The federal government could receive an extra $7 billion in taxes annually if it closed a loophole exploited by Wall Street.

The loophole involves executive compensation that firms can deduct from their income taxes. This deduction cost the Internal Revenue Service (IRS) more than $30 billion over four years (2007-2010), for an average of $7.5 billion a year, according to a paper produced for the Economic Policy Institute.

In 1993, the IRS adopted a rule that limited the deduction for executive compensation at publicly-traded corporations to $1 million per executive. However, the rule exempted compensation that is based on an executive’s performance, which is fully deductible. Salaries, bonuses and stock grants are also deductible up to $1 million for each executive.

Of the $30.4 billion firms avoided paying to the U.S. Treasury, $16.6 billion stemmed from performance-based compensation and $13.8 billion from the other forms of compensation, such as bonuses and salaries.

This revenue loss could end if legislation sponsored by Representative Barbara Lee (D-California) is adopted. Lee’s bill, the Income Equity Act of 2011 (H.R. 382), would amend the Internal Revenue Code to prohibit deductions for excessive compensation for full-time employees.

The legislation defines “excess” compensation as that exceeding $500,000 or 25 times the compensation of the lowest-paid employee, whichever is larger.

-Noel Brinkerhoff

To Learn More:

Executive Compensation Tax Deductions Cost Treasury $30.4 Billion Over 2007-10 (by Lawrence Mishel, Economic Policy Institute)

Taxes and Executive Compensation (by Steven Balsam, Economic Policy Institute)

Executive Stock Options…Tax Break for Big Businesses, Bust for Other Americans (by Noel Brinkerhoff, AllGov)