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2017-01-11 15:22:16
Rex Tillerson, Required to Shed Exxon Shares, Wants to Defer the Taxes

As he prepares for a confirmation hearing on becoming secretary of state, Rex W. Tillerson, Exxon Mobil’s former chief executive, wants to hold on to a big benefit: deferring income taxes on company shares worth around $174 million.

But tax experts say the plan devised by Exxon Mobil to let him do that could run into trouble with the Internal Revenue Service.

Questions about Mr. Tillerson’s compensation may come up on Wednesday at his hearing before the Senate Foreign Relations Committee. He is one of several top business executives Mr. Trump has nominated to cabinet positions, setting up a continuing focus on how they will deal with the assets they must shed to comply with government ethics rules.

During his 41 years with Exxon, Mr. Tillerson has either accumulated or earned a right to receive more than two million shares he is not yet eligible to sell. All told, those are worth about $174 million at Exxon’s current share price. Under a typical executive compensation arrangement, executives can defer the tax bill on their shares until they are eligible to sell, a process known as vesting.

To comply with government ethics rules that require him to divest his stake, and to compensate Mr. Tillerson for his shares that have not yet vested, Exxon has constructed a creative solution: If he is confirmed, the company will cancel the shares and move a pile of cash with roughly the same value into a newly created trust with Mr. Tillerson as the beneficiary. The trust will invest the cash in Treasury securities and other permitted assets and then make payments to Mr. Tillerson gradually over the next decade.

Mr. Tillerson will owe taxes at ordinary income rates as he receives the payments, the company expects, mimicking the tax treatment he would have received if he had stayed with the company.

Tax advisers, however, question whether that is the right way to handle it.

Robert J. Jackson Jr., a law professor and executive compensation expert at Columbia University and a former Obama administration Treasury Department official, said Mr. Tillerson should owe the full tax up front because the cash will effectively be his, with little realistic chance that he will lose it.

“Everything in the trust is his property today, which means he must pay tax on it,” Professor Jackson said. The notion that Mr. Tillerson should defer the tax is “a loser of a position in front of the I.R.S.,” he added. “He should pay income tax this year.”

Here is why: Incentive compensation plans like the ones at Exxon Mobil usually mean executives receive stock with restrictions on when they can sell. In Mr. Tillerson’s case, he has about two million Exxon Mobil shares — or the right to shares — that will vest over the coming decade.

For executives to defer taxes on restricted stock, the shares must be subject to a “substantial risk of forfeiture.” Put another way, if the company simply gave the stock to the executives with no strings attached, they would be taxed. But since the executives must meet certain criteria, like continued employment with the company, they get to defer taxes on their restricted stock.

Exxon Mobil’s plans include a noncompete clause: If executives leave and work for a competitor before their stock is vested, they lose the stock. The company included a similar feature in the trust arrangement it is establishing for Mr. Tillerson, with no other restrictions.

But some executive compensation consultants, citing I.R.S. regulations, say such noncompete clauses on their own may not be sufficient to subject Mr. Tillerson’s interest in the trust to a significant risk of forfeiture.

“The reality is it’s not that much of a limitation, and for tax purposes, in my experience, it doesn’t work,” said Brian T. Foley, a compensation consultant and tax lawyer.

This is especially true for Mr. Tillerson, who is 64 and so is unlikely to risk losing a big chunk of his accumulated compensation by leaving for an Exxon competitor — particularly in the next four years, Professor Jackson said.

“Nor do I think someone who has the ambition of being secretary of state should be taking aggressive tax positions moments before their Senate confirmation hearing,” he said.

An Exxon Mobil spokesman said he expected the deferral benefit to stay in place.

“It’s our expectation that the tax treatment will be identical to if Mr. Tillerson had not reached this agreement and continued in the executive compensation program,” said Alan T. Jeffers, the spokesman. “The agreement has a substantial risk of forfeiture that is similar to that of our executive compensation program.”

Under the trust arrangement, if Mr. Tillerson goes to work for an Exxon competitor, his remaining interest in the trust will be forfeited, and the cash not already paid to him will go to a charity to be determined by the trustee.

The benefit Mr. Tillerson is seeking is different from the one available to executives who own company stock outright whose sale would be subject to capital gains taxes. Executives who must divest the common shares they own to comply with government ethics rules are permitted to defer the capital gains bill, potentially forever, thanks to a tax code provision enacted during the first Bush administration.

Yet no such deferral benefit exists for the type of restricted stock that Mr. Tillerson is giving up in exchange for his interest in the new trust, said Robert Willens, an independent tax consultant.

“He’s not using the tax code section designed to deal with conflicts of interest,” Mr. Willens said. “Instead, they are making one up as they go along and hoping it works.”

He said he thought Mr. Tillerson could make a reasonable argument that the trust arrangement’s restriction on his ability to work for another company in the oil and gas industry was sufficient to put the money at risk.

“His sweet spot is oil and gas,” Mr. Willens said. “That’s what he knows the best.”

Although whether Mr. Tillerson has “engaged in competitive employment” in the oil and gas industry is determined by the trustee, that person is entitled “to rely conclusively, without investigation,” on a certification by Mr. Tillerson, according to the trust documents.