IRS increases scrutiny of compliance with executive compensation deduction limit

March 2012


Continuing recent trends toward increased scrutiny of executive compensation, the IRS has stepped up its audit activity with respect to the $1 million annual deduction limitation on certain compensation paid to "covered employees" of publicly held corporations under Code section 162(m), as well as taxpayer compliance with the requirements for nonqualified deferred compensation arrangements under section 409A. Section 162(m) generally prohibits a tax deduction for any compensation in excess of $1 million paid to the CEO or to the four other most highly compensated officers of a public corporation. The most significant exception to the $1 million annual limit is for "performance-based compensation," including stock options or stock appreciation rights (SARs) issued at fair market value and bonuses or other incentive awards issued following the satisfaction of performance targets approved by an independent compensation committee. The regulations establish detailed requirements that must be met for this exception to apply, and the requirements must be met precisely -- even a "foot fault" may result in a violation. Moreover, if there is a violation, no matter how insignificant, the consequences may be severe -- the entire deduction in excess of $1 million may be lost.

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