[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
EMPLOYEE STOCK OPTION PLANS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON OVERSIGHT
of the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
__________
OCTOBER 12, 2000
__________
Serial 106-67
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
67-812 CC WASHINGTON : 2000
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
______
Subcommittee on Oversight
AMO HOUGHTON, New York, Chairman
ROB PORTMAN, Ohio WILLIAM J. COYNE, Pennsylvania
JENNIFER DUNN, Washington MICHAEL R. McNULTY, New York
WES WATKINS, Oklahoma JIM McDERMOTT, Washington
JERRY WELLER, Illinois JOHN LEWIS, Georgia
KENNY HULSHOF, Missouri RICHARD E. NEAL, Massachusetts
J.D. HAYWORTH, Arizona
SCOTT McINNIS, Colorado
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisory of October 5, 2000, announcing the hearing.............. 2
WITNESSES
American Benefits Council, and Monsanto Company, Wilma Schopp.... 19
Frederic W. Cook & Co., Frederic W. Cook......................... 6
National Association of Stock Plan Professionals, Sandra L.
Sussman........................................................ 26
Proxicom, Inc., Christopher Capuano.............................. 14
U.S. Chamber of Commerce, and Hewitt Associates, Michael J.
Butler......................................................... 27
SUBMISSION FOR THE RECORD
Amazon.com, Inc., Seattle, WA, Robert D. Comfort, letter......... 38
EMPLOYEE STOCK OPTION PLANS
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THURSDAY, OCTOBER 12, 2000
House of Representatives,
Committee on Ways and Means,
Subcommittee on Oversight,
Washington, DC.
The Subcommittee met, pursuant to notice, at 10:30 a.m., in
room 1100, Longworth House Office Building, Hon. Amo Houghton,
(Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON OVERSIGHT
CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE
October 5, 2000
No. OV-24
Houghton Announces Hearing on Employee Stock Option Plans
Congressman Amo Houghton (R-NY), Chairman, Subcommittee on
Oversight of the Committee on Ways and Means, today announced
that the Subcommittee will hold a hearing to examine the
Federal tax treatment of employee stock option plans under
current law. The hearing will take place on Thursday, October
12, 2000, in the main Committee hearing room, 1100 Longworth
House Office Building, beginning at 10:30 a.m.
Oral testimony at this hearing will be from invited
witnesses only. Invited witnesses include representatives from
the U.S. Department of the Treasury and the private sector,
including representatives from trade organizations and benefit
groups. However, any individual or organization not scheduled
for an oral appearance may submit a written statement for
consideration by the Committee and for inclusion in the printed
record of the hearing.
BACKGROUND:
Businesses generally can offer their employees one of three
types of stock option plans: (1) non-qualified stock options,
(2) incentive stock options, and (3) employee stock purchase
plans. Each type of stock option is treated differently under
the Internal Revenue Code (I.R.C.).
Non-qualified stock options are the most utilized form, and
their tax treatment is found in section 83 of the I.R.C.
Typically, non-qualified options are granted by businesses to a
set of employees on a date certain and must be exercised within
a certain time limit. For publicly-traded companies, the price
at which employees may purchase the options (the grant price)
is generally the value of the stock at the close of the markets
on the day that the options are granted. There are no tax
consequences to either the employee or the business at the time
of grant. When the employee exercises an option, he or she
recognizes ordinary income on the difference between the value
of the stock when exercised and the grant price. Income and
employment taxes must be withheld. The employer is entitled to
a deduction equal to the amount of ordinary income recognized
by the employee. If the employee holds the stock for 12 months
after the day he or she exercises the options before selling,
he or she recognizes long-term capital gain on the difference
between the sale price and the exercise price.
A company may offer an unlimited amount of non-qualified
options to its employees (subject only to shareholder
approval). The company may offer non-qualified options only to
its officers or to all of its employees; there are no tax or
Employee Retirement Income Security Act (ERISA) requirements
limiting the amount of options that may be granted to highly
compensated employees vis-a-vis rank and file employees.
The tax treatment of incentive stock options is found in
section 422 of the I.R.C. Generally, incentive stock options
may only be granted at a price, not less than the fair market
value, on the day they are granted. The maximum value that may
vest for the first time in any given year is $100,000 based on
the value of the option on date the options are granted.
Incentive options must also be exercised within 10 years of the
date they are granted. There are no tax consequences to either
the employee or the business when the options are granted. When
the employee exercises the options, he or she does not
recognize ordinary income but may be subject to the alternative
minimum tax. If the employee holds the stock for longer than
two years from the day the options are granted and more than
one year from the day he or she exercises the options, he or
she recognizes long-term capital gain on the difference between
sale price and grant price. If the holding requirements are
met, the company does not receive a deduction. If the holding
requirements are not met, incentive stock options are treated
as non-qualified options, and the employee generally recognizes
ordinary income on the difference between the fair market value
of the stock on the day of exercise and the price at which the
options were granted. No withholding is required for
disqualifying dispositions. In such circumstances, the company
would receive a deduction equal to the ordinary income
recognized by the employee.
