Tesla has vowed to press ahead with its fight to restore Elon Musk’s historic pay package, and failure could come at a high cost: the potential of more than $100 billion in tax and accounting charges for the company and its CEO.
Delaware Judge Kathaleen McCormick recently denied the electric vehicle manufacturer’s second attempt to give Musk the largest stock option package in history: valued at $56 billion at the time of the original ruling and more than $129 billion at the current stock price. It found that shareholders’ overwhelming vote to re-approve the grant did not overturn their earlier rejection of the 2018 deal as unfair and awarded by a board in thrall to its CEO.
His stance has left the board facing a dilemma: file a lengthy and uncertain appeal with the Delaware Supreme Court or grant its CEO a new option package.
If issued with similar terms, a new package could trigger a corporate accounting charge of more than $50 billion and separately impose a punitive tax rate of up to 57 percent on Musk’s shares, triggering a huge bill. fiscal.
In April, tesla warned shareholders that reissuing a new set of stock options allowing Musk to purchase the same 304 million shares would result in a compensation-related accounting charge of more than $25 billion, as the valuation of the company was substantially larger than in 2018. That compares to $2.3 billion. charge for the original 2018 award.
Those calculations were based on a share price of $175 on April 1, when Tesla’s market capitalization was $558 billion. Since then, shares have more than doubled to $425, giving Tesla a valuation of $1.3 trillion, largely due to investor enthusiasm for Musk’s initiative. New relationship with President-elect Donald Trump – implying that the accounting charge could be multiplied by a similar amount.
Less known are the possible tax implications for Muskwhose net worth recently surpassed $400 billion – the first person to reach that level of wealth.
If Tesla prevails in its appeal, which must be filed within 30 days of the Dec. 2 ruling, Musk would pay the standard 37 percent federal stock compensation tax rate when he exercises his 2018 options, something he does not have. obligation to do. until 2028.
If the Delaware Supreme Court declines to overturn the original ruling and the board chooses to issue a new plan on similar terms, the options would already be granted “in the money,” given that the financial goals have already been met.
“It’s very simple. “If options are granted that are ‘in the money,’ as they clearly are now, all sorts of bad things happen,” Schuyler Moore, tax partner at Los Angeles law firm Greenberg Glusker, told the Financial Times. “That is why they are trying so hard to ratify the original agreement. If they grant it again now, taxes will be hell.”
When they were devised in 2018, stock options hinged on ambitious goals, such as increasing revenue by 15 times and valuation by 12 times, that Musk had achieved by 2023.
At the time the package was granted, the options were “out of the money” and not exercisable, so they qualified for exceptions in a part of the tax code known as 409A, which governs deferred compensation.
The rule was introduced in 2005 after Enron executives rushed to cash out vested stock they had received as part of their compensation plans before the company went bankrupt.
McCormick’s decision to rescind Musk’s plan in January canceled his options, which from a tax perspective no longer exist.
Moore said attempting to award a new agreement with the same terms now could violate section 409A, which “triggers immediate taxation of the full value of deferred compensation on the date it is awarded, long before the deferred compensation is subject to taxed according to normal rules.” .
“To add insult to injury, Section 409A would impose an additional 20 percent tax on the value,” Moore wrote in an article in the influential Tax Notes Federal magazine. “The damage occurs on the date of grant.”
That means Musk would immediately be liable for 57 percent income tax on the difference between the exercise price and the current value of the shares, whether he decides to exercise the options or not. At Wednesday’s closing price of $425 and a strike price of $23.34 set in 2018, the difference would be $122 billion, meaning a tax bill of nearly $70 billion.
“The tax issue here is simple. If you give you the same non-409A compliant package now, you will face an income tax acceleration at the time of receipt rather than when you exercise it, with the penalty rate on top,” said Bradford Cohen, tax partner at Jeffer Mangels. Butler and Mitchell. “It could be an unfortunate and very costly mistake.”
Even for Musk, the richest man in the world, that would be dazzling. In early 2022, the billionaire posted on million dollars in 2021.
“The only sure way Musk could avoid these problems is. . . appeal successfully [the decision]since then it should be seen as a nullity,” Moore said. “Much will depend on those attempts.”
Even though Musk chose not to exercise his package when he had the right to do so last year, “having options is powerful and valuable,” Moore said, because they act as a deterrent to potential buyers or activists. Musk can also borrow against their embedded value, as long as he doesn’t place a lien on the options.
The board has another route to help Musk avoid the extra 20 percent in taxes, but it’s still expensive. The directors could give him 304 million Tesla shares worth $129 billion at the current price, which would be subject to the standard rate of 37 percent, about $48 billion.
When asked about the issue by McCormick during a hearing in August, a Tesla lawyer also raised the possibility that a likely higher personal tax rate could result in Musk receiving an even larger package to offset the cost of his taxes.
“Ultimately, because we know how the economy works, we would probably have to pay him more. If you have a number that you want and they pay you taxes, those are passed [to shareholders]”said Rudolf Koch of Richards, Layton & Finger.
Furthermore, if Musk were to flood the market by selling that many shares at once to cover the tax, he would risk causing a drop in the stock price.
The company would still have to assume the accounting burden. And if salary negotiations begin again, Musk may not agree to a five-year lock-up period after the fiscal year during which he cannot sell, a feature of his 2018 package.
Musk had previously raised the possibility of leaving the electric car maker, and the board had argued that the compensation plan was a key way to keep the mercurial billionaire engaged.
In January, he posted on
Tesla did not immediately respond to a request for comment.