Most C-suite executives and their boards would rather leave tax issues in the hands of the accountants. Slogging through the byzantine tax code is a task better suited to CPAs, with at least a fighting chance of making sense of it all.
This year, however, company leaders may find they need to pay an unusual amount of attention to the tax code.
Despite plans on both sides of the political aisle to make various changes and the coming fight in Congress over the issue that is expected after the election, the so-called “Bush tax cuts,” in place since 2003, expire on Dec. 31. Barring Congressional action, income tax rates will rise, as will those on capital gains and dividends. A 2 percent payroll tax cut is also set to expire and a new 3.8 percent surtax on investment income for people earning more than $200,000 that is part of healthcare reform legislation will kick in at the start of the year.
While members of the House, Senate, and both presidential candidates have promised to preserve many of the cuts, a number of consultants and service providers are urging companies not to take any chances. Among the tactics companies can take to ease the tax burden on executives and shareholders, they say, are advancing the issuance of dividend payments and bonus pay into the current year.
Steven Seelig, an executive compensation expert with business consultant Towers Watson, says that shifting bonus timelines may sound simple at first blush, but there are numerous hurdles to overcome, some of which might make boards retreat from the plan.
One potential deal breaker is whether or not a company's compensation committee, as structured, has the authority to pay early bonuses. The company will also have to decide just who should get those accelerated payments. Are they just for executives, for all employees, or just offered to those earning enough see their marginal tax rate increase?
A pressing question is how shareholders will react. “Some suggest the optics of this are not really good, and some shareholders would be up in arms about it,” Seelig says.
Tax accountants say accelerating bonuses into 2012 wouldn't have much of an effect on the financials. “Typically with your bonus pool, these would be items that are accrued as of year's end,” says Michael Jordan, a tax partner with the consulting firm Blum Shapiro. “The financial statement has already set aside these funds, so when they are paid shouldn't have an impact on the earnings of the company. In fact it may create an opportunity if you are looking to increase your bottom line. You may be able to negotiate slightly less pay if the bonuses are big enough, in exchange for accelerating them into 2012.”
An emerging debate in compensation circles is whether bonus acceleration would even need to be disclosed in a company's proxy or 10-K. That may depend on whether named executive officers (NEOs) participate or not.
Open Questions
Seelig takes the view, although one that is debated by some of his peers, that accelerating NEO bonuses would be considered “material” and must be disclosed in the Compensation Discussion & Analysis section of the proxy. Excluding them would allow companies to bypass disclosure.
Managing and administering an accelerated year-end bonus schedule might have other intricacies that outweigh the benefits of saving executives money. “There are interpretational issues out there that the IRS has never been asked before and might not really have had an occasion to ever think about,” Seelig says.
“There are interpretational issues out there that the IRS has never been asked before and might not really have had an occasion to ever think about.”
—Steven Seelig,
Executive Compensation Expert,
Towers Watson
One question: would advancing payments to top executives remain tax deductible under the IRS' Rule 162(m). It establishes a “performance-based compensation” exception to the $1 million deduction cap for bonuses paid before year-end to the CEO and three highest paid executive officers (other than the CFO). Can a compensation committee certify, prior to the payout, that performance goals were met? For the settlement of performance shares that performance period may be a multi-year goal, posing another challenge.
The degree of difficulty will depend on what performance metrics are used. Using, for example, earnings-per-share for a calendar year, would be particularly difficult to justify ahead of that year ending and an estimation would not be allowed.
IRS certification also requires that performance goals be set within 90 days of the start of the year and must specify the time frame used. Whether or not that timeline can be changed is an open question, Seelig says.
Section 409A of the tax code is another potential roadblock in that it restricts early payouts of deferred compensation.
Mark Luscombe, principal federal tax analyst for CCH, a provider of tax, accounting, and audit consulting and services, however, thinks the IRS may not be overly obstinate on the issue.
“The IRS usually looks more at deferral of income rather than acceleration of income, so it probably isn't going to object a lot even though you are moving it into a lower tax period,” he says.
