Corporations that issued stock options to their executives claimed tax deductions that were collectively $52 billion larger than the expenses shown on their books in 2008, according to newly released data.

Senate Permanent Subcommittee on Investigations Chairman Carl Levin, D-Mich., highlighted the IRS data Wednesday. “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,” he said in a statement.

IRS data from 2008 shows that U.S. companies reduced their taxes by billions of dollars by claiming $52 billion more in stock option tax deductions than the stock option expenses shown on their books, Levin noted. The figures from prior years are $48 billion in excess stock option tax deductions in 2007; $61 billion in 2006; and $43 billion in 2005. 

To address the mismatch between the treatment of stock options on companies’ books and tax returns, Levin and Sen. John McCain, R-Ariz., have introduced S. 1491, the Ending Excessive Corporate Deductions for Stock Options Act. This legislation would curb excessive corporate tax deductions for stock options, by requiring that the corporate tax deduction for stock option compensation be no greater than the expense shown on corporate financial reports filed with the Securities and Exchange Commission.

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 Tax Code, on the other hand, provides that companies deducting stock option expenses on their tax returns 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.

This stock option data, compiled by the IRS at Levin’s request, is taken from four years of M-3 tax return schedules, from 2005 to 2008, 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 latest data is taken from M-3 schedules covering corporate year-end tax returns filed between July 1, 2007, and June 30, 2008. The IRS determined that corporations deducted a total of $86 billion during the year, exceeding the stock option expenses recorded on their books by $52 billion.

The IRS also found that the $52 billion stock option book-tax difference was the largest single factor in reported corporate book-tax differences that year. In addition, the IRS data showed that 72 percent of the $52 billion in excess stock option tax deductions were claimed by only 250 corporations.

“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 excessive corporate stock option deductions would likely produce as much as $5 to $10 billion annually, and perhaps as much as $15 billion, 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, and it makes no sense for taxpayers to be subsidizing stock option pay for corporate executives.”

In addition to revising the corporate tax deduction for stock options, the Levin-McCain bill would subject stock option pay for top corporate executives to the existing $1 million cap on the tax deductions that publicly traded corporations can now claim for executive pay under Section 162(m) of the Tax Code.  

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