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Last December, the city of Portland, Oregon became the first in the nation to impose surtax on companies whose chief executives earn more than 100 times the median pay of their employees. Following Portland’s lead, five states – Connecticut, Illinois, Massachusetts, Minnesota, and Rhode Island – and the city of San Francisco, have either introduced or passed pay ratio tax legislation in a new effort to address income inequality at the state and local level. For past McDonald Hopkins coverage on the Portland ordinance, click here.

These actions generally piggyback on the Securities and Exchange Commission’s (SEC) finalized pay ratio disclosure rule, which implements Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The pay ratio disclosure rule requires that public companies calculate and disclose the ratio comparing the annual total compensation of the company’s chief executive to the annual total compensation of the median employee. The pay ratio includes part-time workers but excludes 5 percent of non-U.S. workers as well as non-U.S. workers where data privacy laws prevent disclosure.

The pay ratio disclosure rule technically went into effect as of January 1, 2017; however, it was recently announced by Acting SEC Chairman Michael Piwowar that the SEC may issue further guidance or relief on the rule’s implementation after reports from several affected entities encountering “unanticipated compliance difficulties.” 

The following is a brief overview of the state and city initiatives that would impose a surcharge on executive compensation. Only the city ordinances from Portland, Oregon and San Francisco have been enacted.

States

  • Connecticut: LCO No. 2445 proposes to replace the current corporate income tax on publicly traded companies with a tax that is based on the CEO pay ratio. The tax rates would start with a 5 percent corporate income tax for companies with pay ratio of 25:1 and end with a 25 percent corporate income tax for companies with a pay ratio of more than 250:1.
  • Illinois: House Bill 3335 proposes an annual fee of $1,500 on publicly traded companies doing business in Illinois that report a pay ratio of at least 100:1 and an annual fee of $2,500 on companies that report a pay ratio of 250:1 or greater.
  • Massachusetts: Senate Bill S.1555 proposes a separate compensation ratio calculation contrasting with the SEC’s ratio. The MA pay ratio requires the calculation where the “numerator is the amount equal or greater of the compensation of the chief executive officer or the highest paid employee and the denominator is the amount equal to the median compensation of all employees employed by the business, including all contracted employees in the United States.” This definition contrasts with the SEC defined ratio in that it purposefully includes the highest paid employee or the CEO. For Massachusetts publicly traded companies, this rule would potentially require companies to calculate two separate ratios: one for SEC reporting purposes and one for MA income tax purposes.
  • Minnesota: House Bill 65 proposes a 10 percent surcharge on publicly held companies with pay ratios exceeding 100:1 and a 25 percent surcharge on companies with pay ratios exceeding 250:1. The surcharge would be in addition to the corporate income tax.
  • Rhode Island: House Bill 5141 proposes a 10 percent surcharge on public companies with pay ratios exceeding 100:1 and a 25 percent surcharge on companies with pay ratios exceeding 250:1. The surcharge would be in addition to the corporate income tax.
  • California: It should also be noted that in 2014, the California Senate proposed but did not enact a bill that would have provided a tax break for companies with a corporate pay ratio of less than 100:1.

Cities

  • Portland, OR: Enacted on December 6, 2016. Companies must pay an additional 10 percent tax if their chief executive receives compensation greater than 100 times their median pay. Companies with pay ratios greater than 250 times the median will face a 25 percent surcharge.
  • San Francisco, CA: Enacted on March 24, 2017. The city of San Francisco decided to take a different approach and passed a resolution urging the San Francisco Pension Board to review executive compensation, evaluate best practices on salary compensation, hold a public hearing on the matter, and issue a report back to the city. While there are no tax provisions associated with the new measure, it is clear from the resolution that the San Francisco Pension Board will be analyzing pay ratios closely in an attempt to steer investment away from companies that have high executive pay ratios. 
In addition to federal regulations, companies must now contend with state and local governments that continue to change the executive pay landscape. The increased focus by state and local jurisdictions on executive compensation should lead companies to revisit their executive pay programs to ensure that they are following best practices and effectively positioning themselves with respect to the market.
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