Levin Introduces Bill to End Double Standard in Corporate Tax Break for Executive Stock Options

Current Tax Practice Encourages Large Stock Option Grants to Corporate Executives, Fuels Huge Pay Gap, and Costs Billions in Lost Tax Revenue

WASHINGTON – Today, citing a mismatch between the requirements for book and tax treatment of executive stock options, Sen. Carl Levin, D-Mich., Chairman of the Senate Permanent Subcommittee on Investigations, introduced legislation to require the federal corporate tax deduction for stock option compensation to be the same as the expense shown on corporate financial reports filed with the Securities and Exchange Commission (SEC). “Current stock option accounting and tax rules are out of kilter, lead to corporations reporting inconsistent stock option expenses on their financial books versus their tax returns, and often produce huge tax windfalls for companies that pay their executives with large stock option grants,” said Levin. “Our bill would end the double standard of companies deducting more from their taxes than the stock option expenses shown on their books. By eliminating this outdated and overly generous corporate tax deduction, we would eliminate a tax incentive that encourages corporate boards to hand out huge executive stock option pay which, in turn, fuels the growing chasm between executive pay and the earnings of rank and file workers. The tycoon J.P. Morgan said about a century ago that CEO pay should not exceed 20 times average worker pay. Right now, in the United States, average CEO pay is nearly 400 times average worker pay.” The Levin bill, the Ending Corporate Tax Favors For Stock Options Act, has been endorsed by the Consumer Federation of America, Citizens for Tax Justice, Tax Justice Network-USA, OMBWatch, the Financial Policy Forum, and the AFL-CIO. Stock options give the holder the right to buy company stock at a set price for a specified period of time, typically ten years. Most U.S. CEOs receive stock options as part of their pay. According to Forbes magazine, in 2006, the average pay of CEOs at 500 of the largest U.S. companies was $15.2 million. Nearly half of that amount, 48%, came from stock options that had been cashed in for an average gain of $7.3 million. The bill is the product of an investigation by Levin’s Subcommittee into the different book and tax reporting requirements for executive stock options. Current accounting rules, under Financial Accounting Standard 123R, require companies to report stock option expenses on financial statements filed with the SEC using the fair value of the options on the date they are granted to executives. These rules, which took effect in 2005, are the result of more than 15 years of work by the Financial Accounting Standards Board to devise a fair and accurate method for calculating stock option expenses. Section 83 of the tax code, on the other hand, provides that companies that want to deduct stock option expenses on their tax returns must use the value realized when the stock options are exercised, an event which often occurs years after the options were granted. These tax rules, essentially unchanged since 1969, have yet to be coordinated with the new accounting rules. Under current law, stock options are the only compensation expense where the tax code allows corporations to deduct more than their actual expenses. A Levin Subcommittee hearing, in June 2007, showed that stock option expenses calculated on the exercise date typically result in tax deductions that are many times larger than the grant date expenses shown on company books. Nine companies cooperating with the Subcommittee calculated, for example, that the amount of stock option tax deductions they claimed from 2002 through 2006 was about 5 times greater than the expenses they would have reported to the SEC if the new accounting rules had been in effect when the options were granted. The nine companies reported about $1.2 billion in total tax deductions for stock option expenses that would have totaled about $217 million on their books, for a book-tax difference of about $1 billion. The Subcommittee also asked the IRS for data on stock option book-tax differences for U.S. corporations as a whole. This data, compiled by the IRS from a new M-3 tax return requiring U.S. corporations to explain their book-tax differences, shows that, for corporate tax returns filed primarily in 2004, companies reported a total of about $43 billion more in stock option tax deductions than the stock option expenses shown on their books. The IRS data found that only 250 companies accounted for 82% of this total difference. The IRS also determined that stock options were a key factor in why corporations reported different income on their books compared to their tax returns. “Requiring companies to limit their stock option tax deductions to the amount of stock option expenses shown on their books would eliminate billions of dollars in unwarranted corporate tax deductions each year,” said Levin. “Eliminating unwarranted and excess stock option deductions could mean as much as $5 to $10 billion annually in additional corporate tax revenues that we can’t afford to lose.” “It makes no sense to have two sets of rules for expensing stock options for accounting and tax purposes,” he added, “and it makes no sense for taxpayers to be subsidizing stock option pay for corporate executives. The bill would eliminate this stock option double standard, end existing tax favors for stock options, and remove a federal tax policy that now inadvertently fuels sky-high executive pay.” In addition to revising the corporate tax deduction for stock options, the bill would make stock option pay for top corporate executives part of the same $1 million cap on the tax deductions that can now be claimed by publicly traded corporations for other forms of executive pay under Section 162(m) of the tax code. Bill Summary. The bill would: • match the corporate tax deduction for stock option compensation to the stock option book expense shown on the corporation’s financial statement; • allow corporations to deduct stock option compensation in the same year it is recorded on the company books, without waiting for the options to be exercised; • ensure research tax credits use the same stock option deduction when computing the “wages” eligible for this tax credit; • create a transition rule which would apply the new tax deduction to stock option exercises occurring after enactment, permit the old tax deduction rule to apply to options vested prior to adoption of Financial Accounting Standard 123R (June 15, 2005), and allow a catch-up deduction in the first year after enactment for options that vested after adoption of FAS 123R but before the date of enactment; and • eliminate favored treatment of corporate executive stock options under tax code section 162(m) by making executive stock option compensation deductions part of the exising $1 million cap on corporate deductions that applies to other types of compensation paid to the top executives of publicly held corporations. CONTACT: Tara Andringa 202/228-3685 Tara_Andringa@levin.senate.gov