Disallowance of Deductions for Employee Remuneration in Excess of $1,000,000

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[EE-61-93]

RIN 1545-AS23

Disallowance of Deductions for Employee Remuneration in Excess of

$1,000,000

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Amendments to proposed regulations.

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SUMMARY: This document contains amendments to the proposed regulations

under section 162(m) of the Internal Revenue Code of 1986 (Code),

relating to the disallowance of deductions for employee remuneration in

excess of $1,000,000. The proposed regulations, as amended, will

provide guidance to taxpayers who must comply with section 162(m),

which was added to the Code by the Omnibus Budget Reconciliation Act of

1993.

DATES: Written comments with regard to the amendments to the proposed

regulations and requests for a public hearing must be received by March

2, 1995.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (EE-61-93), room 5228,

Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,

DC 20044. In the alternative, submissions may be delivered to:

CC:DOM:CORP:T:R (EE-61-93), Courier's Desk, Internal Revenue Service,

1111 Constitution Avenue, NW, Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Robert Misner or Charles T. Deliee at

(202)-622-6060 (not a toll free call).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to the proposed Income Tax

Regulations (26 CFR Part 1) under section 162(m) of the Internal

Revenue Code (Code). The proposed regulations were published in the

Federal Register on December 20, 1993, at 58 FR 66310, with a

correction published in the Federal Register on February 14, 1994, at

59 FR 5370. Additional guidance was provided under Notice 94-2, 1994-2

I.R.B. 25, and Notice 94-68, 1994-26 I.R.B. 1. In Notice 94-2, the IRS

provided transition relief relating to the requirement that a

performance goal based on a period of service be ``preestablished.'' In

Notice 94-68, the IRS announced that the final regulations would

provide similar relief on a permanent basis. Notice 94-68 also extended

the transition period during which a corporation can treat

disinterested directors as outside directors until the first meeting of

shareholders at which directors are to be elected that occurs on or

after January 1, 1995. Section 1.162-27(h)(2) of the proposed

regulations defines a disinterested director as a director who is

disinterested within the meaning of Rule 16b-3(c)(2)(i) under the

Securities Exchange Act of 1934 (including the provisions of Rule 16b-

3(d)(3), as in effect on April 30, 1991). Under Sec. 1.162-27(h)(2),

the transition rule for disinterested directors originally was

scheduled to expire upon the first meeting of shareholders at which

directors were to be elected that occurred after July 1, 1994.

These amendments provide guidance on the definition of the term

``outside director.'' The amendments also extend the transition relief

provided in Notice 94-68 until the first meeting of shareholders at

which directors are to be elected that occurs on or after January 1,

1996. Thus, corporations can treat disinterested directors as outside

directors until that first meeting of shareholders. Other modifications

are also included that reflect a number of the comments received on the

December 1993 proposed regulations. The IRS and Treasury will continue

to consider comments previously received on the December 1993 proposed

regulations on issues other than those addressed by these amendments.

The December 1993 proposed regulations, as amended by these

amendments, are generally intended to address broad issues that are

important to most taxpayers in complying with section 162(m) and, thus,

are not comprehensive. To the extent that an issue is not covered by

the proposed regulations, as amended, taxpayers should follow a

reasonable, good faith interpretation of the statutory provisions.

Overview of Amendments

Definition of Publicly Held Corporation

Section 1.162-27(c)(1)(ii) of the proposed regulations defines a

publicly held corporation to include an affiliated group of

corporations, as defined in section 1504 of the Code (determined

without regard to section 1504(b)). Because a subsidiary that is itself

publicly held is subject to reporting requirements of the Securities

and Exchange Commission (SEC), Sec. 1.162-27(c)(1)(ii) is amended to

make clear that any publicly held subsidiary is excluded from the

affiliated group of its parent. Such a publicly held subsidiary, and

its subsidiaries (if any), are separately subject to section 162(m) and

may comprise one or more separate affiliated groups of corporations.

Thus, for example, if 85 percent of the stock of a subsidiary (S1)

is owned by a parent (P) that is publicly held, and 15 percent is

publicly traded, S1 is not considered a member of P's affiliated group

for purposes of section 162(m). In this case, S1 is treated as a

separate publicly held corporation. If, in turn, S1 owns, for example,

100 percent of the stock of another corporation, S2, then S2 is

considered a member of S1's affiliated group, and not a member of P's

affiliated group. Conversely, P (and, for example, a 100 percent

subsidiary of P) are not considered members of S1's affiliated group.

Thus, if P and S1 both pay compensation to the same covered employee,

the compensation paid to the employee by each is not aggregated with

the compensation paid to the employee by the other.

Definition of Compensation Committee

Section 1.162-27(c)(4) provides that a compensation committee must

have the authority to establish and administer a ``performance-based

compensation arrangement described in paragraph (e)(2).'' In order to

clarify that, for example, the entire board of directors may establish

a plan, this section is amended to state more narrowly that a

compensation committee must have the authority to establish and

administer ``performance goals described in paragraph (e)(2).''

Preestablished Performance Goal

Section 1.162-27(e)(2)(i) and Example 1 under Sec. 1.162-

27(e)(2)(vii) are amended to conform to the definition of

``preestablished'' provided in Notice 94-68. As amended, Sec. 1.162-

27(e)(2)(i) now provides that a performance goal is considered

preestablished if it is established in writing by the compensation

committee not later than 90 days after the commencement of the period

of service to which the performance goal relates, provided that the

outcome is substantially uncertain. However, in no event will a

performance goal be considered preestablished if it is established

after 25 percent of the period of service (as scheduled in good faith

at the time the goal is established) has elapsed.

The ``Substantially Uncertain'' Requirement

Commentators have requested additional guidance as to when a

performance goal is ``substantially uncertain.'' While this

determination remains essentially factual in nature, two examples have

been added to the proposed regulations under Sec. 1.162-27(e)(2)(vii).

Under new Example 2, it is concluded that a performance goal based on a

percentage of total sales is not substantially uncertain because some

sales are a virtual certainty. New Example 3, however, illustrates that

a performance goal based on corporate profitability is substantially

uncertain, even for companies with a history of profitability.

Awards Based on a Percentage of Salary

Commentators have raised the question whether a compensation

formula based on a percentage of salary or base pay involves

impermissible discretion to increase the amount payable under the

formula upon attainment of the goal because, by increasing salary, the

amount payable may be increased after the goal has been established.

Section 1.162-27(e)(2)(iii) has been amended to provide that, if the

terms of an objective formula or standard fail to preclude discretion

merely because the amount of compensation to be paid upon the

attainment of the performance goal is based, in whole or in part, on a

percentage of salary or base pay, the objective formula or standard

will not be considered discretionary (and thus Sec. 1.162-27(e)(2)(iii)

will not be violated) if the maximum dollar amount to be paid is fixed

at the time the performance goal is established.

