Gross-Up? Gross Out.

The latest abomination in CEO pay.

Capital One Financial’s purchase of North Fork Bancorp for $14.6 billion, announced Monday, is an inside page of the Wall Street Journal, garden-variety deal: A credit-card giant diversifies by adding a rapidly growing bank.

What’s also routine in this age of excessive CEO pay is how the sale unleashed a tidal wave of compensation for North Fork CEO John Kanas and other top executives. For Kanas $135 million, and more than $200 million for the other guys. As detailed by Gretchen Morgenson in today’s New York Times, Kanas will ride off into retirement with “$66 million in restricted stock, $15 million in severance that he will receive when he retires, $6 million in stock options and $4 million in stock-based units.”

And how much tax will Kanas owe on this windfall? Um, $0. The shareholders of North Fork, and ultimately, Capital One, will pay some $44 million to cover Kanas’ substantial Internal Revenue Service bill. This tax buy-off is known as a “gross-up” because beneficiaries receive “gross” pretax sums rather than net post-tax sums—though it is also well-named because of the reaction it provokes in shareholders: a pressing need to vomit. The gross-up is becoming increasingly common in the executive suite, with Kanas’ merely the grossest.

When employees receive benefits that have a dollar value—relocation expenses, certain health benefits, severance payments—the IRS frequently regards them as income. To insulate employees from paying taxes on such compensation, which frequently isn’t really take-home pay, companies reimburse them by providing gross-up payments.

But in recent years, gross-ups have been pushed up the corporate ladder from relocated middle managers to the bosses, thanks to several forces. First, Congress in the 1980s passed a special excise tax on golden parachutes. Just like a later congressional effort to rein in executive pay—doing away with the taxable deduction of cash salaries of more than $1 million—this one backfired. The measure, meant to discourage the awarding of large golden-parachute payments, instead pushed boards to increase them in order to cover the additional tax.

Gross-ups generally lay dormant for much of the 1990s, when stock options were all the rage. Back then, companies could easily funnel oodles of compensation to bosses in a tax-efficient manner by granting them options. When CEOs exercised options, they’d sell the stock at their own leisure and discretion and happily pay the resulting capital gains and income taxes out of their own pockets. But in the last several years, the stock market has generally moved sideways, and investors have started to pay more attention to executive compensation packages. As a result, pay packages have moved away from options and toward restricted stock, backloaded retirement packages, and access to corporate jets. All these are forms of compensation and can trigger tax obligations. And as these packages have gotten larger and more complex, so, too, have the gross-ups.

Mark Maremont documented many of them in the Wall Street Journal last year. (Here’s the piece, reprinted in the Pittsburgh Post-Gazette.) When the Journal commissioned compensation consultant Equilar Inc. to do a study of the 100 largest companies, it found that “52% of companies disclosed they paid gross-ups to one or more top executives [in 2004], up from 38% in 2000.” Maremont noted, for example, that Home Depot CEO Bob Nardelli gets reimbursement “for taxes due on a slew of perks, including a high-end luxury car, his family’s travel on Home Depot jets and forgiveness of a $10 million loan. Last year, these payments amounted to at least $3.3 million, topping Mr. Nardelli’s $2 million base salary.”

From a company’s perspective, the nice thing about gross-ups is that they are buried deep in financial reports and often don’t appear in the basic compensation tables that investors read. In early March, it was reported that ex-Citigroup CEO Sanford Weill’s compensation for 2005 totaled $21.5 million. But you have to dig down deep into Citigroup’s annual report to see the value of the nearly $1 million gross-up he received (see Page 40).

At Morgan Stanley, the absurd compensation package of canned CEO Philip Purcell has received most of the ink, with its stipulations that Morgan Stanley will continue to make a $250,000 charitable donation in his name each year and fund the salary of his secretary. But little has been said about the generous gross-up provisions for his successor, noted cost-cutter John Mack.

Fortunately, snoops like Slate contributor Michelle Leder dig through the filings to find gross-ups, like this one at chemical company Huntsman Corp. But the work is getting harder, in part because companies keep changing the lingo. At AT&T, Leder notes, former Chairman David Dorman received a $20 million severance package plus “an estimated $11,127,981 to offset certain excise taxes under Section 4999 of the Internal Revenue Code so that he would remain in the same after-tax position he would have been in had the excise tax not been imposed.” Voilà!The lawyers have managed to make a huge chunk of executive compensation sound like a yoga pose—the after-tax position.

Gross-ups are an absurd example of CEO-only behavior. Sure, middle managers can receive them for comparatively minor expense reimbursements. But when middle managers and secretaries and traders—and even most senior executives—receive bonuses or sell restricted stock, they pay taxes on the proceeds. It’s only CEOs who get to duck the taxes on their generous payouts.

It is said that death and taxes are the only two sure things in life. Gross-ups have allowed CEOs of large companies to effectively cheat the latter—on their shareholders’ dimes. It’s a safe bet that if science comes up with a super-expensive procedure that can cheat death, the CEOs of big public companies will find a way to get it written into their employment agreements—tax free.