A recently released September 2007 private letter ruling from the IRS appears to close a loophole under Section 162(m), the regulation that allows corporations to deduct certain top executives’ pay over $1 million only if it qualifies as “performance-based” compensation.

The ruling stipulated that an award that provides for accelerated payout--e.g., at the target or maximum level--upon the holder’s involuntary termination without cause or resignation for good reason would not qualify as performance-based under Section 162(m).

The ruling thus takes aim at all awards of cash incentives or performance-based restricted shares with terms that authorize them to be paid out under involuntary termination scenarios regardless of actual performance—and it appears that such awards would not qualify as performance-based regardless of whether employment termination actually occurs. Previously, termination without cause/constructive termination had been on the list of accelerated payout scenarios--along with death, disability, and a change in control--that would not run afoul of Section 162(m)’s performance-based exceptions.

It’s hard to argue with the IRS’s logic. After all, such involuntary terminations often follow a period of poor results, since “performance” is rarely on the list of reasons that can trigger a top executive’s dismissal for cause. It is still unclear how much pay might be affected by the new guidance, but the ruling is the first sign in some time that the IRS may take a tougher stance on performance-based exceptions under Section 162(m) which, after all, was intended to discourage outsized executive pay packages not driven by positive performance.