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New final regulations (the “Final Regulations”) have been issued clarifying and altering the “qualified performance-based compensation” exception and the transitional “reliance period” exception for newly public companies to the $1 million limit on deductible compensation for covered employees of public companies.
Section 162(m) generally limits deductions by publicly held corporations for remuneration paid to “covered employees” in excess of $1 million per year.
The Final Regulations place extra focus on equity compensation plan issues that have been the subject of recent shareholder litigation. It is likely that the terms of any public company’s equity incentive plan will receive significant scrutiny, and companies and their counsel should carefully review and develop the terms of their plans with this in mind.
The final regulations became effective on April 1, 2015. Public companies should confirm that their equity plans contain a per-employee maximum share limitation that complies with the Final Regulations. In addition, corporations that have recently become, or may become, public should carefully examine their equity plans, especially if they are using (or intend to use) the section 162(m) transitional reliance period. These companies should consider whether they wish to employ forms of equity compensation other than RSUs and phantom stock, which now clearly qualify for the transitional reliance period only if the compensation for such awards is paid prior to the end of such reliance period.
 See 80 Fed. Reg. 16970 (Mar. 31, 2015), available at http://www.gpo.gov/fdsys/pkg/FR-2015-03-31/pdf/2015-07386.pdf.
 A public company’s chief executive officer and its three other most highly compensated executive officers (other than its chief financial officer) are “covered employees.” See I.R.C. § 162(m). All references herein are to the Internal Revenue Code, or Treasury regulations promulgated thereunder, unless otherwise noted.
 The Final Regulations also require that the per-employee share limitation be disclosed to shareholders.
 See Treas. Reg. § 1.162-27(f). This reliance period ends on the earliest of the (i) expiration of the plan, (ii) material modification of the plan, (iii) issuance of all employer stock and other compensation allocated under the plan or (iv) first shareholder meeting at which directors are to be elected that occurs after the close of the third calendar year after the calendar year in which the IPO occurs or, if there was no IPO, the first calendar year after the calendar year in which the corporation became publicly held. In the case of an IPO, the transitional exception applies only to a plan described in the corporation’s IPO prospectus in compliance with all applicable securities laws then in effect.