Of course, a formula or standard based on salary or base pay might

fail to meet the requirements of Sec. 1.162-27(e)(2)(iii) for reasons

other than the fact that the formula or standard is based on salary or

base pay. If that is the case, the relief described in the preceding

paragraph will not prevent the performance goal from failing to meet

the requirements of Sec. 1.162-27(e)(2). A conforming amendment has

been made to Sec. 1.162-27(e)(4)(i) to provide that, when the amount to

be paid is based on a percentage of salary or base pay, the material

terms of a performance goal that must be disclosed to shareholders

include the maximum dollar amount that could be paid.

Earnings on Deferred Performance-Based Compensation

In the case of a deferral of a payment of compensation beyond the

date on which it would otherwise be payable, Sec. 1.162-

27(e)(2)(iii)(B) provides that an increase in the amount of the

compensation is not treated as an increase in the amount payable under

the performance goal if the increase in compensation is based on a

reasonable rate of interest. (Of course, this rule assumes there is no

constructive receipt of the compensation at the time it is deferred.)

Commentators have asked whether this deferral rule also applies to

increases in compensation that are determined on reasonable bases other

than by reference to a rate of interest. The purpose of the rule is

generally to permit a reasonable adjustment in the amount of

compensation to account for the delay in payment. Consequently, the

rule is amended to permit the adjustment to be based on the actual rate

of return on a predetermined investment (including any decrease as well

as any increase in the value of an investment) during the deferral

period (whether or not assets associated with the amount originally

owed are actually invested therein). New Examples 14, 15, and 16 have

been added to illustrate the application of this rule.

Impact of Corporate Transactions on Performance Goals

Section 1.162-27(e)(2)(vi) provides that compensation attributable

to a stock option or stock appreciation right does not fail to be

performance-based to the extent that a change in the grant or award is

made to reflect changes in corporate capitalization. In response to

commentators' suggestions that this relief for changes in corporate

capitalization be expanded, the current provision has been expanded to

apply to all stock-based compensation, not only to stock options and

stock appreciation rights. Thus, the provision has been moved to new

Sec. 1.162-27(e)(2)(iii)(C). In addition, new Example 13 in Sec. 1.162-

27(e)(2)(vii) indicates that the adjustment of a performance goal to

reflect a change in accounting standards will not be considered an

exercise of impermissible discretion, provided that the adjustment is

made pursuant to the terms of the plan or arrangement.

Clarification of Rule Viewing All Plans and Agreements in the Aggregate

Section 1.162-27(e)(2)(iv) provides that all plans, arrangements,

and agreements that provide for compensation to an employee will be

taken into account for purposes of determining whether, under the facts

and circumstances, compensation is only nominally or partially

contingent on attainment of a performance goal. Compensation is only

nominally or partially contingent on attainment of a performance goal

if the employee will receive all or part of the compensation regardless

of whether the performance goal is attained. Section 1.162-27(e)(2)(v)

provides that the determination of whether compensation satisfies the

requirements of Sec. 1.162-27(e)(2), and thus is performance-based, is

made on a grant-by-grant basis.

In order to clarify how these two provisions apply and work

together, the sequence of the two provisions has been reversed and

minor revisions have been made. These changes are intended to clarify

that the grant-by-grant rule is the general rule under which

compensation arrangements are tested for purposes of determining

whether they are performance-based. Thus, whether a compensation

arrangement is performance-based is generally determined without regard

to other compensation arrangements. The changes make clear that the

aggregation rule requiring all plans, arrangements, and agreements

providing compensation to an employee to be taken into account is a

limited exception to the general grant-by-grant rule, and applies only

for the purpose of determining whether the employee would receive,

regardless of whether the performance goal is attained, compensation

that purports to be performance-based. Thus, for example, if payment

under a nonperformance-based compensation arrangement is contingent

upon the failure to attain a performance goal under an otherwise

performance-based arrangement, neither arrangement provides for

compensation that is performance-based.

The amendments also provide that, if a plan providing for

performance-based restricted stock also provides for the payment of

dividends on the stock prior to the attainment of the performance goal,

the restricted stock and the dividends will be considered separate

grants, and the payment of dividends will not ``taint'' the

performance-based character of the restricted stock.

Outside Directors

Under Sec. 1.162-27(e)(3)(i)(D), an outside director is one who

does not receive remuneration, either directly or indirectly, in any

capacity other than as a director. Remuneration for this purpose

includes any payment in exchange for goods or services. Remuneration is

deemed to be paid to a director if it is paid to the director

personally, to an entity in which the director has a beneficial

ownership interest of greater than 50 percent, or (if more than de

minimis remuneration) to an entity by which the director is employed or

in which the director has a beneficial ownership interest of at least

five percent but not more than 50 percent. See Sec. 1.162-27(e)(3)(ii).

Remuneration is de minimis for this purpose if, during the publicly

held corporation's preceding taxable year, payments to the entity did

not exceed the lesser of $60,000 or five percent of the entity's gross

income for the entity's taxable year ending with or within the publicly

held corporation's taxable year. See Sec. 1.162-27(e)(3)(iii).

Commentators have asserted that the $60,000 limit of the de minimis

rule may be unrealistically low in cases where goods or certain types

of services are purchased from entities that employ their directors.

Thus, under the proposed amendments, the $60,000 de minimis limit

applies only if the payment to the entity employing the director is

remuneration for personal services or if the director is a five-

percent-or-more owner of the entity. In addition, the proposed

amendments clarify that a director of an entity will not be considered

employed or self-employed by that entity solely on account of services

as a director of the entity.

Under new Sec. 1.162-27(e)(3)(iv), remuneration is not for personal

services unless two requirements are satisfied. First, the remuneration

must be paid to an entity for personal or professional services,

consisting of legal, accounting, investment banking, and management

consulting services (and other similar services that may be specified

by the Commissioner in revenue rulings, notices, or other guidance

published in the Internal Revenue Bulletin), performed for the publicly

held corporation. For this purpose, remuneration for personal services

that are incidental to the purchase of goods or nonpersonal services

are not taken into account. Second, the director must perform

significant services (whether or not as an employee) for the

corporation, division, or similar organization (within the entity) that

actually provides the personal services described above to the publicly

held corporation, or more than 50 percent of the entity's gross

revenues must be derived from the personal-service-providing

organization.

New Examples 5, 6, and 7 are added to Sec. 1.162-27(e)(3)(ix) to

clarify the revised rules on de minimis remuneration. Other clarifying

amendments have been made to the outside director rules. New

Sec. 1.162-27(e)(3)(v) clarifies the definition of the term ``entity.''

Section 1.162-27(e)(3)(ii)(A) and new Examples 3 and 4 under

Sec. 1.162-27(e)(3)(ix) make clear that directors are not outside

directors if they receive any indirect personal remuneration from the

publicly held corporation.

