Latest CEO Pay Outrage: Two Sets of Books – Sign Petition

Sen. Carl Levin, D-Mich., and Sen. Sherrod Brown, D-Ohio, announced they introduced legislation to end tax breaks for stock options. As pointed out by Paul Hodgson – Chief Communications Officer of The Corporate Library:

Since they are considered performance-related pay, stock option expense is subject to corporate tax relief under Section 162(m) of the IRC. However, the tax relief is given on the actual expense of the stock options, based on the profits made by the executives at the time the options are exercised. This, Sen. Levin and Sen. Brown have discovered, is a much larger figure than the expenses recorded in company accounts, which estimates the cost of the option at its grant date. This differential, the senators claim, is a huge corporate tax break, and closing the loophole would net the Treasury about $25 billion.

This is priceless information and an eye-popping piece of legislation and there are almost too many conclusions here for one little blogger to deal with.

1. If this is true, companies are seriously underestimating the costs associated with stock options, thus bamboozling shareholders and the markets.

2. If this is true, companies are seriously underestimating the amount of pay being granted to their executives, thus bamboozling everyone.

3. If this is true, I was right all along in insisting that the SEC use the amount recorded as profit as the proper record of pay for executives, even though it ignored me.

4. If this is true, virtually every other pay survey – apart from ours – is not just wrong but seriously underestimates the amount of pay that executives receive.

But the real doozy is left to the end, in the summary of the bill. Just read this:

  • make stock option deductions subject to the existing $1 million cap on corporate tax deductions for compensation paid to top executives of publicly held corporations.

In other words, stock options will no longer be considered performance-related pay under Section 162(m). That’s fine by me. I never thought market-priced stock options should be in the first place. Of course, there should be exceptions – premium-priced options, index-linked options, performance-vesting options. But if this went through this would be the death knell of the market-priced option for all but the smallest companies which aren’t affected by the $1million cap anyway.

And no bad thing either.  An End to Tax Breaks for Stock Options? – The Corporate Library Blog

IRS data released by Sen. Levin shows that, each year from 2005 to 2009, corporations as a whole took U.S. tax deductions for stock options that were billions of dollars greater than the expenses shown on their financial statements.  The IRS data also showed that a relatively small number of corporations took the majority of those excess deductions:  in 2005, 2007, and 2008, about three-quarters of all excess deductions were claimed by 250 corporations, out of the millions that filed corporate tax returns each year.

According to Levin and Brown, The Ending Excessive Corporate Deductions for Stock Options Act would:

  • require the corporate tax deduction for stock option compensation not to exceed the stock option book expense shown on a corporation’s financial statement;
  • allow corporations to deduct stock option compensation on their tax returns in the same year it is recorded on the corporate books, without waiting for the options to be exercised;
  • ensure research tax credits use the same method for calculating stock option pay expenses when computing wages eligible for the tax credit;
  • make no changes to stock option compensation rules for individuals, or for incentive stock options under Section 422 of the tax code which may be used by start-up companies and other small businesses;
  • create a transition rule to ensure stock options granted before the enactment date are tax deductible; and
  • make stock option deductions subject to the existing $1 million cap on corporate tax deductions for compensation paid to top executives of publicly held corporations.

Levin’s floor statement as he introduced S. 1491 concludes:

Over the last five years, the stock option book-tax gap has ranged from $12 billion to $61 billion per year, generating deductions far in excess of corporate expenses.   Corporations have avoided paying their fair share to Uncle Sam by simply giving their executives the right to tap huge sums of money from the stock market.  It is a tax policy that forces ordinary taxpayers to subsidize outsized executive compensation and that favors corporations doling out stock options over paying their executives in cash.

Right now, stock options are the only compensation expense where the tax code allows companies to deduct more than their book expense.  In these times of financial distress, we cannot afford this multi-billion dollar loss to the Treasury, not only because of the need to reduce the deficit, but also because the stock option tax deduction contributes to the anger and social disruption caused by the ever deepening chasm between the pay of executives and the pay of average workers.

The Obama Administration has pledged itself to closing unfair corporate tax loopholes and to returning sanity to executive pay.  It should start with supporting an end to excessive stock option corporate deductions.  I urge my colleagues to include this legislation in any deficit reduction package this year, or to pass it separately.

Please sign our petition to Congress to support S. 1491.

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