February 28, 2018

Section 162(m): Performance-Based Comp’s Afterlife

Whether there’s life after death is one of those great unanswerable questions. . .Well, I mean except for Section 162(m)’s performance-based comp provisions – which, despite their untimely demise last December, we can say with certainty are enjoying a robust afterlife in proxy disclosures.

Over on “The Advisors’ Blog,” Broc’s already noted that the plaintiffs’ bar is keeping a watchful eye on performance-based comp proxy disclosures in the wake of tax reform’s changes. But beyond that, some high-profile companies – like Disney & John Deere – have recently filed proxy statements asking shareholders to re-approve existing compensation plans in order to comply with Section 162(m)’s 5-year shareholder re-approval requirements for performance-based comp.

If performance-based comp’s deductibility is a goner, why do that?  This Debevoise memo suggests one possible reason for this portion of 162(m)’s afterlife:

Grandfathered arrangements that rely on the performance-based exception must continue to comply with the formal procedures previously applicable to performance-based compensation. For example, if an executive had a contractual right as of November 2, 2017 to receive a performance-based award in the future, the performance criteria applicable to such award may need to be re-approved by shareholders if, when the award is granted, five years have passed since the last shareholder approval.

Many tax lawyers expect that the IRS may ultimately decide not to require shareholder reapproval for grandfathered awards – but it hasn’t issued transition rules yet, and some companies may have decided that including these proposals in their proxy statements is the prudent thing to do.

Transcript: “Audit Committees in Action – The Latest Developments”

We have posted the transcript for the recent webcast: “Audit Committees in Action – The Latest Developments.”

Enforcement Penalties: Uncle Sam’s No Longer Picking Up Part of the Tab

The new tax legislation makes it tougher to deduct payments made in connection with the resolution of government enforcement actions. Under prior law, Section 162(f) of the Internal Revenue Code allowed deductions for a fairly broad category of payments. This excerpt from a recent Sidley memo provides an overview of the new regime:

Section 13306 of the Act completely repeals the prior language of Code Section 162(f) and replaces it with a general prohibition of business expense deductions for any payments made to or at the direction of a government, a governmental entity or certain nongovernmental self-regulatory entities in connection with a violation of law or an investigation involving a potential violation of law.

However, taxpayers continue to be allowed deductions for payments that they can establish “constitute restitution(including remediation of property) for damage or harm” related to the violation or potential violation of law or that were made “to come into compliance with any law which was violated or otherwise involved” in an investigation.

Nevertheless, amounts paid to reimburse the costs of investigation or litigation are not deductible as restitution or otherwise. Code Section 162(f)(2)(B). Furthermore, as a prerequisite to establishing the right to the remaining allowable deductions, the court order or settlement agreement involved must identify the amounts paid as restitution or payments made to come into compliance with applicable law. Otherwise, no deductions are allowed regardless of the
nature of the payments.

The governmental entity or SRO involved in the action also has to file an information return with the IRS specifying the amounts that are deductive. The new provisions apply to proceedings involving all federal, state & local enforcement agencies, as well as non-governmental enforcement agencies, such as SROs.

This Cleary blog has more on this topic, together some advice on negotiating settlement agreements with the government in order to preserve deductibility.  One interesting suggestion – companies should consider settling civil class actions early & voluntarily repaying victims for their loss and then arguing that the repayment also satisfies any separate disgorgement obligation to a government.

John Jenkins