Under this shelter, executives, often facilitated by their corporate employers, transferred stock options to family controlled partnerships and other related entities typically created for the purpose of receiving the options and avoiding taxes on compensation income normally taxed to the executive, according to the IRS. The tax objective was to defer for up to 30 years taxes on the compensation and, in many cases, resulted in the corporation deferring a legitimate deduction for the same compensation.

To date, the IRS has identified 42 corporations, many more executives, and unreported income of more than $700 million involved in this scheme.

"These transactions raise questions not only about compliance with the tax laws, but also, in some instances, about corporate governance and auditor independence," says IRS Commissioner Mark W. Everson. "These deals were done for the personal benefit of executives, often at the expense of shareholders."

Corporate executives who engaged in these transactions will have until May 23, 2005, to accept an IRS settlement offer to resolve their tax issues. The offer also extends to corporations that issued the options to executives and directors as part of their compensation.

The shelter first involves the transfer of stock options by the executive to a related entity, such as a family limited partnership, under terms of an agreement to defer payment to the executive. Next, the partnership exercises the options and sells the stock in the marketplace. The executive then takes the position that tax is not owed until the date of the deferred payment, typically 15 to 30 years later, although the executive has access to the partnership assets undiminished by taxes, the IRS says.

Tax laws require executives to include in income and pay tax on the difference between the amount they pay for the stock and its value when the option is exercised. Corporations are entitled to a deduction for the compensation when the options are exercised.

Under the terms of the settlement, participating executives must report 100 percent of the compensation and must pay interest and a 10 percent penalty. This is one-half of the maximum 20 percent applicable penalty. Corporations and executives must also pay appropriate employment taxes. The parties will be allowed to deduct their out of pocket transaction costs, typically promoter and professional fees. Corporations will be allowed a deduction for the compensation expense reported by the executive.

The IRS says it will continue to pursue executives and companies who participated in these transactions and do not come forward now to participate in this settlement opportunity.

"We believe a new climate under Sarbanes-Oxley, together with the tougher independence standards for auditors recently proposed by the Public Company Accounting Oversight Board make this sort of thing less likely going forward," says Everson. "However, we want to give executives and corporations a chance to clean up past transactions."