April 9, 2006
Disclosure should be required with respect to compensation that is not deductible for tax purposes by reason of Section 162(m) of the Internal Revenue Code. Under this section, publicly-held companies may generally not deduct compensation in excess of $1 million paid to the CEO and to the four other most highly paid executive officers. Compensation may be excepted from this deduction limit if it is performance-based and meets certain other requirements.
If a company chooses to pay compensation that is not deductible for tax purposes under Section 162(m), the effective economic cost of the compensation is increased. The company's tax liability will be higher than it otherwise would be due to the loss of the compensation deduction. In most circumstances, there is a real cash cost to the Company as a result of its decision to pay non-performance-based compensation that falls under Section 162(m). Since these detrimental economic consequences can be significant, they should be disclosed to shareholders.
Companies should be required to disclose the total amount of taxable compensation during the fiscal year that is required to be reported to the Internal Revenue Service on Form W-2 that will not be deductible by the company on its federal income tax return by reason of Section 162(m). In addition, there should be a narrative discussion of the reasons why the company chose to incur the economic detriment of paying non-performance-based compensation that did not meet the deductibility criteria of Section 162(m).