Tesla has vowed to continue its fight to restore Elon Musk’s historic pay package, and failure could come at a high price: the potential for more than $100 billion in tax and accounting costs for the company and its CEO.
Most recently, Delaware Judge Kathaleen McCormick a second attempt by an electric vehicle manufacturer was rejected to give Musk the largest stock option package in history — worth $56 billion at the time of the original ruling and more than $129 billion at the stock’s current price. She found that the overwhelming shareholder vote to reauthorize the grant did not overturn her earlier rejection of the 2018 contract as unfair and awarded by a board that was in the borough of its chief executive.
Her position left the board with a dilemma: file a lengthy and uncertain appeal with the Delaware Supreme Court or grant the CEO a new option package.
If issued on similar terms, the new package could trigger corporate accounting charges of more than $50 billion and separately impose a punitive tax rate of up to 57 percent on Musk’s shares, triggering a huge tax bill.
In April of Tesla warned shareholders that reissuing a new set of stock options giving Musk the right to buy the same 304 million shares would result in fee-related accounting charges of more than $25 billion, as the company’s valuation was significantly higher than in 2018. That compared to $2.3 billion in original award fees for 2018.
Those calculations were based on a share price of $175 on April 1, when Tesla’s market capitalization was $558 billion. Shares have since more than doubled to $425, giving Tesla a $1.3 trillion valuation — in large part due to investor enthusiasm for Musk newfound relationship with President-elect Donald Trump — implying that the accounting cost could be multiplied by a similar amount.
Less well known are the potential tax implications for Muskwhose net worth recently soared past $400 billion — the first person to reach that level of wealth.
If Tesla wins its appeal, which must be filed within 30 days of the Dec. 2 ruling, Musk would pay the standard federal rate of 37 percent for stock compensation when he exercises his 2018 options, which he is not required to do until 2028 .
If the Delaware Supreme Court refuses to overturn the original ruling and the board decides to issue a new plan under similar terms, the options would already be granted “in the money,” since the financial goals have already been met.
“It’s very simple. If you grant options that are ‘in the money,’ which they clearly are now, all kinds of bad things happen,” Schuyler Moore, a tax partner at Los Angeles law firm Greenberg Glusker, told the Financial Times. “That is why they are trying so hard to ratify the original agreement. If they reassign it now, it will be hell to pay taxes.”
When they were designed in 2018, the stock options were contingent on ambitious goals — like growing revenue 15 times and valuation 12 times — that Musk had achieved by 2023.
At the time the package was granted, the options were “out-of-the-money” and not exercisable, thus qualifying for exceptions in a section of the tax code known as 409A, which governs deferred compensation.
The rule was introduced in 2005 after Enron executives rushed to cash in vested shares they 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 from a tax perspective no longer exist.
Moore said trying to do a new deal on the same terms now could violate Section 409A, which “triggers immediate taxation of the full value of the deferred compensation on the date it vests, long before the deferred compensation would be taxable under ordinary rules.”
“To add insult to injury, Section 409A would impose an additional 20 percent value tax,” Moore wrote in an article in the influential journal Tax Notes Federal. “The damage was done on the day of the award.”
That means Musk would immediately be liable for 57 percent income tax on the difference between the stock’s initial price and its current value, whether or not he chooses to exercise the options. At Wednesday’s closing price of $425 and the $23.34 strike price set in 2018, the difference would be $122 billion, meaning a tax bill of nearly $70 billion.
“The tax issue here is simple. If you give him the same non-409A package now, you face accelerated income taxes at the point of receipt, not when he exercises, with a penalty rate on top,” said Bradford Cohen, tax partner at Jeffer Mangels. Butler & Mitchell. “That could be a very expensive, unfortunate mistake.”
Even Musk, the richest man in the world, would have tears in his eyes. In early 2022, the billionaire posted on X that he “paid the most taxes ever for an individual last year” in response to a message saying he owed the IRS $11 billion in 2021.
“The only sure way Musk could avoid these problems is to . . . to successfully appeal (the decision), as it should then be viewed as null and void,” Moore said. “A lot will depend on those attempts.”
Despite Musk choosing not to exercise his stock last year when he was eligible, “having options is powerful and valuable,” Moore said, because they act as a deterrent to potential buyers or activists. Musk can also borrow against their implied value, until he grants a lien on the options.
The board has another way to help Musk avoid the extra 20 percent tax, but it’s still expensive. Directors could award him 304 million Tesla shares worth $129 billion at the current price, which would be subject to a standard rate of 37 percent, about $48 billion.
When McCormick questioned him on the matter during a hearing in August, Tesla’s lawyer also raised the possibility that a likely higher personal tax rate could result in Musk getting an even bigger package to offset the cost of his taxes.
“Ultimately, because we know how the economy works, then you’d probably have to pay him more. If he has the number he wants and the taxes are paid, those are passed on (to the shareholders),” said Rudolf Koch of Richards, Layton & Finger.
Moreover, if Musk were to flood the market by selling so many shares at once to cover the tax, he would risk a drop in the share price.
The company would still have to bear the accounting costs. And if salary negotiations start over, Musk may not agree to a five-year post-exercise lockout period during which he cannot sell, a feature of his 2018 package.
Musk has previously floated the prospect of pulling out of the electric car maker, and the board has argued that the compensation plan is a key way to retain the mercurial billionaire’s commitment.
In January, he posted on X that he was “uncomfortable growing Tesla to become a leader in AI and robotics without ~25% voting control” and “unless that’s the case, I’d rather make products outside of Tesla.”
Tesla did not immediately respond to a request for comment.
