Friday, July 19, 2013

Senate Finance Committee Mulls Executive Compensation Changes

In late May, the Senate Finance Committee released its seventh paper in a series discussing ways on which it might consider reforming the existing Tax Code. Earlier this week, I discussed some of the possibilities in the retirement arena; today, I explore executive compensation.

For years, the intermingling of executive compensation and the Tax Code was a pretty simple consideration. Companies paid their executives a lot of money (but nowhere near as much as they do today). Essentially, executives paid taxes on compensation when it was constructively received and companies got deductions at the same time.

Each time that there was an abuse or perceived abuse, Congress saw fit to fix it through changes to the Internal Revenue Code. Rather than solving a problem, they often created a newer and bigger one. Congress sought to control the amounts that executives are paid by creating the $1 million pay cap under Code Section 162(m). I wrote about this problem back in 2011. Then, there were the Enron and Worldcom debacles and Congress presented us with Code Section 409A as part of a jobs bill of all things.

In any event, here are the proposals that the Finance Committee "may wish to consider" as it moves forward with all deliberate speed.

  1. Revise the limits on the deductibility of executive compensation.
    1. Repeal 162(m). In my opinion, repealing the limit would allow companies to pay executives more directly and would probably meaningfully decrease executive compensation.
    2. Expand the 162(m) group. This, again in my opinion, would serve to increase the number of people for whom large companies would try to get overly creative and overpay their top employees, especially on the sales side.
    3. Apply 162(m) to all equity compensation as well. 
    4. Change the 162(m) limit to 25 times the compensation of the lowest-paid employee in the company. This would cause companies to eliminate lower-paying jobs. I see no benefit to this proposal.
  2. Revise the rules related to nonqualified deferred compensation (NQDC). 
    1. Modify or repeal Code Section 409A.
      1. Repeal 409A and replace it with Treasury authority to promulgate rules that tax NQDC when it is constructively received. Didn't we used to have these rules?
      2. Repeal 409A for private companies. 409A was put in to stop a run on the bank like the one that occurred in the Enron debacle. Private companies truly are a different situation.
      3. Repeal the 20% penalty tax under 409A. Hmm! If you take the penalty out of a tax penalty, then you lose its teeth. Either repeal the section or keep it, but don't have it there with no teeth.
    2. Repeal NQDC. That is, tax service providers on compensation in the year that it is earned rather than allowing deferral.
      1. As an alternative, tax the employer currently on the buildup in deferred compensation.
      2. Allow either the company or the executive to pay that tax in the item immediately above.
  3. Revise the rules related to equity compensation.
    1. Repeal incentive (at the money) stock options. Since ISOs get special tax treatment, repealing them would remove the incentive for grantees of such options to hold the shares once they exercise their options.
    2. Modify deductibility of stock options.
      1. Limit the deduction to the amount recorded on the company's books when the options are granted.
      2. Deduct the stock option cost in the year that it is expenses.
  4. Revise golden parachute rules.
    1. Essentially repeal the excise taxes and the limitation on employer's deductions. This sounds like the pre-1984 rules.
This is certainly an interesting combination of proposals. I feel sure that even the least observant among my readers can work out which proposal came from Democrats and which from Republicans. Note that not a single one of the proposals talks about repealing Title IX of Dodd-Frank. Alas.

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