Executives' Wages in Merged Corporations Were Not Subject to Sec. 162(m) Limits

Corporation T reports income on a fiscal-year basis. Corporation A reports income on a calendar-year basis.

On date a, A formed Corporation S. S was formed for the sole purpose of acquiring the T stock and did not otherwise engage in any active trade or business. On date b, T and A entered into a merger agreement; the acquisition occurred on date d.

According to T, it would not have to file any reports or statements with the Securities Exchange Commission (SEC) that disclose executive compensation otherwise due after T ceases to be a reporting entity. In turn, there would be no "summary compensation table" for T that would disclose the compensation of the chief executive officer (CEO) and the four highest-paid officers, either for T's year ending on c, or for the subsequent short tax year ending on d.

T also contends that none of its employees would be included in the year e summary compensation table to be filed with the SEC by A. Most of the T executives will continue to be employees, but some will become employees of A or its subsidiaries during the e and f tax years.

Several T and A corporate officers have resigned in e, or intend to resign their positions as officers in a later year. These individuals may continue to perform services as employees of T or A, or another company in the A controlled group, for the remainder of the resignation year and possibly in future years. Thus, the resignation from their positions as officers does not necessarily equate to separation from service as employees. These officers may, however, be listed pursuant to the SEC executive compensation disclosure rules as CEOs or the highest-compensated officers in the resignation year.

Sec. 162(a)(1) allows as a deduction all the ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered.

Sec. 162(m)(1) provides that, in the case of any publicly held corporation, no deduction is allowed for applicable em-ployee remuneration for a covered em-ployee, to the extent that such remuneration for the tax year exceeds $1 million.

Sec. 162(m)(3) defines "covered employee" as any employee of the taxpayer, who, as of the close of the tax year, is the taxpayer's CEO or an individual acting in such capacity, or whose total compensation for the tax year is required to be reported to shareholders under SEC rules, because such employee is among the four highest-compensated officers for the tax year (other than the CEO).

Regs. Sec. 1.162-27(c)(2) provides the general rule as to who is a covered employee—any individual who, on the last day of the tax year, is (1) the corporation's CEO or acting in such capacity or (2) among the four highest-compensated officers (other than the CEO). Whether an individual is the CEO or one of the four highest-compensated officers is determined pursuant to the SEC executive compensation disclosure rules.

In the notice of proposed rulemaking that contains the proposed regulations under Sec. 162(m), the preamble has the following language on the identification of "covered employee":

The regulations clarify which employees are "covered employees" for purposes of section 162(m). The legislative history to section 162(m) provides that "covered employees" are defined by reference to the SEC rules governing executive compensation disclosure under the Exchange Act. Under the regulations, an individual generally is a "covered employee" if the individual's compensation is reported on the "summary compensation table" under the SEC's executive compensation disclosure rules, as set forth in Item 402 of Regulation S-K, 17 CFR 229.402, under the Exchange Act. However, the regulations specifically provide that, in order to be a "covered employee" for section 162(m) purposes, an individual must be employed as an executive officer on the last day of the taxable year. Thus, only those employees who appear on the "summary compensation table" and who are also employed on the last day of the taxable year are "covered employees."

Therefore:

1. Assuming T does not have to file a summary compensation table with the SEC for the fiscal year ending on c or for the short tax year ending on d, for purposes of Sec. 162(m), T's officers would not be covered employees for those years.

2. For Sec. 162(m) purposes, T and A officers who resign their positions as officers before the last day of the tax year, with no intent to resume their duties as officers at any time in the foreseeable future, would not be covered employees in the resignation year. Accordingly, these officers' compensation in the resignation year would not be subject to the Sec. 162(m) deduction limit.

IRS Letter Ruling 200019010 (2/18/00)