The NASPP Blog

August 4, 2009

More on Ending Excessive Corp Deductions for Stock Options

Last week I discussed Senators Carl Levin and John McCain’s bill “Ending Excessive Corporate Deductions for Stock Options.” As promised, this week I have a few more thoughts on this legislation.

More on Senator Levin’s Bill, Starting with ISOs
Right now, ISOs are a potential boon in terms of federal tax revenue–if employees hold their ISO shares long enough to meet the statutory holding periods, the company forgoes its tax deduction but employees still pay tax on the gain. On top of that, some employees are forced to “pre-pay” the tax due upon sale in the form of AMT. But if Levin’s bill is passed, companies would receive a tax deduction for ISOs whether or not employees meet the statutory holding period or even exercise the options.  There would be little reason for companies to grant NQSOs until forced to by the $100,000 limitation, potentially reducing tax revenue even further. 

Why Not Restricted Stock?

Another significant weakness in Levin’s bill is that it ignores restricted stock. I’ve never understood the media and regulator bias for restricted stock. It seems to me that stock options, which contribute capital to the company and which require the stock price to increase before producing any gains for executives, are a better form of compensation than just handing out stock for free. Yet, Levin’s bill would do nothing to address the inequities between book expense and corporate tax deductions for restricted stock.

This would bifurcate the tax accounting required for options versus other types of stock compensation (restricted stock, performance awards, ESPPs), ultimately making the financial reporting for stock compensation more confusing than it already is today.

No Performance-Based Compensation Exception Under 162(m)

Levin’s bill would also exclude “stock option compensation” from qualifying for the performance-based compensation exemption on Section 162(m). This would generate additional tax revenue by including stock option gains in the compensation in excess of $1 million that companies can’t take a deduction for, but, of course, this limit only applies to the company’s named executive officers. It’s hard to say whether this would make up for the lost revenue from tax deductions realized on underwater stock options.

Crunching the Numbers

I looked at a few companies to see which method (Levin’s or the current tax code) produced a bigger tax deduction.  Of course, the first company I looked at–Exxon Mobil (why not start with #1 on the Fortune 500 list)–doesn’t grant stock options, further proving my point about restricted stock.  So I looked at #3, which is Chevron.  In 2008, they recognized $154 million in expense for stock options (excluding options granted to NEOs) and their aggregate intrinsic value for exercises that year was $433 million, so Chevron did better last year with the current tax code.  Then I looked at Time Warner (yes, jumping down to #48 on the Fortune 500–it’s not like I have time to analyze all 500 companies and it’s a challenge to find companies that grant stock options and disclose the expense for their options separately from the rest of their stock plan expense).  Time Warner recognized option expense of $132 million (exclusive of options granted to NEOs) with an aggregate intrinsic value for exercises last year of only $53 million. So Time Warner would have realized a greater tax savings under Levin’s bill than under the current system.  You win some; you lose some.

I looked at several companies that implemented option exchange programs this year (Nvidia, Google, a few others) and all would have come out ahead under Levin’s method, but I admit that looking at these companies was stacking the deck.

It would be fascinating to see an analysis of more than just a few random companies.  Got some free time on your hands? 

NASPP Conference Workshop of the Week
This week’s workshop is “Night of the Living Dead: Equity Compensation Horror Stories.” From IRS auditors, to natural disasters, to misfired communications, we all love to hear about–and learn from stock plan misfortunes. This panel has lined up some doozies for you! Thrill to tales of stock plan disasters with “The Equity Plan Massacre,” lay awake at night dreading the stock exchange and transfer agent horrors in “Nightmare on Wall Street,” and try not to scream during the blood chilling compliance thrills of “Invasion of the IRS Auditors.” This panel will frighten you with nightmares and set you on the path to safety with recommendations on how to avoid similar misfortunes.

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 

– Barbara