A Taxing Blog

Tuesday, July 01, 2003
Executive Compensation Strategy  
Today the IRS (finally) announced that a common tax avoidance strategy was bogus (www.treas.gov/press/releases/js521.htm). This strategy that was not even facially plausible involved the selling of vested, in the money, nonqualified stock options by an executive to a family limited partnership in exchange for the partnership's promise to pay a lump sum in the future. The idea was to defer tax by claiming that the executive realized income only when he received cash pursuant to the promise to pay. Meanwhile, the partnership took a fair market value basis in the option, severely reducing, if not eliminating, the amount of gain it would recognize upon exercise.

To me, the most notable thing about the strategy was how unlikely it was to have any realistic chance of success. There were about 15 different ways to kill the thing, and although one could stretch to make arguments on behalf of the executive with regard to each of them, some of the arguments were only barely non-laughable.

Included in the Joint Committee's Enron report was a draft Arthur Andersen opinion that concluded that on each of the 15 issues, the executive's chance of success was "more likely than not", but did not given an opinion on the executive's chance of success overall. The opinion troubled me, first for its extremely flawed analysis on each issue, and second for the fact that it misleads a statistically-naive reader to conclude that the overall chance of success was more likely than not.



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