Senate Permanent Subcommittee on Investigations Releases New Data on $61 Billion Stock Option Book-Tax Gap

New Data Shows Continued Outsized Tax Deductions Compared to Booked Expenses

WASHINGTON – Today, Sen. Carl Levin, D-Mich., Chairman of the Senate’s Permanent Subcommittee on Investigations, released new data compiled by the Internal Revenue Service (IRS) showing that corporations who issued stock options to their executives claimed 2005 stock option tax deductions that were collectively $61 billion larger than the expenses shown on the company books for options granted during the tax year covered by the returns. “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. “IRS data shows that U.S. companies legally reduced their 2005 taxes by billions of dollars by claiming $61 billion more in stock option tax deductions than the stock option expenses shown on their books. Those companies did not break the law; they benefited from an outdated and overly generous stock option tax rule that produces tax deductions that often far exceed the companies’ reported expenses. It’s a stock option tax break we can no longer afford and ought to end.” Last year, Levin introduced S. 2116, the Ending Corporate Tax Favors For Stock Options Act, 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). Stock options give the holder the right to buy company stock at a set price for a specified period of time, typically ten years. Many U.S. corporate executives receive stock options as part of their pay. According to Forbes magazine, in 2006, the average pay of the Chief Executive Officers (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. Current accounting rules, under Financial Accounting Standard 123R, require corporations to report stock option expenses on their financial statements using the fair value of the options on the date they are granted. 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 federal tax code, on the other hand, requires companies deducting stock option expenses on their tax returns to 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. Because current accounting rules value stock options on their grant date, and the tax code values stock options on their exercise date, the two numbers do not match. Stock option data from the past two years shows that the resulting corporate tax deductions, taken as a whole, far exceed the expenses shown on corporate books. The stock option data comes from IRS analyses, performed at Levin’s request, of M-3 tax return schedules filed by large corporations required to explain the differences between what they report on their tax returns versus what they report on financial statements. The M-3 schedules include figures supplied by companies who reported one total for their stock option expenses on their tax returns and a different total on their financial statements. The IRS has now analyzed two years of this stock option data. The latest IRS analysis, which was provided to the Subcommittee, examines data from M-3 schedules covering corporate year-end tax returns filed between July 1, 2005, and June 30, 2006, and is referred to by the IRS as 2005 stock option data. The IRS determined that the $61 billion book-tax difference attributable to stock options is the largest single factor in reported corporate book-tax differences for that year. The IRS also found that 66% or two-thirds of the $61 billion book-tax difference is attributable to just 250 companies. Last year, the IRS analyzed data from M-3 Schedules covering corporate year-end tax returns filed between December 31, 2004 and June 30, 2005, and determined that the stock option book-tax difference was $43 billion. This 2004 data covered only seven months of returns, because the M-3 Schedule had become mandatory for the first time on December 31, 2004. Later refinements of this data by the IRS increased the 2004 stock option book-tax difference to a final figure of $49 billion. The 2005 stock option book-tax difference of $61 billion is substantially greater than the 2004 book-tax difference of $49 billion, primarily because the 2004 data covered only seven months of tax returns, while the 2005 data covers twelve months. “In 2004, corporations took stock option tax deductions totaling $49 billion more than the expenses shown on their books, and in 2005, the figure was $61 billion. That’s $110 billion in excess corporate stock option tax breaks in just two years, which is a staggering amount,” said Levin. The Levin bill to require stock option tax deductions to match the stock option expenses shown on company books was introduced after a June 2007 hearing held by his Subcommittee. That hearing disclosed the 2004 stock option book-tax data compiled by the IRS. It also disclosed data compiled by nine companies which, in cooperation with the Subcommittee, had traced specific executive stock option expenses. The nine companies calculated that the amount of stock option tax deductions they had claimed from 2002 through 2006 was about 5 times greater than the expenses they would have reported to the SEC if current stock option accounting rules had been in effect when the options were granted. These nine companies alone 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. “My 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,” said Levin. “The tycoon J.P. Morgan said about a century ago that CEO pay should not exceed 20 times average worker pay. But right now, in the United States, average CEO pay is nearly 400 times average worker pay. Stock options are a major factor in that pay gap, and one reason companies keep handing out stock options is because they can generate huge corporate tax deductions that are 2, 3, even 10 times larger than the stock option expense shown on the company books.” The Levin bill 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. “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 could be spent on health care costs, education, the mortgage crisis, or other important needs.” “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.” S. 2116 was referred to the Senate Finance Committee in September 2007. No further action has been taken on the bill to date. ### CONTACT: Tara Andringa 202-228-3685