What is a Tax Clawback Agreement?

In a tax clawback agreement, a company or organization agrees to repay government benefits via higher taxes at a later date.

How Does a Tax Clawback Agreement Work?

Company XYZ agrees to take $40 million from the federal government to prevent the company from going bankrupt. A bankruptcy of Company XYZ might cost the economy thousands of jobs and might force people to obtain products from foreign suppliers rather than the domestic Company XYZ. The company takes the money but then purchases a fleet of private jets for the executives and holds a lavish offsite party in Tahiti. The funds come with a tax clawback agreement.

Congress finds out about the use of funds and decides to clawback the funds by imposing a higher tax rate on Company XYZ going forward. Alternatively, the language in the agreement could state that the government could convert those illegitimate tax benefits into equity in the company, thereby making the government a shareholder in Company XYZ.

Tax clawback agreements also exist in contracts between two private parties, whereby 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.

Why Does a Tax Clawback Agreement Matter?

Tax clawbacks are a way for a government to reclaim funds that it feels have been abused in the private sector. They may accompany a variety of situations. In principle, however, the IRS has the power to recover back taxes without a tax clawback agreement.