Section 1.162-27(e)(3)(ii)(A) further provides that remuneration

described in that section is considered paid when actually paid (and

throughout the remainder of that taxable year of the publicly held

corporation) and, if earlier, throughout the period when a contract or

agreement to pay remuneration is outstanding. New Example 4 illustrates

this rule. By contrast, Sec. 1.162-27(e)(3)(ii)(B) and (C) are amended

to provide that remuneration described in those sections is considered

paid when it is actually paid or, if earlier, when the publicly held

corporation becomes liable to pay it. Thus, for example, if a publicly

held corporation becomes liable in 1998 to pay more than de minimis

remuneration to an entity, but agrees with the entity to defer payment

of that remuneration until 1999, the remuneration would be taken into

account for purposes of Sec. 1.162-27(e)(3)(ii)(B) and (C) only in 1998

when the corporation became liable to pay it. Also, under Sec. 1.162-

27(e)(3)(iii), the five percent de minimis rule is amended to focus on

the entity's gross revenue instead of its gross income. Finally, in

order to clarify the application of the outside director rules to

affiliated groups, new Sec. 1.162-27(e)(3)(viii) provides that the

outside directors of the publicly held member of an affiliated group

are treated as the outside directors of all members of the affiliated

group.

``Key Employees'' as a Description of a Class of Eligible Employees

Section 1.162-27(e)(4)(ii) provides a nonexclusive list of classes

of employees that constitute sufficient disclosure of employees

eligible to receive performance-based compensation. The proposed

regulations are amended to add ``key employees'' to the list.

Shareholder Approval

Under Sec. 1.162-27(e)(4)(i), the material terms of the performance

goal under which compensation is to be paid must be disclosed to and

subsequently approved by shareholders. The proposed amendments make

explicit the requirement that disclosure and shareholder approval must

occur before the compensation is paid. Of course, disclosure and

shareholder approval need not occur during the period within which the

compensation committee is required to establish the performance goal.

Under Sec. 1.162-27(e)(4)(vii), the material terms of a performance

goal are considered approved by shareholders if, in a separate vote,

affirmative votes are cast by a majority of the voting shares. In order

to reflect the fact that certain shares may have more than one vote,

and to properly deal with abstentions, that section is amended to

provide that the material terms of a performance goal are considered

approved by shareholders if, in a separate vote, a majority of the

votes cast on the issue (including abstentions to the extent

abstentions are counted as voting under applicable state law) are cast

in favor of approval.

In addition, in order to clarify the application of the shareholder

approval requirements to affiliated groups, new Sec. 1.162-

27(e)(4)(viii) provides that the shareholders of the publicly held

member of an affiliated group are treated as the shareholders of all

members of the affiliated group. For example, if one of the five

covered employees of an affiliated group is an employee of a wholly-

owned subsidiary of a publicly held parent corporation, the

shareholders of the parent would be required to approve the

performance-based compensation of that covered employee along with that

of the four covered employees who are employees of the publicly held

parent.

Private to Public Exception

Under Sec. 1.162-27(f), the $1 million deduction limit does not

apply to any compensation plan or agreement that existed during a

period in which a corporation was not publicly held, to the extent that

the prospectus accompanying the initial public offering disclosed

information concerning those plans or agreements that satisfied all

applicable securities laws then in effect. Several commentators have

asked whether the exemption should apply in perpetuity to plans or

agreements that existed before the corporation became public. Other

comments have suggested that the exemption be extended to corporations

that are spun off from publicly held corporations.

The IRS and Treasury believe that abuse could occur if the

``private to public'' exemption from the normally applicable rules were

of unlimited duration. Accordingly, new Sec. 1.162-27(f)(2) provides

that the exemption will apply for the duration of a reliance period

that lasts until the earliest of the expiration or material

modification of the plan or agreement; the issuance of all employer

stock or other compensation that has been allocated under the plan; or

the first meeting of shareholders at which directors are elected that

occurs after the close of the third calendar year following the

calendar year in which the initial public offering occurs. A taxpayer

may rely on this exemption for any compensation received pursuant to

the exercise of a stock option or stock appreciation right, or the

substantial vesting of restricted property, if the grant (as opposed to

the exercise or the substantial vesting) occurs before the close of the

reliance period.

The IRS and Treasury have decided that the ``private to public''

exemption should not apply to a subsidiary of a publicly held

corporation, where the subsidiary has been spun off or has otherwise

become a separate publicly held corporation. This is because those

subsidiary corporations are considered to be publicly held before the

spinoff under the affiliated group rule of Sec. 1.162-27(c)(ii).

However, the IRS and Treasury recognize that it may be difficult to

obtain shareholder approval of otherwise performance-based compensation

in some of these situations.

Accordingly, new Sec. 1.162-27(f)(3) provides alternative rules for

satisfying the requirements for performance-based compensation in the

context of a spinoff or similar situations. The first alternative

prescribes the method for applying the existing rules to satisfy the

performance-based compensation requirements for compensation paid after

a spinoff (or similar transaction) pursuant to a plan or arrangement

established before the spinoff (or similar transaction). The second

alternative provides relief from the shareholder approval requirement

during a transition period that ends with the first regularly scheduled

meeting of the shareholders of the new publicly held corporation that

occurs more than 12 months after the date on which the corporation

becomes a separate publicly held corporation. This alternative may be

necessary where shareholder approval of compensation is not obtained

before the spinoff.

Earnings on Deferred Compensation Payable Under a Binding Written

Contract

Section 1.162-27(h)(1)(iii)(B) is amended to conform to changes

made to Sec. 1.162-27(e)(2)(iii)(B) (with respect to permissible

increases in the amount of compensation where payment of compensation

has been deferred).

Special Transition Rule for Outside Directors

Section 1.162-27(h)(2) is amended to extend the transition relief

for the treatment of disinterested directors (as defined in Sec. 1.162-

27(h)(2)) as outside directors until the first meeting of shareholders

at which directors are to be elected that occurs on or after January 1,

1996. Thus, for example, if disinterested directors establish a bonus

plan (that satisfies the performance-based compensation requirements of

Sec. 1.162-27(e)(2)) for 1996 before that first shareholders meeting,

and the plan is approved by shareholders at that meeting, payments

under the plan will satisfy the performance-based-compensation

requirements if the compensation committee comprised of the new outside

directors certifies that the performance goals have been satisfied

prior to payment of the bonuses.

Special Transition Rule for Previously-Approved Plans

The proposed amendments modify Sec. 1.162-27(h)(3)(i) to clarify

that, in order for a plan to qualify under the special transition rule

for previously-approved plans, the disinterested directors need only

administer the plan (and need not also establish it).

Reliance Period for Special Transition Rule for Previously-Approved

Plans

Section 1.162-27(h)(3)(ii) provides that the reliance period that

applies to the transition rule for previously-approved plans under

Sec. 1.162-27(h)(3)(i) ends upon the earliest of the expiration or

material modification of the plan or agreement, the issuance of all

employer stock or other compensation that has been allocated under the

plan, or the first meeting of shareholders at which directors are to be

elected that occurs after December 31, 1996. Questions have been raised

as to whether, under this provision, and under the example provided,

the deductions attributable to stock options, stock appreciation

rights, and restricted property must be taken within the paragraph

(h)(3)(ii) reliance period in order to take advantage of the transition

relief. This was not the intention of the IRS or Treasury. Accordingly,

this provision and the related example are amended to provide that

stock options, stock appreciation rights, and restricted property need

only be granted before the end of the reliance period.

