State Taxes Could Save Executives’ Performance Pay

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

By Che Odom

States could help preserve an approach to executive compensation popular with corporate shareholders after the new federal tax law eliminated its deductibility.

“Investors would like to see states, at least high-tax states like New York, California, New Jersey, and Connecticut, retain incentives for performance-based packages,” Bobby Carter, an investor who managed portfolios for activist funds until his retirement in 2015, told Bloomberg Tax.

“States with active pension funds might take note of this provision and actually press lawmakers to retain the deduction,” he said.

The 2017 federal tax act ( Pub. L. No. 115-97) eliminates the deductibility of qualified performance-based compensation. The tax break had been available under Internal Revenue Code Section 162(m) until Jan. 1, when the new law took effect.

Most companies will want to continue performance-based compensation programs to incentivize executives and respond to the demands of shareholders and proxy advisory firms—but they could tweak them a bit.

A tax break at the state level would help persuade companies to keep performance-based metrics to determine pay, and the high-tax states could make the most difference.

A high-tax state that continues to allow a deduction for more than $1 million for performance-based compensation would provide a greater incentive for a corporation to continue old 162(m) protocols than would states with lower tax rates, Eddie Adkins, partner in the Washington National Tax Office of Grant Thornton LLP, told Bloomberg Tax.

This is “especially the case if the corporation views the old protocols as good governance,” Adkins said.

Abandon Principles?

The old 162(m) requires performance goals to be objective, “such as achieving a prescribed metric,” and it requires that “attainment of the goal be substantially uncertain at the time the goal is established,” Adkins said.

Companies aren’t likely to completely abandon such principles, but companies could move away from applying them fully “now that there is no tax incentive for doing so,” he said.

“For example, some companies may now want to blend both objective and subjective factors in establishing performance goals, although I expect that shareholders will still want to see goals that are primarily objective in nature,” he said.

Large institutional shareholders, such as the California Public Employees’ Retirement System, the New York State Comptroller’s Office, activist investors such as Trillium Asset Management LLC, and non-activist investors such as BlackRock would have an interest in seeing that objective measures are kept in place, Carter said.

These investors might go as far as to seek legislative help to maintain tax incentives for performance-based pay for executives, he said.

“This will play out over years, not months,” he said. “The companies, the shareholders, and, I think, even states may see the benefit of this deduction at the state level.”

Revenue Boon

But, as Illinois revenue officials point out, states will receive a revenue boost from a tightened Section 162(m).

Terry Horstman, a spokesman for the Illinois Department of Revenue, told Bloomberg Tax the new 162(m) provisions would result in a revenue increase of between $2 million and $4 million in fiscal year 2018. Revenue is expected to ramp to between $6 million and $10 million for fiscal year 2019.

Most states haven’t taken up federal business tax provisions and probably won’t until next year, when a fuller picture of their revenue impact is known, Max Behlke, tax and budget director of the National Conference of State Legislatures, told Bloomberg Tax.

That said, Minnesota Gov. Mark Dayton (DFL) could float a strategy for 162(m) in a few weeks.

Conformity’s Benefits

Until states take action, most will automatically take on the new provision because it replaces one to which most states already conform.

States conform to provisions of the federal tax code because it makes administration of tax systems easier and taxpayer compliance less complicated.

Most state legislatures this year will act to conform to the federal code prior to Jan. 1, 2018, and pass individual tax measures. The business-related tax provisions are “pretty complex stuff,” Joe Crosby, a principal with MultiState Associates, told Bloomberg Tax.

Another factor weighing in favor of states maintaining conformity with 162(m) and ending the deduction for performance-based compensation is that about a third of states will experience a budget shortfall this year, or did last year.

With assistance from Andrew M. Ballard in Raleigh, N.C.; Tripp Baltz in Denver; Michael J. Bologna in Chicago; Alex Ebert in Columbus, Ohio; Leslie A. Pappas in Philadelphia; and Gerald B. Silverman in Albany, New York

To contact the reporter on this story: Che Odom in Washington at

To contact the editor responsible for this story: Ryan C. Tuck at

Copyright © 2018 Tax Management Inc. All Rights Reserved.

Request Daily Tax Report: State