The Advisors' Blog

SCOTUS may rule the Liberation Day tariffs illegal sometime in the next few weeks. That means tariffs present another (and different) uncertainty for compensation programs this year. This Pay Governance alert is all about tariffs, the potential for refunds and what they might mean for compensation programs.

Based on accounting literature, if the Supreme Court rules that the tariffs were illegal and must be refunded, they will be reported as income (reduction in expense) in 2026 when a refund is probable, provided they were fully expensed in 2025. If the tariffs were capitalized in inventory in 2025, the portion of the inventory sold in 2025/2026 before the Supreme Court decision—when a refund becomes probable—will result in a reduction in Cost of Goods Sold in 2026. Any remaining tariffs capitalized in unsold inventory will be deducted from the cost of inventory as a balance sheet adjustment and will not impact earnings.

Similar to last year’s timing of Liberation Day when tariffs were first implemented, many companies may have already established their 2026 annual and long‑term incentive plan targets at the time the potential tariff refund was announced and were unlikely to have considered such an impact when setting these targets. In light of this, how should companies think about the impact of a potential tariff refund on 2026 incentive plan payouts?

The alert says you may want to look to last year:

A simple answer might be consistency: if you did not adjust 2025 incentive plan payouts for the impact of tariffs, do not adjust 2026 incentive plan payouts for the refund. Likewise, if you did adjust 2025 incentive plan payouts for the impact of tariffs, adjust 2026 incentive plan payouts for the impact of the refund.

Separate from refunds, there’s also the issue of the tariffs themselves, which may have been included in 2026 incentive plan targets.

Another unclear issue is how IEEPA tariffs that were included in 2026 incentive plan targets should be addressed if the Supreme Court declares them illegal. A simple approach might be to reset the targets by removing the planned tariffs; however, given the uncertainty of new tariffs (or fees) that could be imposed under other rules, it may make sense for companies to take a wait‑and‑see approach until year‑end when the legal landscape is clearer.

In some instances, it may be relatively easy to resolve tariff and refund issues — for example, where immaterial or handled through established plan protocols for unexpected events. But there may be complications:

For example, what if the company uses a cash flow measure and the refund—while probable for accounting purposes—may not be received until 2027 or an even later year? What about companies that altered their performance curves between years, where the impact of the tariffs on 2025 incentive plan payouts was much different from the impact of the refund on 2026 incentive plan payouts?

In any event, monitor for now, but know that this might be another year with some tricky decisions, in which case, “management should prepare a thorough analysis of the impact of tariffs and tariff refunds across years to allow the compensation committee to determine a fair outcome.”

– Meredith Ervine