REITs Executive Compensation Guide

Historically, REITs that had implemented compensation policies to fit within the performance-based exception under Section 162(m) were required to establish objectively determinable performance goals no more than 90 days into the performance period, and they could only make downward adjustments to compensation based on actual performance relative to the pre-determined performance goals. As a result of the elimination of the performance-based compensation exception under the TCJA, subject to restrictions on administrator discretion under applicable plan documents and public disclosures regarding the plans and the company’s administrative practices, REIT compensation committees generally (i) are no longer restricted from establishing performance goals more than 90 days into the performance period, (ii) can exercise discretion upward and downward and (iii) can grant awards without regard to individual award limits that are applicable only to awards intended to qualify for the performance-based compensation exception under Section 162(m). Additionally, the REIT generally will no longer need to seek stockholder re-approval of performance goals every five years. Nevertheless, before taking actions that would have been prohibited under the pre-TCJA rules applicable to performance-based compensation, potential reactions by stockholders and proxy advisors, such as ISS and Glass Lewis, should be considered, and plan documents and prior public disclosures describing plan provisions and administrative practices should be carefully analyzed to determine whether the actions are permitted.

SECTION 162(m) AND UPREITs

In REITs that utilize the UPREIT structure, often much of the compensation paid to executive officers relates to services the executive officer provides to the operating partnership, rather than the REIT. The IRS issued private letter rulings addressing this structure in four letter rulings issued between 2006 and 2008. In these rulings, the IRS concluded that Section 162(m) did not apply to an operating partnership with respect to compensation paid for services performed as an employee of the operating partnership, nor did it apply to the REIT with respect to its distributive share of income or loss from the operating partnership that includes the compensation expense to the extent that such compensation expense is attributable to services performed as employees of the operating partnership. Consistent with these rulings, many REITs took the position that compensation expense for services performed for the operating partnership was not subject to the Section 162(m) deduction limit. However, following on the changes to 162(m) ushered in by the TCJA, regulations were issued reversing the position expressed in these private letter rulings, effectively making them obsolete. Specifically, the regulations modified the definition of compensation for purposes of Section 162 (m) to include an amount equal to a parent entity’s distributive share of the operating partnership’s deduction for compensation expense attributable to the compensation paid by the operating partnership after December 18, 2020, which was the date the final regulations were made publicly available. Consequently, unless a limited grandfathering rule for compensation paid pursuant to a written binding contract that was in effect on December 20, 2019 applies, the prior exception to 162(m) for compensation paid by the operating partnership is no longer available.

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