A company may offer incentive stock options to its officers
or to all of its employees; there are no tax or ERISA
requirements limiting the amount of options that may be granted
to highly compensated employees vis-a-vis rank and file
employees.
The tax treatment of employee stock purchase plans is found
in section 423 of the I.R.C. Employee stock purchase plans
differ from non-qualified options and incentive stock options
in that they must be offered to all employees. Typically,
employees are allowed to contribute a percentage of their
income (up to $25,000 per year), via a payroll deduction,
toward the purchase of company stock. For example, an employee
may contribute 10 percent of his income toward the purchase of
company stock from January 1 through June 30 of a given year.
On June 30, the amount contributed would be used to purchase
stock (the exercise of the option) at a price set under the
plan. The plan may allow the employee to purchase the stock at
the price of the stock at closing of June 30, or, as many plans
do, the plan may allow the employee to purchase the stock at
the lower of the prices on January 1 and June 30. Plans may
grant employees a discount of up to 15 percent below the price
of the stock. Similar to incentive stock options, there are no
tax consequences when an employee exercises the option for
either the employee or the company. If the employee holds the
stock for two years after the day they are granted and one year
after he or she exercises the options, he or she will recognize
ordinary income on the 15 percent discount but long-term
capital gain on the appreciation of the stock. The company
receives no deduction under these circumstances. If the
employee does not meet the holding requirements, he or she
recognizes ordinary income on the discount and short term
capital gain on the remaining amount. In this instance, the
company does receive a deduction. No income or employment tax
withholding is currently required for either the discount or
for disqualifying dispositions.
In announcing the hearing, Chairman Houghton stated:
``Stock option plans help employees become stakeholders in
their companies, which leads to an increase in productivity and
a sense of ownership within the business. We need to make sure
the law offers attractive incentives for employers to offer
stock option plans to all of their employees.''
FOCUS OF THE HEARING:
The focus of the hearing is to examine the Federal tax
treatment of stock option plans under current law and proposals
to strengthen incentives for employers to offer such plans.
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Any person or organization wishing to submit a written
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A.L. Singleton, Chief of Staff, Committee on Ways and Means,
U.S. House of Representatives, 1102 Longworth House Office
Building, Washington, D.C. 20515. If those filing written
statements wish to have their statements distributed to the
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200 additional copies for this purpose to the Subcommittee on
Oversight office, room 1136 Longworth House Office Building, by
close of business the day before the hearing.
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Chairman Houghton. Good morning everybody. The hearing will
come to order. We are delighted to have you here as a panel,
and we want to welcome you. We are here to discuss, as you all
know, the employee stock option plans. Promoting stock options
may sound far removed from the everyday concerns of working men
and women, but nothing could be further from the truth.
Employee-owned stock holds the promise of transforming our
free enterprise system. Two important features of the Federal
Tax Code provided a tremendous security to middle-income
Americans during the 20th century. First, the deductibility of
mortgage interest transformed a nation of renters into a nation
of homeowners; and secondly, tax incentives for employer-
sponsored pensions and for retirement savings have made it
possible for millions of working people to be secure in their
retirement years.
So, think for a moment how different our country would be
if we didn't have these incentives in our tax system. At the
beginning of the 21st century, I believe employee stock options
will make it possible for working middle-class, middle-income
Americans to become greater stakeholders in our free enterprise
system. Someone once said that the problem with socialism is
socialists and the problem with capitalism is capitalists.
That may be, but it seems to me that the only problem with
the capitalists is that there are not enough of them. Today we
are going to look at the tax treatment of stock option plans
under current law and what, if anything, needs to be done to
strengthen incentives for employers to offer them to a broader
base of employees.
Free enterprise is strong in America today because it has
offered security to many. It seems obvious to me that the next
step in broadening the base of our free enterprise system is to
allow for more working men and women to own stock in the
companies for which they work. So, I'm pleased to recognize our
senior Democrat on our subcommittee, the distinguished Mr.
Coyne from Pennsylvania, for an opening statement.
Mr. Coyne. Thank you, Mr. Chairman.
This hearing will provide the Ways and Means Oversight
Subcommittee with valuable information about the current tax
rules designed to encourage employers to offer employees the
opportunity to obtain stock in the companies for which they
work. Many hard-working Americans would like to have the chance
to become stockholders, not just employees, of the corporations
they work for.
The bipartisan legislation proposed by Chairman Houghton
deserves our close attention and support. Our tax laws
currently provide for various employee stock option
arrangements, which will be discussed today. In doing so, it is
important that we consider what more can be done to provide
employers with incentives to expand the availability of
employee stock options and to provide employees with incentives
to participate.
I want to commend Chairman Houghton for taking this
initiative to introduce the Universal Employee Stock Option Act
of 2000. I also want to commend the chairman for the
outstanding leadership that he has provided all through this
106th Congress on the Oversight Subcommittee on so many various
subjects that we have taken up.
Thank you.
