Turning a Tax-Collector's Eye on Executive Pay

There's a new spoil-sport on Capitol Hill.

While the Senate Finance Committee looks to snip away at tax advantages for private equity and hedge fund chiefs, the Permanent Subcommittee on Investigations is taking aim at bigger prey: Corporate executive compensation.

Chairman Carl Levin, the Democratic Senator from Michigan, introduced legislation Friday that would bar U.S. companies from gaining what he sees as a tax advantage on stock options granted as compensation.

Levin's bill would make it so that corporate tax deductions for stock options was equal to the stock option expenses reported in regulatory filings.

Some companies have legally avoided paying billions of dollars in taxes in recent years by claiming tax deductions for options far in excess of what they told their shareholders those options had cost them. The Internal Revenue Service got one number, the Securities and Exchange Commission got another number for the same transaction.

This discrepancy is the result of conflicting provisions of the tax code and General Accepted Accounting Principles. Starting in 2005, companies were required by GAAP standards to report an expense equal to the fair value of stock options on their grant date.

But under the tax code, companies can still claim a deduction for stock options based on gains realized on the exercise date. So under the right circumstances, the difference in value between what's reported and what's taxed can be substantial.

In an investigation last summer, for instance, nine companies cooperating with the subcommittee calculated that the amount of stock option tax deductions they claimed from 2002 through 2006 was about five times greater than the expenses they would have reported to the S.E.C., had the new accounting rules been in effect at the time.

"By eliminating this outdated and overly generous corporate tax deduction, we would eliminate a tax incentive that encourages corporate boards to hand out huge executive stock option pay which, in turn, fuels the growing chasm between executive pay and the earnings of rank and file workers," Levin said.

The "Ending Corporate Tax Favors for Stock Options Act" has found plenty of support on Main Street, with endorsements from the Consumer Federation of America, Citizens for Tax Justice, and the AFL-CIO, among others.

It's not quite as popular on the Hill. The bill has no co-sponsors in the Senate and there is no similar legislation in the House of Representatives, as lawmakers are likely wary of the backlash that could ensue from companies in their constituencies.

by Liz Gunnison