Proposed Effective Date

Except as otherwise provided, these amendments are proposed to be

effective for any payment that would be deductible for taxable years

beginning on or after January 1, 1994. Later effective dates are

proposed for several of the amendments under Sec. 1.162-27(i)(2).

Special Analysis

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. It also has

been determined that section 553(b) of the Administrative Procedure Act

(5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C.

chapter 6) do not apply to these regulations, and, therefore, a

Regulatory Flexibility Analysis is not required. Pursuant to section

7805(f) of the Code, this notice of proposed rulemaking will be

submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on its impact on small business.

Comments and Requests for Public Hearing

Before adopting these amendments to the proposed regulations,

consideration will be given to any written comments that are submitted

timely (preferably 8 copies) to the Commissioner of Internal Revenue.

All comments will be available for public inspection and copying. A

public hearing may be held upon written request to the Commissioner by

any person who has submitted written comments. If a public hearing is

held, notice of the time and place will be published in the Federal

Register.

Drafting information

The principal authors of the amendments to the proposed regulations

are Charles T. Deliee and Robert Misner, Office of the Associate Chief

Counsel (Employee Benefits and Exempt Organizations), IRS. However,

other personnel from IRS and the Treasury Department participated in

their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Amendments to the Proposed Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority for part 1 continues to read as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.162-27, as proposed to be added on December 20,

1993 at 58 FR 66313, is amended as follows:

1. Paragraph (c)(1)(ii) is amended by adding two sentences after

the first sentence.

2. Paragraph (c)(4) is revised.

3. Paragraph (e)(2) is amended as follows:

a. In paragraph (e)(2)(i), the second sentence is removed and two

new sentences are added in its place.

b. Paragraph (e)(2)(iii) is amended as follows:

i. A new sentence is added at the end of paragraph (e)(2)(iii)(A).

ii. Paragraph (e)(2)(iii)(B) is revised.

iii. Paragraph (e)(2)(iii)(C) is added.

c. Paragraphs (e)(2)(iv) and (v) are revised.

d. Paragraph (e)(2)(vi)(C) is removed.

e. Paragraph (e)(2)(vii) is amended as follows:

i. The first sentence of Example 1 is revised.

ii. Example 2 through Example 10 are redesignated as Example 4

through Example 12, respectively.

iii. New Examples 2 and 3 are added.

iv. The second sentence of newly designated Example 6 is revised.

v. Examples 13, 14, 15, and 16 are added.

4. Paragraph (e)(3) is amended as follows:

a. Paragraphs (e)(3)(i)(D), (e)(3)(ii), and (e)(3)(iii) are

revised.

b. Paragraph (e)(3)(vi) is redesignated as paragraph (e)(3)(ix);

Example 2 is revised; and Examples 3, 4, 5, 6, and 7 are added.

c. Paragraphs (e)(3)(iv) and (e)(3)(v) are redesignated as

paragraphs (e)(3)(vi) and (e)(3)(vii) respectively.

d. New paragraphs (e)(3)(iv), (e)(3)(v) and (e)(3)(viii) are added.

5. Paragraph (e)(4) is amended as follow:

a. Paragraph (e)(4)(i) is revised.

b. The last sentence of (e)(4)(ii) is revised.

c. Paragraph (e)(4)(vii) is revised.

d. Paragraph (e)(4)(viii) is redesignated as paragraph (e)(4)(ix).

e. New paragraph (e)(4)(viii) is added.

6. The heading for paragraph (f) is revised, the text of paragraph

(f) following the heading is designated as paragraph (f)(1) and

revised, and paragraphs (f)(2) through (5) are added.

7. The last sentence of paragraph (h)(1)(iii)(B) is revised.

8. The first sentence of paragraph (h)(2) is revised.

9. Paragraph (h)(3) is amended as follows:

a. Paragraph (h)(3)(i) is revised.

b. Paragraph (h)(3)(ii)(B) is revised.

c. Paragraph (h)(3)(iii) is redesignated as paragraph (h)(3)(iv)

and the Example is revised.

d. New paragraph (h)(3)(iii) is added.

10. Paragraph (i) is amended as follows:

a. The text of paragraph (i) following the heading is designated as

paragraph (i)(1).

b. A paragraph heading is added for newly designated paragraph

(i)(1).

c. Paragraph (i)(2) is added.

The revisions and additions read as follows:

Sec. 1.162-27 Certain employee remuneration in excess of $1,000,000.

* * * * *

(c) * * * (1) * * *

(ii) Affiliated groups. * * * However, an affiliated group of

corporations does not include any subsidiary that is itself a publicly

held corporation. Such a publicly held subsidiary, and its subsidiaries

(if any), are separately subject to this section. * * *

* * * * *

(4) Compensation Committee. The compensation committee means the

committee of directors (including any subcommittee of directors) of the

publicly held corporation that has the authority to establish and

administer performance goals described in paragraph (e)(2) of this

section, and to certify that performance goals are attained, as

described in paragraph (e)(5) of this section. A committee of directors

is not treated as failing to have the authority to establish

performance goals merely because the goals are ratified by the board of

directors of the publicly held corporation or, if applicable, any other

committee of the board of directors. See paragraph (e)(3) of this

section for rules concerning the composition of the compensation

committee.

* * * * *

(e) * * *

(2) * * * (i) * * * A performance goal is considered preestablished

if it is established in writing by the compensation committee not later

than 90 days after the commencement of the period of service to which

the performance goal relates, provided that the outcome is

substantially uncertain at the time the compensation committee actually

establishes the goal. However, in no event will a performance goal be

considered to be preestablished if it is established after 25 percent

of the period of service (as scheduled in good faith at the time the

goal is established) has elapsed. * * *

* * * * *

(iii) * * * (A) * * * If the terms of an objective formula or

standard fail to preclude discretion to increase the amount of

compensation merely because the amount of compensation to be paid upon

attainment of the performance goal is based, in whole or in part, on a

percentage of salary or base pay, the objective formula or standard

will not be considered discretionary for purposes of this paragraph

(e)(2)(iii) if the maximum dollar amount to be paid is fixed at the

time the performance goal is established.

