Tillerson’s Exxon-Ethics Plan Has $72 Million Tax Advantageby
Proposal for removing conflicts sets up independent trust
Specialists question whether tax authorities will sign off
The exit package Exxon Mobil Corp. has agreed to pay Rex Tillerson if he’s confirmed as secretary of state is structured to preserve roughly $180 million in deferred compensation for him -- and might let him avoid an immediate federal income tax bill of as much as $72 million, according to tax specialists who have reviewed the plan.
The arrangement was designed to sever Tillerson’s ties to the global oil company he led since 2006 and allow him to comply with federal ethics law. Under the plan, Exxon would make a cash payment into an independent trust managed by Northern Trust Corp. for Tillerson. In exchange, Tillerson, 64, would give up his rights to more than 2 million restricted shares and restricted stock units that haven’t vested yet.
Ordinarily, cash payments made in lieu of unvested stock awards would trigger an immediate income-tax liability for the recipient. But in Tillerson’s case, the trustee will disburse funds to him on a schedule that mirrors the company’s long-horizon vesting schedule.
That means that even though the trust would hold all the cash from the awards, Tillerson wouldn’t receive some of the money for as long as 10 years and would pay ordinary tax as payments trickle in instead of all at once. Exxon can take a corporate income-tax deduction for the payouts, but will do so only when they’re made.
“It’s unusual in that he’s getting a special arrangement that will allow him to continue the value of his deferred compensation through the trust while deferring taxes,” said Michael Kosnitzky, a tax partner in charge of law firm Boies, Schiller & Flexner’s Tax and Middle Markets Practice Group. Kosnitzky, one of six experts contacted for this story, reviewed the publicly available documents in Tillerson’s case.
Tax experts said there’s nothing illegal or unethical about the novel arrangement. Still, the Internal Revenue Service might question the way it effectively converts deferred compensation, which is taxed under tighter rules, into property, which is subject to more lenient deferral rules, Kosnitzky said. “That would be my concern,” he said.
Exxon spokesman Alan Jeffers confirmed that the payout structure won’t present Tillerson with an immediate income-tax bill. “We’re confident that the trust arrangement complies with all applicable law governing deferred taxation,” said Reginald Brown, a lawyer at WilmerHale who represents Tillerson.
Deferring income tax on the payout may benefit Tillerson over time; the current top individual income tax rate is 39.6 percent; President-elect Donald Trump and House Republicans want to cut it to 33 percent as part of a broad tax overhaul for individuals and businesses.
Tillerson began his confirmation hearings on Wednesday. His deferred compensation consists of two forms, disclosures show: First, he has 1.1 million so-called restricted shares, which are company shares awarded to employees that vest over time. He has been awarded 900,000 restricted stock units, which aren’t actual shares, but serve as their economic equivalents. They too vest only over time.
Exxon is known for its stringent compensation policy, which allows for accelerating the vesting of deferred shares only in case of an executive’s death. In Tillerson’s case, “they are making an exception,” said Alan Johnson, an executive-compensation consultant in New York.
The payout plan, which has been approved by the federal Office of Government Ethics, calls for making the payout to a trust in order to separate Tillerson’s finances from Exxon’s. But because Tillerson wouldn’t have access to the money immediately, the arrangement also serves to help him avoid immediate taxation, according to tax lawyers.
Federal law tries to help executive-branch appointees avoid paying large tax bills when they take pains to avoid conflicts of interest. For example, they can defer any capital-gains taxes they might owe when they sell assets to avoid such conflicts -- provided that they reinvest in an approved list of new assets, such as Treasuries or mutual funds.
Tillerson will be eligible to defer gains on the sale of more than 600,000 shares of Exxon common stock that he owns outright -- if he reinvests appropriately. The plan that he and Exxon have agreed to would allow a similar tax-free diversification for his 2 million or so restricted shares and restricted stock units that have yet to vest.
Executives can choose to delay taking possession of deferred compensation when it vests -- and thus defer paying income taxes on it -- but usually only if the company’s obligation to the executive is “unfunded,” meaning the company’s promise to pay is subject to claims by creditors. But because the company would make the payment to Tillerson’s trust, Exxon’s obligation would be funded, the trust documents show.
Another requirement for deferral holds that the future payments to the employee must be at “substantial risk of forfeiture” -- meaning there are strings attached to the payout. For example, stock awards might be canceled if the executive goes to work for a competitor.
In Tillerson’s case, tax experts question whether the new plan still contains a real risk of forfeiture. Tillerson would forfeit trust payouts if he goes to work for a competitor in the next decade -- the trust would donate any forfeited amounts to charity. But trust documents show that, in deciding whether to pay Tillerson, the trustee could simply rely on Tillerson’s word to show that he hadn’t violated the non-compete restriction.
That arrangement might call into question whether there’s a true risk of forfeiture, tax lawyers say. Federal regulations already say that simply working for a competitor doesn’t automatically constitute a substantial risk of forfeiture, Kosnitzky said.
I.R.S. rules on the subject are “a little loosey-goosey,” he said.