IRS Provides Transition Relief from Recent Performance Compensation Private Letter Ruling

02.26.2008

As we described in more detail in our Client Alert on February 12, 2008, the IRS recently released a private letter ruling espousing a change in its position on the deductibility of certain common severance arrangements.  See the Heller Ehrman client update “IRS Change of Position on Performance-Based Compensation Causes Concern” dated February 12, 2008.   

On February 25, 2008, the IRS issued Revenue Ruling 2008-13, which confirms the position taken in the recent letter ruling.  The import of these developments for public companies subject to U.S. taxation is that certain incentive compensation that may have been structured to qualify as "performance-based" compensation under the Internal Revenue Code Section 162(m) deduction limitation rule may in fact not so qualify if the compensatory amounts may be paid as a result of the officer's involuntary termination or voluntary retirement.  The Revenue Ruling is apparently in reaction to the outcry raised by taxpayers and their advisors following release in January of the private letter ruling.  The Revenue Ruling confirms the change in position, but makes it clear that it will apply only prospectively.  Specifically, it provides transition relief by clarifying that this changed position will not apply to (1) performance-based compensation for which the performance period begins on or before January 1, 2009 or (2) compensation payable pursuant to the terms of an agreement that are in effect on February 21, 2008 (without regard to renewals or extensions, whether automatic or by agreement).

The transition relief gives companies an opportunity to review and revise existing compensation and severance arrangements and design future arrangements with respect to the impact of the Internal Revenue Service’s new position with respect to qualifying certain common compensatory arrangements as “performance-based” compensation under Section 162(m). 

IRS Circular 230 Disclosure:  To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalty or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.