(B) If compensation is payable upon or after the attainment of a

performance goal, and a change is made to accelerate the payment of

compensation to an earlier date after the attainment of the goal, the

change will be treated as an increase in the amount of compensation,

unless the amount of compensation paid is discounted to reasonably

reflect the time value of money. If compensation is payable upon or

after the attainment of a performance goal, and a change is made to

defer the payment of compensation to a later date, any amount paid in

excess of the amount that was originally owed to the employee will not

be treated as an increase in the amount of compensation if the

additional amount is based either on a reasonable rate of interest or

on one or more predetermined actual investments (whether or not assets

associated with the amount originally owed are actually invested

therein) such that the amount payable by the employer at the later date

will be based on the actual rate of return of a specific investment

(including any decrease as well as any increase in the value of an

investment). If compensation is payable in the form of property, a

change in the timing of the transfer of that property after the

attainment of the goal will not be treated as an increase in the amount

of compensation for purposes of this paragraph (e)(2)(iii). Thus, for

example, if the terms of a stock grant provide for stock to be

transferred after the attainment of a performance goal and the transfer

of the stock also is subject to a vesting schedule, a change in the

vesting schedule that either accelerates or defers the transfer of

stock will not be treated as an increase in the amount of compensation

payable under the performance goal.

(C) Compensation attributable to a stock option, stock appreciation

right, or other stock-based compensation does not fail to satisfy the

requirements of this paragraph (e)(2) to the extent that a change in

the grant or award is made to reflect a change in corporate

capitalization, such as a stock split or dividend, or a corporate

transaction, such as any merger of a corporation into another

corporation, any consolidation of two or more corporations into another

corporation, any separation of a corporation (including a spinoff or

other distribution of stock or property by a corporation), any

reorganization of a corporation (whether or not such reorganization

comes within the definition of such term in section 368), or any

partial or complete liquidation by a corporation.

(iv) Grant-by-grant determination. The determination of whether

compensation satisfies the requirements of this paragraph (e)(2)

generally shall be made on a grant-by-grant basis. Thus, for example,

whether compensation attributable to a stock option grant satisfies the

requirements of this paragraph (e)(2) generally is determined on the

basis of the particular grant made and without regard to the terms of

any other option grant, or other grant of compensation, to the same or

another employee. In addition, whether a restricted stock grant

satisfies the requirements of this paragraph (e)(2) is determined

without regard to whether dividends on the restricted stock are payable

prior to the attainment of the performance goal.

(v) Compensation contingent upon attainment of performance goal.

Compensation does not satisfy the requirements of this paragraph (e)(2)

if the facts and circumstances indicate that the employee would receive

all or part of the compensation regardless of whether the performance

goal is attained. Thus, if the payment of compensation under a grant or

award is only nominally or partially contingent on attaining a

performance goal, none of the compensation payable under the grant or

award will be considered performance-based. For example, if an employee

is entitled to a bonus under either of two arrangements, where payment

under a nonperformance-based arrangement is contingent upon the failure

to attain the performance goals under an otherwise performance-based

arrangement, then neither arrangement provides for compensation that

satisfies the requirements of this paragraph (e)(2). Compensation does

not fail to be qualified performance-based compensation merely because

the plan allows the compensation to be payable upon death, disability,

or change of ownership or control, although compensation actually paid

on account of those events prior to the attainment of the performance

goal would not satisfy the requirements of this paragraph (e)(2). As an

exception to the general rule set forth in the first sentence of

paragraph (e)(2)(iv) of this section, the facts-and-circumstances

determination referred to in the first sentence of this paragraph

(e)(2)(v) is made taking into account all plans, arrangements, and

agreements that provide for compensation to the employee.

* * * * *

(vii) * * *

Example 1. No later than 90 days after the start of a fiscal

year, but while the outcome is substantially uncertain, Corporation

S establishes a bonus plan under which A, the chief executive

officer, will receive a cash bonus of $500,000, if year-end

corporate sales are increased by at least 5 percent. * * *

Example 2. The facts are the same as in Example 1, except that

the bonus is based on a percentage of the Corporation's total sales

for the fiscal year. Because Corporation S is virtually certain to

have some sales for the fiscal year, the outcome of the performance

goal is not substantially uncertain, and therefore the bonus does

not meet the requirements of this paragraph (e)(2).

Example 3. The facts are the same as in Example 1, except that

the bonus is based on a percentage of the Corporation's total

profits for the fiscal year. Although some sales are virtually

certain for virtually all public companies, it is substantially

uncertain whether a company will have profits for a specified future

period even if the company has a history of profitability.

Therefore, the bonus will meet the requirements of this paragraph

(e)(2).

* * * * *

Example 6. * * * If both the earnings-per-share goal and the

stock-price goal are preestablished, the compensation committee's

discretion to choose to pay a bonus under either of the two goals

does not cause any bonus paid under the plan to fail to meet the

requirement of this paragraph (e)(2) because each goal independently

meets the requirements of this paragraph (e)(2). * * *

* * * * *

Example 13. Corporation W adopts a plan under which a bonus will

be paid to the CEO only if there is a 10% increase in earnings per

share during the performance period. The plan provides that earnings

per share will be calculated without regard to any change in

accounting standards that may be required by the Financial

Accounting Standards Board after the goal is established. After the

goal is established, such a change in accounting standards occurs.

Corporation W's reported earnings, for purposes of determining

earnings per share under the plan, are adjusted pursuant to this

plan provision to factor out this change in standards. This

adjustment will not be considered an exercise of impermissible

discretion because it is made pursuant to the plan provision.

Example 14. Corporation X adopts a performance-based incentive

pay plan with a four-year performance period. Bonuses under the plan

are scheduled to be paid in the first year after the end of the

performance period (year 5). However, in the second year of the

performance period, the compensation committee determines that any

bonuses payable in year 5 will instead, for bona fide business

reasons, be paid in year 10. The compensation committee also

determines that any compensation that would have been payable in

year 5 will be adjusted to reflect the delay in payment. The

adjustment will be based on the greater of the future rate of return

of a specified mutual fund that invests in blue chip stocks or of a

specified venture capital investment over the five-year deferral

period. Each of these investments, considered by itself, is a

predetermined actual investment because it is based on the future

rate of return of an actual investment. However, the adjustment in

this case is not based on predetermined actual investments within

the meaning of paragraph (e)(2)(iii)(B) of this section because the

amount payable by Corporation X in year 10 will be based on the

greater of the two investment returns and, thus, will not be based

on the actual rate of return on either specific investment.

Example 15. The facts are the same as in Example 14, except that

the increase will be based on the rate of return of Moody's Average

Corporate Bond Yield over the five-year deferral period. Because

this index reflects a reasonable rate of interest, the increase in

the compensation payable that is based on the index's rate of return

is not considered an impermissible increase in the amount of

compensation payable under the formula.

Example 16. The facts are the same as in Example 14, except that

the increase will be based on the rate of return for the Standard &

Poor's 500 Index. This index does not measure interest rates and

thus does not represent a reasonable rate of interest. In addition,

this index does not represent an actual investment. Therefore, any

additional compensation payable based on the rate of return of this

index will result in an impermissible increase in the amount payable

under the formula. If, in contrast, the increase were based on the

rate of return of an existing mutual fund that is invested in a

manner that seeks to approximate the Standard & Poor's 500 Index,

the increase would be based on a predetermined actual investment

within the meaning of paragraph (e)(2)(iii)(B) of this section and

thus would not result in an impermissible increase in the amount

payable under the formula.

