August 5, 2016
A History Lesson: The Politics of Section 162(m)
– Broc Romanek
Someone recently posted a question in our “Q&A Forum” (#1142) asking why Section 162(m) doesn’t apply to private companies. Here’s the answer that I posted:
This was the first piece of legislation signed by President Clinton, and he wanted to make a statement about where he stood on “fat cat” CEO pay. It is my understanding that the leadership at the Treasury Department did not favor this legislation as they believed this was a shareholder issue, not a tax policy issue and the tax code was not an effective way to address the problem. It is also my understanding their objection to the law is one of the reasons the performance based exemption was written so broadly.
The reason the law was enacted was Congress believed public company CEO pay was a rigged game, as CEOs sat on each other’s boards and/or the CEOs picked their friends to be on the Board (just like Cap’n Cashbags). Thus, Congress wanted to try and reign in CEO pay or punish public company (shareholders) if pay exceeded $1 million (because, after all, Section 280G worked so well in 1984 in limiting the spread of in golden parachutes!)
Because the law stated that options were “inherently performance based” and therefore all gains were fully tax deductible, the size of stock options shot up over the next few years, creating thousands of stock option millionaires and a few option billionaires (the accounting rules also helped facilitate outsized option grants as there was no P&L charge for options).
The law also pushed CEO base salaries to $1 million base salary (just like Section 280G created the 3x severance formula).
The reason entertainers and sports figures were not covered by Section 162(m) is their pay is set by arms-length negotiations, and not a friendly public company board, thus there was no reason to limit tax deductibility.
Private companies were not included because the IRS already had Section 162 (a) , which they use extensively to attack owners of private companies when pay was not considered reasonable…