BONUS DEDUCTION DENIED DUE TO EMPLOYMENT AGREEMENT PROVISION
A public company generally may not deduct compensation paid to the CEO and each of certain other officers that is in excess of $1 million dollars. The major exception is “performance based compensation,” including bonuses paid under a shareholder approved performance incentive plan.
The IRS recently ruled that an executive’s bonus could not be treated as “performance based compensation” due to a provision in his employment agreement. The agreement required the employer to pay him a pro rata share of his annual bonus if the company terminated him without cause or if he quit for “good reason.” The agreement stated that in those circumstances, performance goals for the year of termination would be deemed satisfied. The IRS held that the annual bonus was not performance based compensation because the executive might receive it without meeting any performance goals, even though he had not been terminated. This appears to reflect a change in the IRS’ ruling position on this issue.
If the employment contract had provided—as many such contracts do—that the executive would receive a pro rata share of his bonus for the year of termination based on actual achievement of the performance goals, the payments under the incentive plan should still have qualified as performance based compensation. Alternatively, the employer and executive could have achieved the same result by negotiating a separate severance payment unrelated to the executive’s incentive pay opportunity.
What Employers Should Do
To avoid jeopardizing the deduction for performance based compensation, employers should examine and revise, if necessary, performance incentive plans and other executive agreements to ensure that plan payments will qualify as performance based compensation.
If you have questions or concerns about the content of this alert, please contact a member of Oppenheimer’s Tax, Employee Benefits or Labor & Employment Groups.