(3) * * * (i) * * *

(D) Does not receive remuneration from the publicly held

corporation, either directly or indirectly, in any capacity other than

as a director. For this purpose, remuneration includes any payment in

exchange for goods or services.

(ii) Remuneration received. For purposes of this paragraph (e)(3),

remuneration is received, directly or indirectly, by a director in each

of the following circumstances:

(A) If remuneration is paid, directly or indirectly, to the

director personally or to an entity in which the director has a

beneficial ownership interest of greater than 50 percent. For this

purpose, remuneration is considered paid when actually paid (and

throughout the remainder of that taxable year of the corporation) and,

if earlier, throughout the period when a contract or agreement to pay

remuneration is outstanding.

(B) If remuneration, other than de minimis remuneration, was paid

by the publicly held corporation in its preceding taxable year to an

entity in which the director has a beneficial ownership interest of at

least 5 percent but not more than 50 percent. For this purpose,

remuneration is considered paid when actually paid or, if earlier, when

the publicly held corporation becomes liable to pay it.

(C) If remuneration, other than de minimis remuneration, was paid

by the publicly held corporation in its preceding taxable year to an

entity by which the director is employed or self-employed other than as

a director. For this purpose, remuneration is considered paid when

actually paid or, if earlier, when the publicly held corporation

becomes liable to pay it.

(iii) De minimis remuneration--(A) In general. For purposes of

paragraphs (e)(3)(ii)(B) and (C) of this section, remuneration that was

paid by the publicly held corporation in its preceding taxable year to

an entity is de minimis if payments to the entity did not exceed 5

percent of the gross revenue of the entity for its taxable year ending

with or within that preceding taxable year of the publicly held

corporation.

(B) Remuneration for personal services and substantial owners.

Notwithstanding paragraph (e)(3)(iii)(A) of this section, remuneration

in excess of $60,000 is not de minimis if the remuneration is paid to

an entity described in paragraph (e)(3)(ii)(B) of this section, or is

paid for personal services to an entity described in paragraph

(e)(3)(ii)(C) of this section.

(iv) Remuneration for personal services. For purposes of paragraph

(e)(3)(iii)(B) of this section, remuneration from a publicly held

corporation is for personal services if--

(A) The remuneration is paid to an entity for personal or

professional services, consisting of legal, accounting, investment

banking, and management consulting services (and other similar services

that may be specified by the Commissioner in revenue rulings, notices,

or other guidance published in the Internal Revenue Bulletin),

performed for the publicly held corporation, and the remuneration is

not for services that are incidental to the purchase of goods or to the

purchase of services that are not personal services; and

(B) The director performs significant services (whether or not as

an employee) for the corporation, division, or similar organization

(within the entity) that actually provides the services described in

paragraph (e)(3)(iv)(A) of this section to the publicly held

corporation, or more than 50 percent of the entity's gross revenues

(for the entity's preceding taxable year) are derived from that

corporation, subsidiary, or similar organization.

(v) Entity defined. For purposes of this paragraph (e)(3), the term

entity means an organization that is a sole proprietorship, trust,

estate, partnership, or corporation. The term entity also includes an

affiliated group of corporations as defined in section 1504 (determined

without regard to section 1504(b)) and a group of organizations that

would be an affiliated group but for the fact that one or more of the

organizations are not incorporated. However, the aggregation rules

referred to in the preceding sentence do not apply for purposes of

determining whether a director has a beneficial ownership interest of

at least 5 percent or greater than 50 percent.

* * * * *

(viii) Members of affiliated groups. For purposes of this paragraph

(e)(3), the outside directors of the publicly held member of an

affiliated group are treated as the outside directors of all members of

the affiliated group.

(ix) * * *

Example 2. Corporation Z, a calendar-year taxpayer, uses the

services of a law firm by which B is employed, but in which B has a

less-than-5-percent ownership interest. The law firm reports income

on a July 1 to June 30 basis. Corporation Z appoints B to serve on

its compensation committee for calendar year 1998 after determining

that, in calendar year 1997, it did not become liable to the law

firm for remuneration exceeding the lesser of $60,000 or five

percent of the law firm's gross revenue (calculated for the year

ending June 30, 1997). On October 1, 1998, Corporation Z becomes

liable to pay remuneration of $50,000 to the law firm on June 30,

1999. For the year ending June 30, 1998, the law firm's gross

revenue was less than $1 million. Thus, in calendar year 1999, B is

not an outside director. However, B may satisfy the requirements for

an outside director in calendar year 2000, if, in calendar year

1999, Corporation Z does not become liable to the law firm for

additional remuneration. This is because the remuneration actually

paid on June 30, 1999 was considered paid on October 1, 1998 under

paragraph (e)(3)(ii)(C) of this section.

Example 3. Corporation Z, a publicly held corporation, purchases

goods from Corporation A. D, an executive and less-than-5-percent

owner of Corporation A, sits on the board of directors of

Corporation Z and on its compensation committee. For 1997,

Corporation Z obtains representations to the effect that D is not

eligible for any commission for D's sales to Corporation Z and that,

for purposes of determining D's compensation for 1997, Corporation

A's sales to Corporation Z are not otherwise treated differently

than sales to other customers of Corporation A (including its

affiliates, if any) or are irrelevant. In addition, Corporation Z

has no reason to believe that these representations are inaccurate

or that it is otherwise paying remuneration indirectly to D

personally. Thus, in 1997, no remuneration is considered paid by

Corporation Z indirectly to D personally under paragraph

(e)(3)(ii)(A) of this section.

Example 4. (i) Corporation W, a publicly held corporation,

purchases goods from Corporation T. C, an executive and less-than-5-

percent owner of Corporation T, sits on the board of directors of

Corporation W and on its compensation committee. Corporation T

develops a new product and agrees on January 1, 1998 to pay C a

bonus of $500,000 if Corporation W contracts to purchase the

product. Even if Corporation W purchases the new product, sales to

Corporation W will represent less than 5 percent of Corporation T's

gross revenues. In 1999, Corporation W contracts to purchase the new

product and, in 2000, C receives the $500,000 bonus from Corporation

T. In 1998, 1999, and 2000, Corporation W does not obtain any

representations relating to indirect remuneration to C personally

(such as the representations described in Example 3).

(ii) Thus, in 1998, 1999, and 2000, remuneration is considered

paid by Corporation W indirectly to C personally under paragraph

(e)(3)(ii)(A) of this section. Accordingly, in 1998, 1999, and 2000,

C is not an outside director of Corporation W. The result would have

been the same if Corporation W had obtained appropriate

representations but nevertheless had reason to believe that it was

paying remuneration indirectly to C personally.

