Party Like Wells Fargo, But What Happens Tax-Wise If You Forfeit Pay?

Wells Fargo executives continue to be in hot water. The news that Wells Fargo’s Board has forced CEO John Stumpf to forfeit $41 million in stock awards may help with the outrage. Still, the Wells Fargo fake account scandal isn’t over, and executives–including the $41 million poorer CEO John Stumpf–aren’t out of the woods. In the first hearing, Senators began pushing Wells Fargo for pay clawbacks. Democratic Senator Elizabeth Warren of Massachusetts called for Stumpf’s resignation, said he should give back his salary, and be criminally investigated.

And before the next set of hearings, Wells Fargo’s Board took action that may actually end up helping the CEO. Some people will clearly still expect him to lose his job, but being stripped of some of his pay may help him to keep it. In addition to stripping Stumpf of $41 million, the Board also required former community banking head Carrie Tolstedt to forfeit $19 million. How this is being done may seem unimportant. In reality, though, the specific way in which this claw back is being done is important.


(Photo by Joe Raedle/Getty Images)

To start, these are mostly unvested options, so they aren’t really pay yet, at least not in the traditional sense. And tax-wise, that makes them vastly easier to undo than if Wells Fargo had issued a payroll check and had to get it back. Say you get a payroll check for $100,000, of which your take home pay after taxes is $60,000. Then, you are ordered to return it. Do you owe $100,000, $60,000, or some other amount? Can you get tax money back from the IRS? And what about state taxes and Social Security?

The answer can depend on timing and many other variables. But timing and the legal background for the giveback are big factors. The Dodd-Frank Wall Street Reform and Consumer Protection Act (PL 111-203) expanded SEC regulatory authority. Paybacks can be required even when directors and officers had no knowledge of wrongdoing. Section 304 of the Sarbanes-Oxley Act also has a clawback remedy. And there are many clawbacks via lawsuits, and in other contexts, as is occurring with Wells Fargo.

In general, the IRS doesn’t allow you to undo a prior transaction as if it never occurred. Rescission is sometimes possible, but only if everything occurs (including the giveback) in the same tax year. In most cases, the giveback happens in a later tax year. Usually you can’t just amend your prior year tax return either. Amending a prior tax return is generally allowed only to correct a mistake. A pay giveback may not be a ‘mistake,’ since you were entitled to the pay when you received it. Besides, you can amend tax returns only within three years of filing the original return, or within two years of the date the tax was paid, whichever is later.

But, you can surely claim a business expense deduction, right? Maybe, but usually it would only be a miscellaneous itemized deduction, subject to the 2% adjusted gross income floor. Plus, there is phase out and alternative minimum tax. And the payroll tax problem is thorny. If you are lucky, your company could agree to reduce your current year salary. Of course, this works only for current employees, and many repaying persons are former employees. Besides, it isn’t clear if an offset would achieve the same public relations or legal effect.

For all of these reasons, most people in this unenviable position end up claiming an odd kind of tax refund under Section 1341 of the tax code. It embodies the “claim of right” doctrine, and attempts to place the taxpayer back in the position he would have been in had he never received the income. To claim a deduction under Section 1341, the taxpayer must have included money in income in the prior year because he had an unrestricted right to it then. The taxpayer must learn in a later year that he did not have an unrestricted right to it after all (i.e., he has to give it back).

But the nuances of these rules are not simple, nor are the mechanics. And there are frequent problems in application, and in the IRS reaction to it when it sees this on a tax return. There’s also the question of voluntary v. mandatory givebacks. If you are being urged to give back pay but not required to, it isn’t clear how these rules apply. The tax headaches one will face on having to give back money can be palpable. Of course, when a highly paid executive messes up and has to return some pay, many people may not have much sympathy.

For alerts to future tax articles, email me at This discussion is not legal advice.

via The Tax Lawyer


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