162(m) if he/she is one of the top two highest paid executives other than the CEO.
Wait a Minute! The CFO Isn’t Subject to 162(m)?
Yep, that’s right. For larger reporting companies, it may seem crazy, but the CFO isn’t ever a covered employee under Section 162(m). This is because the definition of a named executive officer under Item 402 of Reg S-K for purposes of the executive compensation disclosures in the proxy has evolved and the definition of a covered employee under Section 162(m) hasn’t kept pace.
Section 162(m) applies to the following executives:
The CEO
The top four highest paid executives other than the CEO, as determined for proxy disclosure purposes.
Back when 162(m) was adopted, this was the same group of people that were considered NEOs for purposes of the proxy disclosures. But in 2006, the SEC changed Item 402 to carve out a separate requirement for CFOs. So now, the NEOs in the proxy are:
Anyone serving as CEO during the year
Anyone serving as CFO during the year
The top three highest paid executives other than the CEO and the CFO.
Up to two additional executives that would have been in the top three except that they terminated before the end of the year.
Unfortunately, only Congress can change the statutory language under Section 162(m), so the IRS can’t modify the definition of a covered employee to match the SEC’s new definition of an NEO. (When Congress drafted Section 162(m), they probably should have just said that it applies to all NEOs as determined under Item 402 of Reg S-K.)
All the IRS can do is interpret the requirement under 162(m) in light of the SEC’s definition. Their interpretation is that the SEC’s change exempts CFOs from Section 162(m) (see the NASPP alert “IRS Issues Guidance on ‘Covered Employees’ Under Section 162(m),” June 9, 2007). (If you are wondering, former employees are also not subject to Section 162(m); this is another evolution in the SEC definition that hasn’t been implemented in the tax code.)
What Gives With Smaller Reporting Companies?
Smaller reporting companies are subject to abbreviated reporting requirements, including fewer NEOs for proxy reporting purposes. Thus, the SEC’s new definition in 2006 never applied to smaller reporting companies. Instead, NEOs in smaller reporting companies are defined as:
The CEO
The top two highest paid executives other than the CEO.
Per Chief Counsel Memorandum 201543003, because the CFO isn’t separately required to be included in the proxy disclosures for smaller reporting companies, he/she is still a covered employee for Section 162(m) if he/she is one of the top two highest paid executives other than the CEO.
For today’s blog entry, I cover yet another challenge in the ongoing saga of awards that provide for accelerated or continued vesting upon retirement.
A recent Chief Counsel Advice memorandum casts doubt on the treatment of dividend equivalents paid on vested but unpaid RSUs. This comes up when dividend equivalents are paid on RSUs that allow for deferred payout on either a mandatory basis or at the election of the award holder. This arrangement is relatively rare, however, and probably only impacts a few of my readers. More commonly, however, this is also an issue where dividend equivalents are paid on awards that provide for accelerated or continued vesting upon retirement and the award holder is eligible to retire.
Background
In either of the above situations, the RSU is subject to FICA when no longer subject to a substantial risk of forfeiture. For traditional deferral arrangements, risk of forfeiture lapses when the award vests. In the case of awards that provide for accelerated or continued vesting upon retirement, the risk of forfeiture substantively lapses when the award holder is eligible to retire.
Any dividend equivalents accrued on the award prior to when the award is subject to FICA will be subject to FICA at the time paid (if they are paid out to award holders at the same time they are paid to shareholders) or when the award is subject to FICA (if they will be paid out with the underlying award). But what about the dividend equivalents paid after the award has been subject to FICA? Does the company need to collect FICA on those equivalents when they are accrued/paid?
The Non-Duplication Rule
Under, Treas. Reg. §31.3121(v)(2)-1(a)(2)(iii), referred to as the “non-duplication rule,” once an RSU has been taken into income for FICA purposes, any future earnings on the underlying stock are not subject to FICA. So the answer to FICA treatment of the dividends depends on whether the dividends paid after this point are considered a form of earnings, akin to appreciation in value in the underlying stock (in which case, they would not be subject to FICA), or additional compensation (in which case, they would still be subject to FICA).
I’ve spoken with a number of practitioners about this. Most believe that an argument can be made that the dividend equivalent payments are a form of earnings and, thus, are not subject to FICA.
The CCA
In Chief Counsel Advice 201414018, issued earlier this year, the IRS argued that dividends paid after the award is subject to FICA are still subject to FICA. The situation the memorandum addresses, however, involved a number of facts not typically characteristic of RSUs that receive dividend equivalents:
The RSUs were granted by a private company
The awards were paid out only in cash
The dividend equivalents were paid out to award holders at the same time dividends were paid to shareholders, rather than with the underlying award
While concerning, the memorandum doesn’t necessary dictate a change in practice with respect to the FICA treatment of dividend equivalents, especially if your company is public, your RSUs are paid out in stock, and your dividend equivalents are paid out with the underlying award. It may, however, be worth reviewing the ruling with your tax advisors to ensure they are comfortable with your procedures (especially if any of the conditions in the memorandum also apply to your RSUs and dividend equivalents).
For today’s blog, I have another exciting smorgasbord of random stock plan related tidbits.
IRS Issues GLAM on Stock Compensation Deductions and CICs In January, the IRS issued general legal advice memorandum AM2012-010 clarifying that when NQSOs and SARs are cashed out due to a change in control, the tax deduction is attributable to the acquired company. This is because the obligation to make the payments became fixed and determinable at the closing and the payments were for services performed prior to the acquistion.
Two things to note here:
This is unfortunate because chances are the target company isn’t all that profitable, making the deduction less than useful.
The acronym for this type of IRS pronouncement is GLAM. That makes the whole thing sound way cooler than it actually is.
For more information see the WSGR alert we posted on this development.
ISS Theme Song: Coming Around Again? I’m sure you’ve heard about this by now, but just in case, ISS has announced that it will replace the GRId analysis system with a new system called “QuickScore,” which does have the advantage of sounding niftier and friendlier. If you are thinking “what the heck, didn’t they just switch to the GRId system,” time must be flying by for you just as fast as it does for me. ISS switched to GRId back in 2010 (I blogged about it, see “Will ISS Red Light Your Stock Compensation?” March 23, 2010). Still, it does feel like ISS is changing systems almost as often as they change their name.
Under QuickScore, companies will receive a relative ranking from 1 to 10 (1 is good, 10 is bad) by region and industry, instead of the color coded (red, yellow, green) score companies received under GRId. Which is similar to ISS’s Corporate Governance Quotient system that was replaced by GRId. Sort like how ISS changed to RiskMetrics and then changed back to ISS.
Backdating Bad for Your Career A recent academic study found that CFOs that lost their job as a result of option backdating have had a tough time re-entering the workforce. Only 18.7% found a comparable position (compared to 35.1% of CFOs that had lost their job for other reasons) and only 48.4% found any full-time corporate position (compared to 83.8% of other CFOs).
Which was a little surprising to me because how would a potential employer even know that’s how you lost your job? You wouldn’t exactly put “falsifying corporate records to reduce expense” under the skills listed on your resume and, in my experience, companies don’t give out that kind of information about former employees. But I guess a quick Google search these days can be very revealing about job candidates.