Tesla fights to avoid the steep cost of scrapping Elon Musk’s pay package

Tesla has vowed to continue fighting to restore Elon Musk’s historic pay package, and failure could come at a high price, with the potential for more than $100 billion in tax and accounting bills for the company and its CEO.

Lately Delaware Judge Kathleen McCormick denied the electric car maker’s second attempt To give Musk the largest stock option package in history, worth $56 billion at the time of the original decision and at a current stock price of more than $129 billion, he found that the overwhelming shareholder vote to reaffirm the grant did not outweigh his earlier rejection of the 2018 deal as unfair and unfair. given by the board to its CEO.

His stance left the board with the dilemma of whether to pursue a lengthy and uncertain appeal to the Delaware Supreme Court or grant its chief executive a new set of options.

If issued on similar terms, the new package could trigger a $50 billion-plus corporate accounting charge and individually impose a punitive tax rate of up to 57 percent on Musk’s shares, creating a huge tax bill.

in April Tesla warned shareholders that the reissue of the new stock, which would give Musk the right to buy the same 304 million shares, would result in an accounting charge of more than $25 billion because the company’s valuation was significantly higher than in 2018. That compares to 2, 3 billion with the original 2018 prize.

Those calculations were based on a share price of $175 on April 1, when Tesla’s market capitalization was $558 billion. The stock has since doubled to $425, valuing Tesla at $1.3 trillion, most of which is owned by Musk. is due to investor enthusiasm. new relationship with President-elect Donald Trump — assuming the accounting fee can be multiplied by the same amount.

Less well known are the potential tax implications 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 will pay the standard federal rate of 37 percent tax on the stock compensation when he exercises his 2018 options, which he must not to do until 2028.

If the Delaware Supreme Court refuses to overturn the original decision and the board decides to issue a new plan with similar terms, the options will be awarded “in the money” because the financial goals have already been met.

“It is very simple. If you provide options that are ‘in the money,’ which they clearly are now, all kinds of bad things happen,” Schuyler Moore, a tax partner at the Los Angeles law firm Greenberg Glusker, told the Financial Times. “That’s why they try so hard to validate the initial transaction. If they award it again now, it will be hell to pay taxes.”

When they were created in 2018, the stock options hinged on ambitious goals such as a 15x increase in revenue and a 12x valuation, which Musk had achieved by 2023.

At the time the package was granted, the options were “out-of-the-money” and not exercisable, thereby qualifying for exemptions under a section of the tax code known as Section 409A that governs deferred compensation.

The rule was introduced in 2005 after Enron’s executives rushed to cash out the privatized stock they had received as part of their compensation plans before the company went bankrupt.

McCormick’s decision to cancel Musk’s plan in January canceled his options, which no longer exist from a tax perspective.

Moore said that trying to enter into a new deal now under the same terms could violate Section 409A, which “causes the full value of the deferred compensation to be taxed immediately on the date it is granted, well before the deferred compensation would be taxed under normal rules.”

“To add insult to injury, Section 409A would impose an additional 20 percent tax on the value,” Moore wrote in an article published in the influential journal Tax Notes Federal.

That means Musk will be immediately liable for a 57 percent income tax on the difference between the strike price and the stock’s current value, whether or not he exercises the options. will be $122 billion, which means a tax bill of almost $70 billion.

“The tax problem here is clear. If you give him the same non-409A package now, you face accelerated income tax at the time of receipt, not when he works out, and the penalty rate at the top,” says Bradford Cohen, a tax partner at Jeff Mangels, Butler & Mitchell . “It could be a very expensive, unfortunate mistake.”

Even for the world’s richest man, Musk, it would be a shock. In early 2022, the billionaire posted on X that he “paid the most taxes for an individual in history last year” in response to reports that he would be paying the 2021 US Internal Revenue Service. the service is owed $11 billion.

“The only sure way Musk could have avoided these problems was to . . . appeal successfully [the decision]because it should be considered invalid,” Moore said. “A lot will be done on those attempts.”

Although Musk chose not to exercise his stock when he became eligible last year, “having options is powerful and valuable,” Moore said, because they act as a deterrent to potential buyers or activists he does not place a lien on the options.

The board has another way to help Musk avoid the extra 20 percent tax, but it’s still costly: Directors could award him 304 million shares of Tesla worth $129 billion at the current price, which would be subject to a standard rate of 37 percent, about 48 percent. billion dollars.

When questioned by McCormick at a hearing in August, Tesla’s attorney also raised the prospect that a potentially higher personal tax rate could result in Musk receiving a larger package to offset the cost of his taxes.

“At the end of the day, because we know how the economics work, you’re probably going to have to pay him more. If he has the number he wants, and he gets taxed, they’re passed on [to shareholders]said Rudolf Koch of Richards, Layton & Finger.

Furthermore, if Musk were to flood the market by selling enough stock at once to cover the tax, it could cause the stock price to drop.

The company still has to absorb the accounting costs.And if pay talks begin, Musk may not agree to a five-year lock-up period after the exercise, during which he cannot sell, which is a feature of his 2018 package.

Musk had previously raised the prospect of exiting the electric car maker, and the board argued that the compensation plan was a key way to keep the mercurial billionaire’s commitments intact.

In January, he posted on X that he was “uncomfortable with Tesla’s growth to be a leader in AI and robotics without 25% voice control” and “if it wasn’t, I’d rather build products outside of Tesla.”

Tesla did not immediately respond to a request for comment.