Tax consequences of compensation clawbacks for issuers and executives
Corporate executives with lucrative contracts may face “clawbacks,” where previously paid compensation is reclaimed due to policy violations, breaches of agreement, or legal infractions. This situation triggers tax considerations both for the company initiating the clawback and the executives affected.
For the company:
Compensation subject to clawback is typically accrued following generally-accepted accounting principles, even if the likelihood of clawback is considered remote initially. However, if incentive-based compensation is deducted in one tax year and subsequently recouped due to errors or misconduct, the company may need to include the recouped amount in income during the year of repayment under the “tax benefit rule.” This rule stipulates that previously deducted amounts must be included in income when events contradict the original deduction.
For the executive:
Compensation returned in the same year it was initially paid is treated as if it was never received for income and FICA tax purposes. However, if a bonus paid in a prior year is clawed back in a subsequent year, the tax implications become more complex. In this case, it’s best to consult a ShindelRock tax professional for a complete review of the tax implications of the clawback.