Example 5. Corporation R, a publicly held corporation, purchases

utility service from Corporation Q, a public utility. The chief

executive officer, and less-than-5-percent owner, of Corporation Q

is a director of Corporation R. Corporation R pays Corporation Q

more than $60,000 per year for the utility service, but less than 5

percent of Corporation Q's gross revenues. Because utility services

are not personal services, the fees paid are not subject to the

$60,000 de minimis rule for remuneration for personal services

within the meaning of paragraph (e)(3)(iii)(B) of this section.

Thus, the chief executive officer qualifies as an outside director

of Corporation R, unless disqualified on some other basis.

Example 6. Corporation A, a publicly held corporation, purchases

management consulting services from Division S of Conglomerate P.

The chief financial officer of Division S is a director of

Corporation A. Corporation A pays more than $60,000 per year for the

management consulting services, but less than 5 percent of

Conglomerate P's gross revenues. Because management consulting

services are personal services within the meaning of paragraph

(e)(3)(iv)(A) of this section, and the chief financial officer

performs significant services for Division S, the fees paid are

subject to the $60,000 de minimis rule as remuneration for personal

services. Thus, the chief financial officer does not qualify as an

outside director of Corporation A.

Example 7. The facts are the same as in Example 6, except that

the chief executive officer, and less-than-5-percent owner, of the

parent company of Conglomerate P is a director of Corporation A and

does not perform significant services for Division S. If the gross

revenues of Division S do not constitute more than 50 percent of the

gross revenues of Conglomerate P for P's preceding taxable year, the

chief executive officer will qualify as an outside director of

Corporation A, unless disqualified on some other basis.

(4) Shareholder approval requirement--(i) General rule. The

material terms of the performance goal under which the compensation is

to be paid must be disclosed to and subsequently approved by the

shareholders of the publicly held corporation before the compensation

is paid. The requirements of this paragraph (e)(4) are not satisfied if

the compensation would be paid regardless of whether the material terms

are approved by shareholders. The material terms include the employees

eligible to receive compensation; a description of the business

criteria on which the performance goal is based; and either the maximum

amount of compensation that could be paid to any employee or the

formula used to calculate the amount of compensation to be paid to the

employee if the performance goal is attained (except that, in the case

of a formula based, in whole or in part, on a percentage of salary or

base pay, the maximum dollar amount of compensation that could be paid

to the employee must be disclosed).

(ii) * * * A general description of the class of eligible employees

by title or class is sufficient, such as the chief executive officer

and vice presidents, or all salaried employees, all executive officers,

or all key employees.

* * * * *

(vii) Shareholder vote. For purposes of this paragraph (e)(4), the

material terms of a performance goal are approved by shareholders if,

in a separate vote, a majority of the votes cast on the issue

(including abstentions to the extent abstentions are counted as voting

under applicable state law) are cast in favor of approval.

(viii) Members of affiliated group. For purposes of this paragraph

(e)(4), the shareholders of the publicly held member of the affiliated

group are treated as the shareholders of all members of the affiliated

group.

* * * * *

(f) Companies that become publicly held, spinoffs, and similar

transactions--(1) In general. In the case of a corporation that was not

a publicly held corporation and then becomes a publicly held

corporation, the deduction limit of paragraph (b) of this section does

not apply to any remuneration paid pursuant to a compensation plan or

agreement that existed during the period in which the corporation was

not publicly held, to the extent that the prospectus accompanying the

initial public offering disclosed information concerning those plans or

agreements that satisfied all applicable securities laws then in

effect. In accordance with paragraph (c)(1)(ii) of this section, a

corporation that is a member of an affiliated group that includes a

publicly held corporation is considered publicly held and, therefore,

cannot rely on this paragraph (f)(1).

(2) Reliance period. Paragraph (f)(1) of this section may be relied

upon until the earliest of--

(i) The expiration of the plan or agreement;

(ii) The material modification of the plan or agreement, within the

meaning of paragraph (h)(1)(iii) of this section;

(iii) The issuance of all employer stock or other compensation that

has been allocated under the plan; or

(iv) The first meeting of shareholders at which directors are to be

elected that occurs after the close of the third calendar year

following the calendar year in which the initial public offering

occurs.

(3) Stock-based compensation. Paragraph (f)(1) of this section will

apply to any compensation received pursuant to the exercise of a stock

option or stock appreciation right, or the substantial vesting of

restricted property, granted under a plan or agreement described in

paragraph (f)(1) of this section if the grant occurs before the

earliest of the dates specified in paragraph (f)(2) of this section.

(4) Subsidiaries that become separate publicly held corporations--

(i) In general. If a subsidiary that is a member of the affiliated

group described in paragraph (c)(1)(ii) of this section becomes a

separate publicly held corporation (whether by spinoff or otherwise),

any remuneration paid to covered employees of the new publicly held

corporation will satisfy the exception for performance-based

compensation described in paragraph (e) of this section if the

conditions in either paragraph (f)(4)(ii) or (iii) of this section are

satisfied.

(ii) Prior establishment and approval. The remuneration satisfies

the requirements for performance-based compensation set forth in

paragraphs (e)(2), (3), and (4) of this section (by application of

paragraphs (e)(3)(viii) and (e)(4)(viii) of this section) before the

corporation becomes a separate publicly held corporation, and the

certification required by paragraph (e)(5) of this section is made by

the compensation committee of the new publicly held corporation (but if

the performance goals are attained before the corporation becomes a

separate publicly held corporation, the certification may be made

before it becomes a separate publicly held corporation by the

compensation committee referred to in paragraph (e)(3)(viii) of this

section). Thus, this paragraph (f)(4)(ii) requires that the outside

directors and shareholders (within the meaning of paragraphs

(e)(3)(viii) and (e)(4)(viii) of this section) of the corporation

before it becomes a separate publicly held corporation establish and

approve, respectively, the performance-based compensation for the

covered employees of the new publicly held corporation in accordance

with paragraphs (e)(3) and (4) of this section.

(iii) Transition period. The remuneration satisfies all of the

requirements of paragraphs (e)(2), (3), and (5) of this section. The

outside directors (within the meaning of paragraph (e)(3)(viii) of this

section) of the corporation before it becomes a separate publicly held

corporation, or the outside directors of the new publicly held

corporation, may establish and administer the performance goals for the

covered employees of the new publicly held corporation for purposes of

satisfying the requirements of paragraphs (e)(2) and (3) of this

section. The certification required by paragraph (e)(5) of this section

must be made by the compensation committee of the new publicly held

corporation. However, a taxpayer may rely on this paragraph (f)(4)(iii)

to satisfy the requirements of paragraph (e) of this section only for

compensation paid, or stock options, stock appreciation rights, or

restricted property granted, prior to the first regularly scheduled

meeting of the shareholders of the new publicly held corporation that

occurs more than 12 months after the date the corporation becomes a

separate publicly held corporation. Compensation paid, or stock

options, stock appreciation rights, or restricted property granted, on

or after the date of that meeting of shareholders must satisfy all

requirements of paragraph (e) of this section, including the

shareholder approval requirement of paragraph (e)(4) of this section,

in order to satisfy the requirements for performance-based

compensation.

