What is a 'Tax Clawback Agreement'

A tax clawback agreement is an arrangement whereby the tax benefits received from a given venture are reinvested into that venture to cover any cash shortages. A tax clawback is just one of many types of similar arrangements that cover various distributions such as profits, dividends or even stock distributions.

BREAKING DOWN 'Tax Clawback Agreement'

Tax clawbacks are among the most popular type of clawback arrangements, providing instant and easy access to additional financing. Clawbacks are also used to describe what, in effect, amounts to a return of previously distributed money.

For example, when Troubled Asset Relief Program (TARP) funds were used in some cases to finance executive bonuses in 2008, it prompted members of Congress to advocate for a tax clawback, whereby the executives in question would be forced to pay back some of the bonus money in the form of higher taxes.

In other words, say Company A agrees to take $100 million from the government to avoid bankruptcy, which would cost the economy thousands of jobs, and overall harm the country. Company A takes the money, but then uses the funds for bonuses and vacations for executives. Because the funds come with a tax clawback agreement, should Congress find out about Company A’s use of taxpayer money, politicians could claw back the funds and impose a higher tax rate on Company A going forward.

Tax clawbacks are a way for government to reclaim funds that have been abused in the private sector, and there are many situations where tax clawbacks may be necessary. In principle, however, the Internal Revenue Service (IRS) has the power to recover back taxes without a tax clawback agreement.

Clawback agreements can also exist in contracts between two private parties, in which one party contributes equity to a project or organization if the project or organization created tax benefits for the investor, but is now short on cash flow.

Tax Clawback Agreements Versus Dividend Clawback Agreements

Dividend clawbacks are similar to tax clawbacks in that they involve reinvesting to cover cash shortages. A dividend clawback is an arrangement under which those financing a project agree to contribute, as equity, any prior dividends received from the project to cover any cash shortages. When there is no cash shortfall, those investors who provided funding are able to keep their dividends. A dividend clawback arrangement provides incentive for a project to remain on budget so that investors do not have to return dividends received prior to a cost overrun.

 

RELATED TERMS
  1. Dividend Clawback

    A dividend clawback is an arrangement where investors contribute ...
  2. Cash Dividend

    Cash dividend is the money paid to stockholders normally as a ...
  3. Dividend Exclusion

    Dividend exclusion is a rule that allows corporations to subtract ...
  4. Dividend Tax Credit

    The dividend tax credit is the amount that a Canadian resident ...
  5. Effective Tax Rate

    The effective tax rate is the average rate at which an individual ...
  6. Reinvestment

    Reinvestment is using dividends, interest and any other form ...
Related Articles
  1. Investing

    Learn the Lingo of Private Equity Investing

    Because of the non-public nature of private equity, it can be difficult to the learn the lingo. We break it down here.
  2. Investing

    How Dividend Reinvestment Grows Your Money Faster

    Dividend reinvestment is a smart strategy for growing your investments faster over the long term, but it’s not a get-rich-quick proposition.
  3. Retirement

    How Reinvesting Dividends Pays in the Long Run

    Dividend reinvestment is one of the easiest ways to grow wealth and can increase your investment income over time.
  4. Investing

    Put Dividends to Work in Your Portfolio

    Find out how a company can put its profits directly into your hands.
  5. Taxes

    How Tax Cuts Stimulate the Economy

    Learn the logic behind the belief that reducing government income benefits everyone.
  6. Investing

    Why Dividends Matter To Investors

    There is much evidence as to why dividends matter for investors, profitability in the form of a dividend check can help investors sleep easily. Learn more.
  7. Taxes

    Investment Tax Basics For All Investors

    Asset placement and tax-loss harvesting can reduce the tax burden, however, Investors should still consult tax advisors for investment strategies.
  8. Investing

    How Tax-Efficient Is Your Mutual Fund?

    Learn about factors that influence the tax-efficiency of your mutual fund, how income from your investment is taxed and what to look for when choosing a fund.
  9. Financial Advisor

    Income tax on mutual funds: The basics

    Learn about the basics of income tax on mutual funds, including what types of income may be subject to the capital gains tax rate.
RELATED FAQS
  1. Cash Dividends or Stock Dividends: Which is better?

    The purpose of dividends is to return wealth back to the shareholders of a company. There are two types of dividends: cash ... Read Answer >>
Trading Center