The Russell 3000 companies could collectively lose almost $100 billion over the next three years because of compensation-related provisions in the Tax Cuts and Jobs Act, new research shows. But they’ll make that up, and more, from the decreased corporate tax rate.
On the negative side, the big-ticket item in the new tax law is the loss of deductions for performance-based pay. Companies can still deduct compensation expenses up to $1 million per person for certain top executives, but until now incentives based on performance were exempt from that cap.
Compensation-research firm Equilar examined executive compensation data in Securities and Exchange Commission filings for the 3,000 companies over the last three fiscal years to estimate how much corporate America was able to deduct under IRS Section 162(m).
After making certain necessary assumptions to arrive at an estimate, Equilar calculated that the companies were entitled to claim deductions of about $92 billion based on the exemption over the three years.
Another change to executive compensation in the new tax law added finance chiefs to the list of covered executives. Under the old rules, a company’s CEO and next three highest-paid officers, excluding the CFO, were subject to both the $1 million deductibility cap and the exemption for performance-based pay.
Had CFOs been included on the list over the past three fiscal years, the companies would have been able to deduct an additional $13 billion.
Parsing the retrospective data by industry, Equilar found that consumer services companies and retailers had the greatest deductible compensation, averaging $160 million and $159 million per company, respectively. Banks and software companies also had averages greater than $100 million. At the bottom of the list were household and personal products companies, with an average of just under $5 million. Next up the ladder were food and staples retailing at $11 million and insurance at $12 million.
However, for perspective, Equilar also conducted a broad analysis of effective tax rates for Russell 3000 companies in order to gain a rough understanding of how material the lost deductions are.
The conclusion: they’re not very material. The companies’ tax expenses for the most recent fiscal year, at the former 35% corporate tax rate, collectively added up to about $377 billion. Had the new compensation-deductibility rules (negative impact) and 21% corporate rate (positive impact) applied to that year, that tab would have shrunk by 35% to $245 billion.
Also because of the lower tax rate, as well as the wishes of shareholders, the loss of tax deductibility for performance-based pay likely won’t much affect companies’ practices for granting long-term incentives, according to the report. For its part, influential proxy advisory firm Institutional Shareholder Services issued a statement saying it will continue to focus on pay for performance.
Indeed, top corporate executives at well-performing companies may be positioned to make even more money as a result of the new tax law. “An evolution toward a more employee-friendly compensation scheme may prove popular as compensation committees and professionals learn and adjust to the new landscape,” the report says.