If you've ever wondered why so many CEOs make a base salary of $1 million a year — not including bonuses and stock options — it's because of an obscure tax rule known as Section 162(m).
The rule, signed into law 15 years ago, was designed to punish companies that paid top executives more than $1 million by taxing the company on anything above that at the corporate tax rate, currently in the 30% to 40% range.
But in an example of the law of unintended consequences, the rule actually ended up boosting CEO compensation because it penalized only base pay. Companies that paid CEOs tens of millions of dollars in incentive pay, such as bonuses and options, could deduct it as a pre-tax expense, just like the first $1 million in salary.
Now, the boards of directors of most big companies routinely structure the lion's share of CEO compensation as incentive pay, while doling out a base salary at or near the magical $1 million mark.
Yet, some CEOs still receive a base salary above $1 million.
In the case of General Electric, ge CEO Jeff Immelt got a base salary of $3.3 million in 2007 — $2.3 million of which generated a tax liability of nearly $1 million for GE. But GE earned $22.2 billion in 2007, which dwarfs the tax bill on Immelt's base pay. "That's not even a scintilla of a rounding error," says Jeff Cunningham, CEO of Directorship magazine.
"Most boards view the $1 million deductibility as not a huge item," says compensation consultant Ross Zimmerman of Exequity. "It's a low-lying issue on the radar."
That may be the case for large firms, but for smaller companies, the taxes on base pay above $1 million can mean real money.
Using a representative sample of 500 companies that the Securities and Exchange Commission selected to showcase a new technology for researching compensation, USA TODAY identified several CEOs making more than $1 million in base pay, even though their companies have $100 million or less in profit:
•In 2007, Jarden jah CEO Martin Franklin's base pay of $1.95 million will trigger a tax penalty of more than $300,000. The company reported net profits of $28.1 million, but Jarden spokesman Evan Goetz says the board bases salary decisions on "continuing net income," which rose from $169 million to $211 million from 2006 to 2007.
•In 2007, Scientific Games sgms CEO A. Lorne Weil got $1.5 million in base pay, while the company earned $65.4 million.
•At FTI Consulting, fcn CEO Jack Dunn was paid a base salary of $1.25 million in 2006, when the company earned $42 million. FTI posted $92.1 million in earnings for 2007, and Dunn's salary for the year will match or exceed the previous year's, FTI says.
There are times when no penalty applies. If a CEO defers all base salary above $1 million until retirement, the company isn't taxed. Another way is to post a loss. Sirius Satellite Radio siri CEO Mel Karmazin had a base salary of $1.25 million in 2006, but since Sirius has yet to turn a profit, no tax penalty applied. Sirius, which is expected to file a 2007 proxy statement later this month, would not disclose if Karmazin's base pay had changed.