|
Introduction
In
the US there is a broad division between stock
ownership schemes that benefit widely defined
types of employee and attract tax benefits (called
'qualified' schemes) and discretionary schemes
which receive less interesting tax treatment,
often called 'broad' stock option schemes. US
qualified schemes are often tied to retirement
schemes under ERISA.
At
least 200 large public companies provide stock
option schemes to all their employees, as well
as many thousands of private companies. In one
survey of electronics companies, just over half
the responding companies said they provide options
to most or all employees, with companies under
100 employees being the most likely to do so.
A 1997 study by the NCEO concluded that at least
5 million employees now work for companies that
offer stock options to most or all full-time
employees meeting minimal service requirements.
However,
the most typical form of employee ownership
in the US is the qualified scheme known as an
employee stock ownership plan, or ESOP, followed
up by schemes using the 401(k) retirement structure.
Broad
ownership schemes, and limited schemes for senior
executives or other special categories of employee
are more likely to use discretionary schemes
known as incentive stock options and employee
stock purchase plans, both of which receive
limited tax benefits under the IRS Code.
As
in some other countries, the position of an
expatriate executive who becomes tax-resident
and has existing overseas share options can
be very negative; likewise, a resident alien
(foreigner) who acquires stock options while
working in the US and then returns home may
be in a very complex and disadvantageous tax
situation. Expert advice is essential for such
individuals.
In
2003 the International Accounting Standards
Board (IASB) and the Financial Accounting Standards
Board (FASB) moved towards requiring equity
compensation expensing, ie that share options
should be charged as an expense. Both organisations
applied their new standards with effect from
2005.
In
June 2007, a Senate subcommittee hearing on
the vexed issue of executive stock options concluded
that new tax and accounting rules are needed
to bring more transparency for investors regarding
CEO pay, and to rein in huge and undeserved
salaries enjoyed by some bosses at non-performing
companies.
The
hearing, held by the Senate’s Permanent
Subcommittee on Investigations examined corporate
accounting and tax rules that require corporations
to report one set of stock option compensation
figures to investors on their financial statements
and completely different figures to the Internal
Revenue Service on their tax returns.
Three
Fortune 500 companies that were among the nine
who helped the Subcommittee with its calculations
contributed to the hearing, along with the Acting
Commissioner of the IRS Kevin Brown, the SEC
Director of Corporation Finance, and three stock
option experts.
“Stock
options are a major factor in the growing gap
– now chasm – between executive
pay and average worker pay,” said Sen.
Carl Levin (D - Mich), subcommittee chairman.
“Companies pay their executives with stock
options in part because, right now, those stock
options often generate huge tax deductions that
are 2, 3, even 10 times larger than the stock
option expense shown on the company books."
Levin
said that nine companies examined by the subcommittee
claimed stock option tax deductions over five
years that exceeded their stock option expenses
by more than $1 billion, or 575%, even after
using tougher new accounting rules to calculate
the book expense.
New
IRS data, examining tax returns for periods
ending between December 2004 to June 2005, shows
a stock option book-tax gap of $43 billion,
"which means US companies legally reduced
their taxes by billions of dollars for that
period by claiming $43 billion more in stock
option tax deductions than the stock option
compensation amount shown on their books,"
Levin stated.
"Those
companies did not break the law," he continued.
"They are benefiting from an outdated and
overly generous stock option tax rule that produces
tax deductions that often far exceed the companies’
reported expenses.”
Stock
options give employees the right to buy company
stock at a set price for a specified period
of time, usually 10 years. According to Forbes
magazine, in 2006, the average pay of the chief
executive officers of 500 of the largest US
companies was $15.2 million. Nearly half of
that amount, 48%, came from exercised stock
options that produced average gains of about
$7.3 million. On the high end, one CEO cashed
in stock options for $290 million, another for
$270 million. Forbes also published a list of
30 CEOs in 2006, who each had at least $100
million invested stock options that had yet
to be exercised. In the United States, average
CEO pay has grown from100 times average worker
pay to nearly 400 today, according to Levin.
“Stock
options are valuable and legitimate incentive
tools used to reward and retain high performing
executives,” said Norm Coleman (R - Minn),
ranking member of the subcommittee. “However,
anything can be problematic in excess, and I
fear we have reached that point. It is clear
that favorable tax and accounting rules have
caused companies to issue far too many stock
options on far too generous terms, greatly contributing
to the meteoric rise in executive pay."
Publicly
traded corporations are required by law to follow
Generally Accepted Accounting Principles (GAAP)
issued by the Financial Accounting Standards
Board (FASB), which is overseen by the Securities
and Exchange Commission (SEC). Until recently,
GAAP allowed corporations to show a zero expense
on their financial statements for most stock
options. In 2005, FASB issued a new accounting
rule, Financial Accounting Standard (FAS) 123R,
requiring companies to show an expense on their
books equal to the stock options’ fair
value on the date they are granted.
Under
Section 83 of the tax code, first enacted in
1969, the stock option tax deduction does not
reflect the expense shown on a company’s
books. Instead, the stock option deduction is
calculated on the date that a stock option is
exercised, which is often years after it is
granted. The deduction is equal to the difference
between what the employee paid to exercise the
option and the market value of the shares on
the exercise date.
Because
the accounting rule values stock options on
their grant date, and the tax deduction values
stock options on their exercise date, the two
numbers do not match. The data indicates that,
in most cases, the tax deduction exceeds the
book expense. Stock options are the only type
of compensation expense where companies are
allowed to take a tax deduction that exceeds
the expense shown on their books.
“It
is time to take a serious look at whether it
makes sense to have two completely different
sets of stock option rules for financial accounting
and tax purposes,” said Levin, “especially
when the result is a revenue loss of billions
of dollars.”
BACK
TO TOP
|
