TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, December 22, 2005

WSJ on Tax-Free Gross-Ups for Corporate Execs

Interesting front page story in today's Wall Street Journal:  Latest Twist in Corporate Pay: Tax-Free Income for Executives; Companies Reimburse Bosses For Levies on Perks, Stock; Scant Details in Filings, by Mark Maremont:

Like most Americans, rank-and-file employees of Home Depot Inc. must reach into their own pockets to pay taxes. But not Robert Nardelli, the home-improvement retailer's chief executive. Under his employment contract, Home Depot picks up a big chunk of his federal and state income taxes. Specifically, the company is obliged to reimburse its CEO for taxes due on a slew of perks, including a high-end luxury car, his family's travel on Home Depot jets and forgiveness of a $10 million loan. Last year, these payments amounted to at least $3.3 million, topping Mr. Nardelli's $2 million base salary.

Amid soaring CEO compensation, a number of companies are paying extra sums to cover executives' personal tax bills. Many companies are paying taxes due on core elements of executive pay, such as stock grants, signing bonuses and severance packages. Others are reimbursing taxes on corporate perquisites, which are treated as income by the IRS. They run the gamut from personal travel aboard corporate jets to country-club memberships and shopping excursions....

Details of the little-known payments, called "tax gross-ups," are often buried in impenetrable footnotes or obscure filings....

According to a study done by compensation-research firm Equilar Inc., 52% of companies disclosed they paid gross-ups to one or more top executives last year, up from 38% in 2000....

The SEC is conducting a broad crackdown on hidden compensation of all types, although it hasn't yet focused on gross-ups. The agency worries that investors may not realize just how much senior managers are paid beyond their base salaries....

In an effort to shield executives from any tax bite on their pay, gross-ups can quickly spiral into huge sums. When a company reimburses executives for their tax payments, that creates new taxable compensation. The company then has to cover taxes on that new amount, which creates yet more taxable pay, and so on. The spiral ends when the ever-decreasing amount of new income reaches zero, or close to it. The bottom line: Grossing up an executive for taxes on $1 million can easily cost an additional $700,000 to $900,000. In some circumstances, gross-up reimbursements can be more than double the covered pay.












Tax gross-ups have proliferated for one major reason, many compensation experts say: They allow companies to quietly pay more to top managers at a time when executive compensation is increasingly controversial. The current rules don't require companies to disclose tax reimbursements separately in pay tables given to shareholders. Instead, gross-ups tend to get lumped into a category called "other annual compensation" in companies' proxy statements. The details are then relegated to densely worded footnotes. Even there, some companies don't disclose the exact amounts of gross-up payments.

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Apparently, neither executive compensation professionals, nor WSJ readers are familiar with the high school algebra technique knowns as solving simultaneous equations.

Posted by: ohwilleke | Dec 23, 2005 9:23:56 AM