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Helping Fat Cats Dodge the Taxman

By Louis Lavelle The news of L. Dennis Kozlowski's indictment, and his subsequent relinquishing of the throne at Tyco International (TYCO), has proved baffling to many. After all, how could a man who earned nearly $275 million over three years allegedly get involved in nickle-and-diming the taxman over a measly $1 million? In fact, getting the company to pay an exec's taxes is a fairly commonplace -- and quite legal -- perk. But Kozlowski carried the practice to an extreme that violated the law, prosecutors charge.

His case involves the alleged nonpayment of sales tax on some well-known art works. But run-of-the-mill executive tax avoidance involves perfectly legal practices of a more mundane variety: restricted shares that are about to vest, contributions to supplemental retirement plans, company-paid life-insurance premiums, stock-buying loans suddenly forgiven -- even country-club dues, family travel, and other executive perks.

Outside of the executive suite, such payments are added to the employee's taxable income, and the employee is responsible for paying up come tax time. But for the highest-ranking execs, companies often make hundreds of thousands, even millions, of dollars in tax reimbursements, courtesy of shareholders.

TRIPLE-DIPPING. Unlike country-club dues and fat pensions, tax reimbursements aren't just another executive perk. In fact, while the amounts usually aren't large, they can be triply egregious, representing a perk on top of a perk on top of a perk.

How does it work? First, there's the perk itself. Let's say a company makes $100,000 in payments into a supplemental retirement plan on the executive's behalf (perk No. 1). This has tax consequences, but often companies will pay their top executives extra to cover the expense. These are called "gross-up" payments. So a CEO will get an extra $67,000 -- $40,000 to pay the 40% tax rate on the retirement plan contribution (perk No. 2) and $27,000 to pay the taxes on the $67,000 (perk No. 3).

Critics of sky-high executive pay say such gross-up payments are a little-noticed, and fundamentally unfair, way for companies to inflate already exorbitant pay packages. Says Kenneth Bertsch, corporate-governance director at TIAA CREF, the world's largest pension system: "It's not clear to us why in the tax area top executives should be treated so much differently from everybody else."

PLENTY OF COMPANY. Of course, the irony in all this is that the executives escaping their tax burdens are those with the greatest ability to pay. Kozlowski himself took advantage of several programs at Tyco, allowing the company to pick up the tab for the taxes on company-paid life-insurance premiums and borrowing tens of millions of dollars from Tyco -- subsequently repaid -- to pay the taxes on restricted shares, according to Tyco securities filings. But he was far from alone.

Consider Christos Cotsakos, the E*Trade Group CEO whose $88.2 million 2001 payday raised investor ire in a year when the online brokerage lost $241 million. More than $18 million of Cotsakos' pay package represents tax reimbursements from the company, according to E*Trade (ET) filings, including $15.2 million he received to compensate him for taxes he paid on a forgiven $15 million loan and $2.4 million for the taxes he paid on restricted shares.

E*Trade says Cotsakos would have been entitled to the loan forgiveness and related tax payments in the event there's a change of control, adding that Cotsakos gave up additional perks to get those benefits early. In response to criticism over his pay package, Cotsakos returned $9.6 million and 4 million restricted shares, but E*Trade says the gross-up payments weren't part of the giveback.

Underperforming CEOs are just as likely to benefit from corporate tax largesse as the ones who meet expectations or outperform. Jill Barad, whose brief tenure at the helm of Mattel (MAT) was marked by anemic earnings and strategic missteps, nevertheless received nearly $3.6 million to cover the taxes on a forgiven $8.5 million loan and $1 million in contributions to a supplemental retirement plan.

"STANDARD PRACTICE." Similarly, at Global Crossing (GBLXQ), which declared bankruptcy in January, CEO John Legere was promised a gross-up of $13.5 million needed to reimburse him for the taxes on a $15 million loan forgiven by Asia Global Crossing. The promised $13.5 million was reduced in bankruptcy court proceedings to $4.7 million, which Legere received. Mattel did not return calls seeking comment, and Global Crossing declined to comment for this story.

Tax reimbursements aren't confined just to executives like Kozlowski and companies like Global Crossing. In fact, they're relatively standard at many U.S. companies, including those that are doing well. Take Gillette (G) -- which is in the midst of a turnaround under the stewardship of CEO James Kilts, who was brought in last year. Unlike Kozlowski or Cotsakos, Kilts is hardly overpaid by CEO standards -- he received $2.8 million in cash and options worth $28.5 million last year. Plus, he spent $1 million of his own money to buy Gillette stock in order to demonstrate his "commitment to the company," says a Gillette spokesman.

Yet Gillette provides him with tax-reimbursement assistance. In a year when Gillette stock was essentially flat, Kilts got his company to pick up the $206,563 tax tab on the extra money Gillette paid him to cover both his lawyers' expenses during contract negotiations and his housing expenses in Boston, where he lives during the work week. The Gillette spokesman says the gross-ups were part of Kilts's negotiated employment contract. He adds that such gross-ups are "standard practice" among companies Gillette competes with in the consumer-products industry.

EGALITARIAN SPIRIT. Then there's Dominion Resources (D), where shares fell 10% in 2001 after an 80% runup the previous year. Nonetheless, CEO Thomas Capps got $214,860 to pay the taxes on interest payments the company made on a loan Capps used to buy Dominion stock. A spokesman for Dominion says the interest and gross-up payments were designed to encourage stock ownership by executives and align their interests with those of shareholders.

Few would argue with the logic of executive stock ownership or with offering a prospective CEO the best possible deal. But boards don't need to give away the farm to accomplish those goals. Executives should pay taxes like everyone else, and if they need help, it should come in the form of a commercial loan.

Top execs already receive an embarrassment of riches, and paying their tax bill only widens the vast pay chasm separating them from the rank-and-file. At a time when CEOs are held in historically low regard, they may want to think twice before handing their tax bills to shareholders. On this point, Leona Helmsley was wrong: Paying taxes shouldn't be just for the little people. Lavelle covers executive compensation issues for BusinessWeek from New York

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