This Alert serves as a reminder of a few action items that may need to be taken by publicly traded companies early in 2017 to minimize or avoid the application of the deduction limitations imposed by Section 162(m) of the Internal Revenue Code of 1986, as amended.
Section 162(m) generally provides that a publicly-traded corporation may not deduct compensation with respect to its CEO or its 3 next most highly compensated officers other than its principal financial officer (each a “covered employee”) to the extent that the amount of the compensation payable to the covered employee for the taxable year exceeds $1 million. Compensation that qualifies as “performance‐based compensation,” however, is disregarded in applying the $1 million limitation.
2017 proxy-related action items
Ordinarily, Section 162(m) approval is sought if a publicly-traded company is seeking approval of a new equity or bonus plan or the company is seeking to increase the number of shares available under an existing equity plan in which covered employees participate. However, even if the company would not otherwise need to seek approval of such plans this year, stockholder approval at the company's 2017 annual meeting may be required for Section 162(m) compliance in certain circumstances.
Such approval may be necessary if the performance goals and grant limits contained in any equity, bonus and other incentive compensation plan are intended to provide “performance-based compensation” for Section 162(m) purposes and any of the following applies:
- The company's initial public offering (IPO) was in 2013, and the company's post-IPO stockholders have not previously approved Section 162(m) grant limits or business and financial performance measures used to construct performance goals under an equity compensation or cash incentive plan adopted by the company prior to the IPO.
- The company became publicly traded as a result of a spinoff, and the 2017 annual meeting is the first regularly scheduled meeting of stockholders occurring more than 12 months after the spinoff.
- The company has a performance-based compensation plan containing business and financial performance measures used to construct performance goals for which specific target amounts are not specified, and those performance measures have not been approved or re-approved by the stockholders since 2012.
Consider institutional investor impact of Section 162(m) proxy proposal
If the company expects its proxy statement to be reviewed by an institutional investor advisory firm (e.g., by ISS or Glass Lewis), we recommend consulting with the company’s proxy advisors about how those firms may evaluate any Section 162(m) proposal. In particular, a post-IPO company submitting an equity plan for initial Section 162(m) approval by its stockholders will receive a full review of that plan from ISS (including plan cost, plan features and the company’s past grant practices). Further, in 2016 ISS revised its proxy voting policies to more clearly differentiate the evaluation framework applicable to plan amendments presented solely for the purposes of compliance with Section 162(m) versus those involving bundled amendments that increase the cost of the plan or that include an increase in the number of authorized shares under the plan. ISS generally recommends in favor of proposals that (1) solely seek to amend administrative features of the equity compensation or cash incentive plan, or (2) only seek approval for Section 162(m) purposes so long as the plan administering committee consists entirely of “independent outside directors.” On the other hand, the ISS will evaluate a proposal on case-by-case basis if the shareholder proposal bundles an approval for 162(m) purposes with non-administrative amendments.
Consider non-proxy related Section 162(m) to-do’s in early 2017
- For 2017 compensation to be exempt from the Section 162(m) deduction limitations, the company’s compensation committee must set the performance goals during the first 90 days of the performance period. For a performance award for calendar year 2017, the goals should be set no later than March 31, 2017.
- For performance‐based bonuses and other compensation earned for a performance period ending in 2016 to qualify as “performance‐based compensation” that is exempt from Section 162(m), the company’s compensation committee should certify in writing the extent to which performance goals have been satisfied before the equity, bonus and other incentive compensation is paid.
- If any employee has been promoted or has otherwise become a covered employee under Section 162(m), consider whether any amendments are necessary for his or her offer letter, employment agreement, restricted stock unit and other equity, bonus and incentive agreements to comply with Section 162(m).
For more information, please contact any of the members of our Employee Benefits and Executive Compensation group.
 To qualify as performance-based compensation, the following primary requirements must be met:
- The compensation must be paid solely on account of the attainment of one or more pre-established, objective performance goals
- The goals must be established by a committee comprised solely of two or more outside directors (the “Committee”)
- The goals must be established in writing not later than 90 days after the beginning of the performance period (but, in no event, after 25 percent of the performance period has run) and at a time when the outcome is substantially uncertain
- The Committee may not retain discretion to increase the award, although an award, once determined on the basis of objectively determinable criteria, may be reduced at the discretion of the Committee;
- The “material terms” of the award must be disclosed to and subsequently approved by the company's shareholders and
- The Committee must certify in writing that the performance goals have been satisfied before the payment of the compensation.
 This assumes that the applicable stock or incentive plan was not approved by the stockholders of the company's former publicly-traded parent.