A recent Harvard Law Corporate Governance
blog featured a
paper by Boston University School of Law professor
David Walker which addresses the complexities of recovering taxes paid on amounts recouped due to the application of a clawback.
Section 954 of the Dodd-Frank Act requires that companies adopt no-fault clawbacks that would be triggered by a material restatement due to non-compliance with financial reporting requirements. Companies would be required to recoup compensation received in excess of that which would have been paid based upon the restated results. This clawback requirement applies to current and former executive officers spanning a three year look back period from the date of the restatement. While the regulations implementing section 954 have not been finalized, many companies have adopted their own versions of clawback policies. In the event a company takes action to recoup all or a portion of previously distributed incentive payments, a question arises as to whether the impacted executive would be able to recover personal income taxes paid on the incentives that were clawed back.
Professor Walker suggests in his paper that recovering personal tax payments on recouped incentives may be available through a deduction in the year of repayment under a “claim of right” as provided in §1341 of the Internal Revenue Code. Walker also discusses potential approaches that companies may consider to mitigate the need for the impacted executive to recover taxes paid on the incentives that are clawed back. Potential approaches include:
- Recouping the excess payments from future earnings;
- Deducting the recoupment from deferred compensation; or
- Cancelling a portion of unvested long-term incentive awards.
However, if companies are considering satisfying clawbacks by reducing future earnings or cancelling unvested awards, Walker cautions they must be mindful of the non-qualified distribution limitations of I.R.C. §409A. If the compensation that is to be clawed back would be deducted from future earnings, companies should be cautious that clawing back future earnings is not deemed inconsistent with the prohibition of executive loans under Sarbanes Oxley.
