 Hello and welcome to this session in which we will discuss excessive executive compensation. What is excessive? Excessive means too much executive compensation. Hold on a second. We are in a capitalistic system. Is there such a thing as paying an executive too much? Not at all. You can pay your executives as much as possible. However, if you are a publicly traded company, then you can only deduct a certain amount of that deduction. If you want to pay your executives, you can pay them for that matter 200 million per year. That's fine. You can pay them 300 million per year. That's fine. That's your business. That's the company's business. When it comes to the IRS, how much can you deduct for IRS purposes? You are limited to $1 million. And because you can deduct as much as possible on the financial statements, which is GAAP, and you are limited to $1 million for IRS, what's that going to do? It's going to create a difference between GAAP deduction and IRS deduction, which we'll have to reconcile later on. Now, who are the covered employees? So the rules applies to covered employees. Covered employees are the principal executives. We're talking about the CEO here. We're talking about the principal financial officer, the CFO, and the three highest paid officers in the company. Once again, when it comes to GAAP, you can go crazy. Pay them as much as possible, deduct as much as possible. That's your problem. So when the shareholders agree with that, because, again, if you pay the executives, it's taken away profit from the shareholder, but that's not their business. That's not the IRS business. The IRS business is to limit you from the deduction perspective. So differences will arise. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course, such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead. Start your free trial today. Let's talk a little bit more about what type of compensation are we discussing here. The one million applies to various form of compensation. That's including your W-2 compensation, any form of compensation that they give you. Also, commission based on individual performance. Well, they say, this is not a W-2, but if you reach a certain number, we'll give you a compensation, a commission for that. That's also included. Also, performance-based, linked to the overall performance of the company. Well, if the company reach a certain net income or certain earnings per share, we'll give you a certain amount of money or stock option or whatever value. That's also compensation. Now, you don't count what we called the third compensation. What's the third compensation? The third compensation, something like a retirement plan. So basically what you do now, the executive is working in the year 2025 in your company. This is the year 2025. Now, you are saying, look, I'm going to put money away for you when you retire in year 2055. This is money for your retirement. Well, the money for your retirement, let's assume you put away for them for that year 100,000. Well, that money is not counted in this compensation. Or if you are giving them benefits that are executed, remember, if they're included, if they're taxable, if they're executed from gross income, if they're non-taxable, that's fine. You also don't count those benefits. And there's few benefits. Healthcare benefits is one of them. But if the fringe benefits, all fringe benefits are taxable, then it's included. So only non-taxable fringe benefits. And you have to be careful about this because they might try to trick you into telling you it's some sort of a fringe benefits. Well, is it taxable? Well, it's included. If it's non-taxable, it's not included. Also, there's a special rules for business entertainment expenses for officers, directors, and people who own more than 10% of the company. So if the company incur entertainment expenses for those individuals, sport event, golf outing, or whatever business entertainment you incur, that's fine. You can deduct. No problem whatsoever. The company can deduct them. However, wherever you deduct, you have to take this money and include under W-2s of the officers, the directors, or the shareholders. So as a company, you can deduct for the receivers, for the people who benefited from this, it's income for them. So it's deductible for the company, but they are included under W-2 as gross income. Now, we've been talking about up to this point for public companies. Public companies and public companies are heavily regulated because they're public companies. I'm sure some of you are thinking, OK, this is public company. How about private companies? Can we pay if it's a C Corp and if it's a private company? What would happen? Well, under private companies, we don't have a particular dollar amount. The IRS says, look, if the compensation are unreasonable. Now, what is unreasonable compensation? They don't put a number for it. It's a private company. You can pay your executives as much as possible. But if it's unreasonable, well, we're going to allow that tax deduction. So if you allow it as a tax deduction, how would you classify it? So if you pay an executive $5 million per year, which is not much for executives, well, for some executives at least. Well, if it's not an expense, what are you going to do? You're going to reclassify it as dividend because the IRS don't want you to take the deduction. OK, why? What's the purpose of this? Again, the purpose is to prevent corporation from deducting too much executive pay that's not justified by the value or performance contributed by the company. That's the whole purpose. Well, this pay does not justify the performance of this individual. Why are you paying them too much and getting a tax deduction? So rather than a tax deduction, reclassify this payment as dividend, which is not tax deductible. If you want to pay them, that's fine. But you cannot get a tax deduction. Let's take a look at an example to illustrate this concept. NOAA, a newly hired CEO by Farhat Company. It's a publicly traded. We're going to assume it's publicly traded. NOAA compensation included the following. Cash, $3.5 million. Bonus type to their performance or to the company's performance, $4 million. Taxable fringe benefit, $35 million. Non-taxable fringe benefits, $38 million. So if it's a publicly traded company, how much can Farhat as a company deduct? Well, if it's a publicly traded company, it's easy. The amount is a million dollar in cash and any non-taxable fringe benefits. Well, that's fine. A million dollar in cash is deductible. Non-taxable fringe benefit is deductible as well. Non-taxable, because it's non-taxable. Now, if this was a, if Farhat was a private C Corp. Private C Corp. Well, and Farhat paid NOAA this much. Well, it all depends. It depends on the situation. Well, is this justified? What do I mean by this? Let's assume Farhat is a five billion company in sales. If it's a five billion company in sales and after they hired NOAA, NOAA is able to increase sales by 20%. And NOAA has a history of increasing sales and saving companies. Well, if they improve the company's performance by 20%, if my math is right, it means they improved their sales by a billion. Well, I would say 7.5 million is not much, is not much. It's not too much compensation for a person that raised sales by a billion. But let's assume Farhat is a 50 million company and you're paying NOAA 7.5 million. I would say that's too much, right? So basically 7.5 million plus some benefits. You're approaching 10 million, right? You're approaching 10 million, not 10 million, but 7.5, you're talking, what's 7.5 or 50 million? Just kind of give you an exact percentage. 7.5 divided by 50, it's approximately 7.5 divided by 50. That's approximately 15%. So 15% of the companies is going toward the executive pay alone. That will be, I would say, if I'm an IRS agent, I would say this is excessive executive compensation, you would need to reclassify. You can pay them that much, we're not stopping you, but you cannot take the deduction. Again, this is for private. And the reason I mentioned private, because in this session, we're working for C Corporation and specifically, this session is about public because most of you will be thinking, how about if it's a private company? This is what happened in a private company. What should you do now? Whether you are a CPA candidate, accounting students, under-old agent, go to FAHAT lectures, look at MCQs, True Fals, additional resources that's gonna help you understand how C corporations operate. Good luck, study hard, and of course, stay safe.