The Internal Revenue Service recently issued proposed changes to the compensation deduction rules under Section 162(m) of the federal tax code. Section 162(m) generally limits a public company's compensation deduction with respect to its top executives to $1 million per executive per tax year. If adopted, the proposed changes would clarify two details related to certain exceptions to the Section 162(m) deduction limit discussed below.

To the extent it is considered "performance-based," compensation is exempt from the $1 million deduction limit of Section 162(m). Stock options and stock appreciation rights (SARs) are only able to be considered "performance-based compensation" if certain requirements are met. One such requirement dictates that the plan under which an option or SAR is granted must specify the maximum number of options or SARs an employee may receive during a specified period of time. The proposed changes clarify that that the plan must state a per-employee limit (e.g., 100,000 shares per any 3-year period) to qualify the options and SARs as "performance-based compensation." If a plan only states an aggregate limit on the maximum number of shares that can be granted under the plan, the options and SARs will not qualify as "performance-based compensation" for purposes of Section 162(m).