Continuing on FIN 48

Executive Compensation Considerations

This section highlights the frustration of any blog. This discussion is based on the prior discussion of new FASB Interpretation 48 – Accounting for Uncertainty in Income Taxes.  So, you need to read that section before you read this discussion. These postings are aimed at raising the awareness of the readers to compensation matters which may be considered “uncertain” under the new financial reporting rules and, as such, should trigger questions from the employer.

FIN 48 focuses attention on tax return positions. To sign a tax return, the position only needs a realistic possibility of success. That is a one in three standard.  FIN 48 requires more likely than not, which is something better than a 1 in 2 chance of success. This focuses a lot of attention on tax return positions that involve a degree of subjective decision making.  Those issues are very common when it comes to executive compensation.

1. IRC Section 162(m) generally limits the deduction of compensation for certain persons employed by a publicly traded enterprise to $1 million. That is an objective standard.  But there are many areas under Section 162(m) that are subject to judgment:
   1. Where equity compensation is included was the fair value actually determined at grant date? Was the determination of fair value reasonable?
   2. Has there been sufficient disclosure of the terms of the option plan?
   3. Can the performance pay exception be relied upon?
2. IRC Section 280G imposes very significant limits on the deduction of compensation triggered by a change in control. Like, 162(m), this includes objective and subjective criteria.
   1. Are amounts paid properly classified as reasonable compensation for services rendered following the change in control?
   2. Has base year compensation been measured properly?
   3. Has the exception for a small business corporation been properly applied?
3. Equity compensation takes many forms – options, restricted stock, phantom stock, stock appreciation rights and others.
   1. Was a transfer actually made?
   2. Was the date that the property was no longer subject to a substantial risk of forfeiture properly determined?
   3. Was the property valued correctly?
   4. Have any lapse or nonlapse restrictions been identified and considered?
4. Cash deferred compensation should be easy, but even here there are issues to consider.
   1. If services during the deferred period were rendered to multiple entities – who gets the deduction upon payment?
   2. Is it deferred compensation or a restricted property award? There are somewhat different deduction timing rules under Section 404 versus Section 83.
   3. When did “vesting” occur relative to payment? Is the payment truly deferred compensation?

Please do not assume that this is a comprehensive list. It would be nice if the readers would add other issues to this list to expand the idea of the kind of compensatory devices that are subject to evaluation under this standard.

Tomorrow, we will cover how the standard applies to benefit plans that are subject to a financial statement audit.

Comments

[Becky Miller]

It is true that 409A presents a bunch of uncertain tax positions, but they generally do not go to the employer's tax calculations. The tax reporting, interest and penalty fall to the employee / service provider. Even if there is an indemnification provision to the sponsor, that would not be an "income tax" liability under FIN 48. The timing of the service recipient's tax deduction is not changed by the 409A change in the service provider's recognition of the income. So - it is a hugely uncertain issue, but one that we don't have to grapple with here.

Thanks - Becky

[Barbara Flom]

And don't forget 409A! Since the regulations aren't even final yet, there are lots of uncertain positions.