Accelerated Dividend Payments
Robert Spielman, a tax partner at Marcum, an accounting and advisory services firm, says publically traded companies could pay year-end 2012 quarterly dividends to shareholders on or before Dec. 31 as another way to avoid tax increases. By moving their payable dates into the current calendar year, companies will enable shareholders to benefit from the current 15 percent dividend tax rate before any possible tax hike takes effect on Jan. 1.
SECTION 162(M)
The Following is an excerpt from a 2008 Internal Revenue Bulletin discussing Section 162(m) of the Internal Revenue Code.
Performance-based compensation
This ruling holds that compensation paid to an executive is not qualified performance-based compensation for purposes of section 162(m) of the Code, even if the compensation is paid upon the attainment of the performance goal, if the plan agreement or contract provides for payment of compensation to an executive upon the attainment of a performance goal or for (1) termination without “cause” or for “good reason” or (2) voluntary retirement.
Issue
Is compensation payable by a publicly held corporation to a covered employee (within the meaning of §162(m)(3) of the Internal Revenue Code) considered “remuneration payable solely on account of attainment of one or more performance goals” under § 162(m)(4)(C) if the plan or agreement under which the covered employee is paid provides that the compensation will be paid upon attainment of a performance goal and also provides that the compensation will be paid without regard to whether the performance goal is attained in either of the following situations: (i) the covered employee's employment is involuntarily terminated by the corporation without cause or the covered employee terminates his or her employment for good reason, or (ii) the covered employee retires.
Analysis
Under § 162(m)(4)(C) and § 1.162- 27(e), compensation is not considered applicable employee remuneration, and thus is not subject to the $1,000,000 limit in § 162(m)(1), if it satisfies the requirements for “qualified performance-based compensation.” Among these requirements is that the compensation is payable “solely” on account of the attainment of one or more performance goals. Under § 1.162-27(e)(2)(v), compensation is not performance-based if the facts and circumstances indicate that the employee would receive all or part of the compensation regardless of whether the performance goal is attained. Section 1.162-27(e)(2)(v) provides further that compensation does not fail to be qualified performance-based compensation merely because the plan allows the compensation to be payable upon death, disability, or change of ownership or control.Source: Internal Revenue Service.
He cites Wal-Mart as an example. If it rolled back its dividend pay date 48 hours from the declared date of Jan. 2, 2013, it could potentially save shareholders $261.8 million, if Congress doesn't act to preserve the rate. If paid in 2013, those same dividends would cost shareholders a minimum of $173.3 million (at 18.8 percent) or as much as $400.1 million (at 43.4 percent), absent an extension of the lower rate. The 18.8 percent rate reflects the current 15 percent dividend tax plus a 3.8 percent Medicare surcharge on unearned income. The 43.4 percent rate includes a 39.6 percent tax on dividends as ordinary income at the highest rate plus the 3.8 percent surcharge.
Spielman says this shift would be “ideal for companies looking for shareholder-friendly programs,” adding that the Securities and Exchange Commission has advised companies that they can change dividend dates at the discretion of the boards of directors. “Utilities and widely held companies really should be thinking about how they benefit their shareholders,” he says. “There is no net tax cost to the businesses and only a potential upside to the recipient.”
Spielman expects the move would take about two-to-four weeks for most companies to execute. “The challenge that you have is getting transfer agents or dividend-paying agents to be able to accommodate the change,” he says. “But if you are a Fortune 500 company and you tell them to make the change, they have to make it. It is no different from declaring a special dividend.”
Some companies are taking a wait-and-see approach before they make any concrete decisions, especially since the November elections could provide more clarity on how the tax issues will play out. “A lot of our clients are getting things in place and developing an overall game plan, but we are seeing an inability to plan and make long-term decisions,” Jordan says.
“The tax posture of some of my clients is that they will kick it down the road— defer, defer, defer—and not pay any taxes sooner than they have to,” says Jordan. “Others will want to try to take a balanced approach and hedge their bets. It really depends on what their thoughts are and their cash flow needs.”
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