Growth Strategies

Executive Comp Splits Minimum Wage Camps

Large companies are complaining about a revenue-raising measure that would limit the amount that highly paid executives can defer on their taxes.
Sarah JohnsonFebruary 6, 2007

Since the 110th session Congress began with the Democrats in charge, legislators’ push to raise the minimum wage has been moving quickly. But the Senate’s insistence that the $2.10 wage hike be bundled with tax credits for small businesses could slow progress toward the increase.

That’s because the two houses will have to compromise if the issue has any chance of moving forward. Last week, the Senate passed the House’s bill to raise the minimum hourly wage from $5.15 to $7.25, by a margin of 94-3. The Senate, however, tacked on a resolution to grant $8.3 billion in tax cuts to small businesses that could be hamstrung by the wage increase. The House’s original bill required only that all companies raise their minimum-wage floor in three increments over two years and two months.

Many Republican senators, as well as President Bush, have said a wage hike must be tied to tax relief for small businesses, and the Democratic senators have gone along with that compromise. The issue hinges now on the question of how much the House is willing to adjust its original plan.

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As legislators work out their differences, small-business advocates are praising the Senate’s legislation, which includes several tax incentives and offsets. At the same time, other business lobbyists say those credits could come at the expense of larger companies, which would have to make up for the tax relief over the long term by forfeiting such tax deductions as those on the cost incurred from liability suits. The Senate bill’s tax sweeteners, which are mostly extensions of existing tax breaks, would be temporary while the loss to the tax deductions enjoyed by mostly large companies would be permanent, according to Bruce Josten, executive vice president of government affairs for the U.S. Chamber of Commerce.

The chief complaint about the Senate bill among large companies is a revenue-raising measure limiting the amount that corporations’ most highly paid executives can defer on their taxes. The proposed $1 million cap on non-qualified deferred compensation plans would create “administrative and enforcement nightmares for companies and for the IRS,” wrote David Heywood, chairman of Financial Executives International’s tax committee, in a letter to a number congressmen and senators. Under the bill, executives could not defer more than $1 million or their average taxable compensation for the previous five years, whichever is less. Failure to do so could result in a 20 percent penalty in taxes and fines.

Estimated by the Senate staff to raise $307 million over 10 years, the deferred compensation provision is one of the most expensive items in the Senate’s Small Business and Work Opportunity Act, notes Mark Prysock, FEI general counsel. This change to executive compensation is not surprising, he adds, as it has been a hot topic for some time after high-profile CEO exits from Home Depot and Pfizer led to shareholder outcry about excessive pay packages.

Still, attempts in Congress “to advance a certain social policy using the tax code as a way to do that is not appropriate,” Prysock told CFO.com. “The best way to address executive compensation issues is through the Securities and Exchange Commission.” The Senate Finance Committee wants to limit how much top executives can avoid paying in income taxes because rank-and-file employees generally cannot defer compensation, according to the committee’s markup of the bill.

Limiting the amount of compensation that can be deferred could hurt larger companies financially and reduce the amount of their available cash, since it’s money that is usually reinvested in the business until the executive’s retirement, Heywood wrote. Because they offer lower salaries, smaller businesses would not be affected by this provision, says Macey Davis, tax counsel for the National Federation of Independent Business.

Another aspect of the bill purports to fix a loophole on the $1 million limit on tax deductions companies can take for their top executives’ salaries. This provision expands who qualifies as a “covered employee.” The new definition, estimated to bring in $230 million over 10 years, would still apply to the chief executive officer and the four highest paid employees. But the rule would include any of those people who were working at the company during the taxable year.

Republicans and business advocates have been less critical of the other methods proposed for offsetting the small-business tax credits. Those include eliminating tax deductions for fines and punitive damages in court cases (estimated to raise $543 million over 10 years) and stopping companies from claiming losses on foreign sales-leasebacks for leases created on or before March 12, 2004 (estimated to raise $4.1 billion over 10 years).

Small businesses are due for some relief, says Davis. “Even aside from the minimum wage increase, I think small businesses have a difficult compliance burden bestowed on them,” she told CFO.com. The bill’s easing of taxes and reduction of paperwork would help smaller companies run more efficiently. “They don’t have the resources that larger businesses have to keep up with changes in the tax laws,” she adds.

The bill would allow some small businesses to reduce their documentation by switching to the cash method of accounting. Under the bill, businesses with average annual gross receipts in the previous three tax years under $10 million would qualify. Small businesses with such receipts above the current law’s threshold of $5 million have complained that the accrual method is burdensome, considering that they are short staffed and need to hire outside accounting help. The provision, which could save businesses a total of $931 million over 10 years, adjusts for inflation, Davis notes.

Another highlight of the bill, Davis thinks, is the extension of small businesses’ right to expense the cost of qualified assets in the year they were purchased. The proposal extends the current rules for one year, through the end of 2010. Although small businesses would benefit more if it were permanent, the extension helps qualified businesses with their planning, Davis says, and could save companies $257 million over 10 years. The Work Opportunity Tax Credit would also be extended for five years. That extension, which provides employers with tax credits for hiring certain disabled workers and people who use public assistance, could save businesses $3.6 billion over the next decade.

Further, the bill would extend by one year a rule allowing companies to write off leasehold and restaurant improvements over 15 years. The move could save businesses $847 million over 10 years, according to Senate staff. Previously, the cost of such changes couldn’t be recovered until 39 years after the improvements were made. Considering that half of U.S. retailers own and half lease their properties, the extension puts leaseholders on more level ground because businesses that own their buildings have always had this benefit, says Rob Green, vice president of government and political affairs for the National Retail Federation.

In a statement released on February 1, President Bush urged the House to agree to combine the minimum-wage increase with tax relief for small businesses. Democrats in favor of the wage hike are hoping the president will see something on his desk soon. “I’m confident that our dedication to a minimum wage increase is stronger than any differences between our two bills,” said Sen. Max Baucus, chairman of the Senate Finance Committee.

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