Washington has been fixated on the issue of boosting taxes on private equity and hedge fund managers by raising the tax rate on "carried interest"–the investment gains of fund managers–from 15% to 35%. But there are other revenue-raising tax measures that could potentially have far-reaching effects on the way that executives are compensated. At a hearing held in June, Sen. Carl Levin (D-Mich.), chairman of the permanent subcommittee on investigations, raised the issue of how stock options are expensed on a company's financial statements versus their treatment on company tax returns. Financial Accounting Standard (FAS) 123R, enacted in 2005, requires companies to expense stock options on the grant date; the tax code, on the other hand, requires that companies deduct stock option expenses on the exercise date. Stock options, claims Levin, are the only compensation expense where companies are allowed to deduct much more on their tax returns than the expense shown on their books. In 2004 alone, the mismatched rules allowed corporations to take tax deductions $43 billion greater than the stock options expenses shown on their financial statements. Levin plans to introduce a bill that would bring stock option expensing and the tax deductions into alignment.


This is not the first time Levin has brought up the issue. In 2003, he introduced similar legislation that went nowhere, notes Steven Seelig, the executive compensation counsel with Watson Wyatt Worldwide. Says Seelig, "According to Levin, we wouldn't have companies handing out stock options if we did not have this mismatched expensing and tax deduction." Clearly, the odds on the bill's success are better this time around in a Democratic Congress, and given public outrage over executive compensation in general and stock option abuses in particular. "This measure does have legs," says Mark Borges, a principal with Mercer Human Resources Consulting. Besides its potential to curb the distribution of options, "Congress is looking around for revenue sources without hurting anyone but the fat cats."


Another revenue-raising measure with legs is the proposal to cap nonqualified deferred compensation. The proposal would limit the amount an individual can defer each year under such plans to the lesser of $1 million or the individual's average taxable compensation over the past five years. The business community is following the issue closely since, if the proposal were to become law, it would have a huge impact on often generous deferred compensation agreements.

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