Sen. Carl Levin, D-Mich., and John McCain, R-Ariz., have introduced legislation aimed at curbing excessive corporate tax deductions for stock options.

The bill would require the corporate tax deduction for stock option compensation to be not greater than the stock option book expense shown on a corporation’s financial statement; and 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.

The bill would also ensure that research tax credits use the same stock option deduction when computing the “wages” eligible for this tax credit; and make no changes to stock option compensation rules for individuals, or for incentive stock options under Tax Code Section 422, which are often used by start-up companies and other small businesses.

“Current stock option accounting and tax rules are out of kilter, leading corporations to report stock option expenses on their financial books at one value, and later on using a different value when claiming an expense on their tax returns,” said Levin in a statement. “Stock option tax deductions in excess of book expenses often produce huge tax windfalls for companies that pay their executives with large stock option grants.”

In addition, the bill would create a transition rule that 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. The bill would also eliminate favored treatment of corporate executive stock options under Tax Code Section 162(m) by making executive stock option compensation deductions part of the existing $1 million cap on corporate deductions that applies to other types of compensation paid to the top executives of publicly held corporations.

This bill, the Ending Excessive Corporate Deductions for Stock Options Act, S. 1491, is the product of an investigation conducted by the Permanent Subcommittee on Investigations, chaired by Levin, 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 Securities and Exchange Commission using the fair value of the options on the date they are granted to executives. These rules, which took effect in 2005, were 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. Prior to that action by the FASB, most companies treated stock options as having no value on their books.

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.

Because the current Tax Code allows corporations to take tax deductions for the values of stock option compensation on the exercise date, as opposed to the grant date (as required by accounting rules), corporations are often able to claim tax deductions that are many times larger than their book expenses. Under current law, stock options are the only compensation expense where the Tax Code allows corporations to deduct more than the expenses shown on their books.

In June 2007, the subcommittee held a hearing presenting nine case histories in which a company’s stock option expenses, as calculated on the exercise date, resulted in tax deductions that were many times larger than the grant date expenses on the company’s books. Nine companies cooperating with the subcommittee calculated that, altogether, the amount of stock option tax deductions they claimed from 2002 through 2006 was about five 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. These nine companies reported about $1.2 billion in total tax deductions, compared to a projected total of $217 million in stock option expenses on their books, for a book-tax difference of about $1 billion.

The subcommittee has also obtained data from the Internal Revenue Service on stock option book-tax differences for U.S. corporations as a whole. The data, compiled by the IRS from the M-3 tax return that requires U.S. corporations to explain their book-tax differences, shows that, for corporate tax returns filed from July 1, 2005, to June 30, 2006, the first full year in which it was available, companies’ stock option tax deductions totaled about $61 billion more than the stock option expenses on their books. Similar data for July 1, 2006, to June 30, 2007, showed that the excess stock option tax deductions totaled about $48 billion. In addition, the IRS data shows that nearly 60 percent of the excess tax deductions in 2007 were attributable to only 100 corporations; 75 percent were attributable to only 250 corporations.

“Eliminating unwarranted and excess 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,” said Levin.

According to an Equilar Inc. analysis of SEC filings, the CEO of Oracle Corp. collected $543 million in stock options gains in 2008. The CEO of Qualcomm collected $209 million in stock options gains in 2008, while the CEO of Occidental Petroleum collected $184 million. As those options gains are locked in, these three enormous gains will mean hundreds of millions in tax deductions for their companies, despite corporate book expenses that were likely much less.


Register or login for access to this item and much more

All Accounting Today content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access