(5) Example. The following example illustrates the application of

paragraph (f)(4)(ii) of this section:

Example. Corporation P, which is publicly held, decides to spin

off Corporation S, a wholly owned subsidiary of Corporation P. After

the spinoff, Corporation S will be a separate publicly held

corporation. Before the spinoff, the compensation committee of

Corporation P, pursuant to paragraph (e)(3)(viii) of this section,

establishes a bonus plan for the executives of Corporation S that

provides for bonuses payable after the spinoff and that satisfies

the requirements of paragraph (e)(2) of this section. If, pursuant

to paragraph (e)(4)(viii) of this section, the shareholders of

Corporation P approve the plan prior to the spinoff, that approval

will satisfy the requirements of paragraph (e)(4) of this section

with respect to compensation paid pursuant to the bonus plan after

the spinoff. However, the compensation committee of Corporation S

will be required to certify that the goals are satisfied prior to

the payment of the bonuses in order for the bonuses to be considered

performance-based compensation.

* * * * *

(h) *** (1) ***

(iii) ***

(B) *** If the contract is modified to defer the payment of

compensation, any compensation paid in excess of the amount that was

originally payable to the employee under the contract will not be

treated as a material modification if the additional amount is based on

either a reasonable rate of interest or one or more predetermined

actual investments (whether or not assets associated with the amount

originally owed are actually invested therein) such that the amount

payable by the employer at the later date will be based on the actual

rate of return of a specific investment (including any decrease as well

as any increase in the value of an investment).

* * * * *

(2) Special transition rule for outside directors. A director who

is a disinterested director is treated as satisfying the requirements

of an outside director under paragraph (e)(3) of this section until the

first meeting of shareholders at which directors are to be elected that

occurs on or after January 1, 1996. ***

(3) *** (i) In general. Any compensation paid under a plan or

agreement approved by shareholders before December 20, 1993, is treated

as satisfying the requirements of paragraphs (e) (3) and (4) of this

section, provided that the directors administering the plan or

agreement are disinterested directors and the plan was approved by

shareholders in a manner consistent with Rule 16b-3(b), 17 CFR 240.16b-

3(b), under the Exchange Act or Rule 16b-3(a) (17 CFR 240.16b-3(a) as

contained in 17 CFR Part 240 to End, revised April 1, 1990). In

addition, for purposes of satisfying the requirements of paragraph

(e)(2)(vi) of this section, a plan or agreement is treated as stating a

maximum number of shares with respect to which an option or right may

be granted to any employee if the plan or agreement that was approved

by the shareholders provided for an aggregate limit, consistent with

Rule 16b-3(b), 17 CFR 250.16b-3(b), on the shares of employer stock

with respect to which awards may be made under the plan or agreement.

(ii) ***

(B) The issuance of all employer stock or other compensation that

has been allocated under the plan; or

* * * * *

(iii) Stock-based compensation. This paragraph (h)(3) will apply to

any compensation received pursuant to the exercise of a stock option or

stock appreciation right, or the substantial vesting of restricted

property, granted under a plan or agreement described in paragraph

(h)(3)(i) of this section if the grant occurs before the earliest of

the dates specified in paragraph (h)(3)(ii) of this section.

(iv) ***

Example. Corporation Z adopted a stock option plan in 1991.

Pursuant to Rule 16b-3 under the Exchange Act, the stock option plan

has been administered by disinterested directors and was approved by

Corporation Z shareholders. Under the terms of the plan, shareholder

approval is not required again until 2001. In addition, the terms of

the stock option plan include an aggregate limit on the number of

shares available under the plan. Option grants under the Corporation

Z plan are made with an exercise price equal to or greater than the

fair market value of Corporation Z stock. Compensation attributable

to the exercise of options that are granted under the plan before

the earliest of the dates specified in paragraph (h)(3)(ii) of this

section will be treated as satisfying the requirements of paragraph

(e) of this section for qualified performance-based compensation,

regardless of when the options are exercised.

(i) Effective date--(1) In general. ***

(2) Delayed effective date for certain provisions--(i) Date on

which remuneration is considered paid. Notwithstanding paragraph (i)(1)

of this section, the rules in the second sentence of each of paragraphs

(e)(3)(ii) (A), (B), and (C) of this section for determining the date

or dates on which remuneration is considered paid to a director are

effective for taxable years beginning on or after January 1, 1995.

Prior to those taxable years, taxpayers must follow the rules in

paragraphs (e)(3)(ii) (A), (B), and (C) of this section or another

reasonable, good faith interpretation of section 162(m) with respect to

the date or dates on which remuneration is considered paid to a

director.

(ii) Separate treatment of publicly held subsidiaries.

Notwithstanding paragraph (i)(1) of this section, the rule in paragraph

(c)(1)(ii) of this section that treats publicly held subsidiaries as

separately subject to section 162(m) is effective as of the first

regularly scheduled meeting of the shareholders of the publicly held

subsidiary that occurs more than 12 months after December 2, 1994. The

rule for stock-based compensation set forth in paragraph (f)(3) of this

section will apply for this purpose, except that the grant must occur

before the shareholder meeting specified in this paragraph (i)(2)(ii).

Taxpayers may choose to rely on the rule referred to in the first

sentence of this paragraph (i)(2)(ii) for the period prior to the

effective date of the rule.

(iii) Subsidiaries that become separate publicly held corporations.

Notwithstanding paragraph (i)(1) of this section, if a subsidiary of a

publicly held corporation becomes a separate publicly held corporation

as described in paragraph (f)(4)(i) of this section, then, for the

duration of the reliance period described in paragraph (f)(2) of this

section, the rules of paragraph (f)(4) of this section do not apply to

remuneration paid to covered employees of that new publicly held

corporation pursuant to a plan or agreement that existed prior to

December 2, 1994 provided that the treatment of that remuneration as

performance-based is in accordance with a reasonable, good faith

interpretation of section 162(m). However, if remuneration is paid to

covered employees of that new publicly held corporation pursuant to a

plan or agreement that existed prior to December 2, 1994, but that

remuneration is not performance-based under a reasonable, good faith

interpretation of section 162(m), then the rules of paragraph (f)(4) of

this section apply as of the first regularly scheduled meeting of

shareholders that occurs more than 12 months after December 2, 1994.

The rule for stock-based compensation set forth in paragraph (f)(3) of

this section will apply for purposes of this paragraph (i)(2)(iii),

except that the grant must occur before the shareholder meeting

specified in the preceding sentence if the remuneration is not

performance-based under a reasonable, good faith interpretation of

section 162(m). Taxpayers may choose to rely on the rules of paragraph

(f)(4) of this section for the period prior to the applicable effective

date referred to in the first or second sentence of this paragraph

(i)(2)(iii).

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 94-29536 Filed 12-1-94; 8:45 am]

BILLING CODE 4830-01-U