Chairman Houghton. Thanks very much, Bill. I really
appreciate that. It has been wonderful working with you and I
look forward to doing so. Now, the distinguished gentlemen from
Ohio, Mr. Boehner. I am sure you have an opening statement. At
least, I hope so.
Mr. Boehner. Well, Mr. Chairman, let me commend you for
having this hearing today and thank you for the invitation to
join your panel. I think when we think about the new economy
today, we think in terms of technology. But the more important
factor in the new-economy companies is teamwork. American
businesses are learning that to compete successfully in the
global marketplace, they need to engage the full talents of
their workers, their teams, if you will, as never before.
I think they are finding their most important asset is not
their physical plant; it is the talent, cohesiveness and work
ethic of their entire workforce. That is why team-building is
replacing bureaucracy throughout our economy for companies that
make sofas in southwestern Virginia, as well as companies that
make Internet servers in Silicon Valley.
The new economy is not just about the Internet or
technology, rather it is about philosophies and technologies
that make the most of the human talent in any company. A
critical part of team-building is getting everyone on the same
page, making sure that everyone is motivated by common
interest. That is the value of stock options, by making the
employees a shareholder, stock options also make them valued
team members who see their interest and those of the rest of
the team as one and the same.
New-economy companies understand this. Stock options are a
part of almost any compensation package in the high-tech
sector, but increasing numbers of more-established companies
also understand the power of stock options and make them widely
available to their employees. Those companies range from 3M to
Pepsi, to Merrill Lynch and CitiGroup. Unfortunately, for
reasons that I think we will hear today, Federal law does not
maximize the potential benefit to workers and to employers that
stock options can't offer.
I am here today because I share Chairman Houghton's deep
commitment to changing that. He and I have introduced separate,
but complementary, bills in this Congress to address these
obstacles. I think this issue will be a compelling one,
certainly for the next Congress. A new economy means new
opportunities, and we in Congress should help our constituents
embrace those opportunities. Working together, I believe that
we will.
Chairman Houghton. Thanks very much, Mr. Boehner.
I would like to call the first panel and I would like to
ask Mr. Frederic Cook, of Frederic Cook & Co. in New York, to
begin the testimony.
STATEMENT OF FREDERIC W. COOK, CHAIRMAN, FREDERIC W. COOK &
CO., NEW YORK, NEW YORK
Mr. COOK. Thank you, Mr. Chairman, Mr. Coyne, Mr. Boehner.
It is a pleasure to be here today. My name is Fred Cook. I
represent the firm of Frederick W. Cook & Co., which is a
management compensation consulting firm. For 30 years, our firm
and a predecessor firm have advised corporations on the design
and administration of employee stock ownership and stock option
plans.
We are strong advocates of such plans and the sharing of
ownership and wealth-creation opportunities broadly in the
corporation because we believe that benefits our economy as a
whole. Do the members have my charts that are accompanied by
testimony, because I plan to speak from them?
Chairman Houghton. I think we do.
Mr. Cook. All right. On page one, I give a brief summary of
the current tax situation, which I will not go into detail
because it has been written up ably by the committee materials
in advance. I would merely point out that, of the three types
of plans available to employee stock options, please note that
one of the major advantages of tax qualification is there is no
tax at exercise. Tax is deferred until sale, at which time
there is long-term capital gains tax on the appreciation above
the value at grant if the holding period requirements are met.
That has been fundamental in tax legislation on stock
option since the 1950s. In exchange for that, on the two tax
qualified plans, employee stock purchase plans and incentive
stock options, the corporation forgoes its tax deduction. That
is the balance of the tax equation between employees and
corporations that was put in place with the Revenue Act of 1950
and with minor modifications remains in place today.
Let me next go to a quick summary of incentive stock
options under Code section 422 on chart two. The basic things
to have you focus on here, if I may, are that the employee
exercises the option with after-tax money; that is line one. In
line six, there is, as I mentioned earlier, no tax at exercise;
however, the gain at exercise is subject to the alternate
minimum tax as an item of tax preference. On line seven, to
reiterate, there is no corporate tax deduction at exercise or
at sale of the stock when capital gains applies to the
employees.
My comments here are that the imposition of the alternate
minimum tax discourages holding of the stock, and the lack of
corporate tax deduction is regarded by most corporations as
financially inefficient. Please note here that in giving
capital gains to employees versus ordinary income and thereby
letting employees obtain the tax differential between capital
gains and ordinary income, the corporation is giving up its
full tax deduction, which it otherwise obtains in non-qualified
plans.
So, to provide an incremental benefit to employees, the
corporation forgoes its full tax deduction in qualified plans.
That is what I mean by tax inefficiency on the corporate side--
and discourages the use of incentive stock options for key
employees. My comments and suggestions for consideration in tax
legislation are on chart three.
The basic ideas that I would present for the subcommittee's
consideration are that in line four, we consider encouraging
companies to spread the use of incentive stock options by
imposing a requirement that at least half of the shares granted
in any year go to non-highly-compensated employees, as defined
under Code Section 401.
With that in place, we would not really need the $100,000
maximum annual vesting limit that is in line five. I would
continue to exclude employee taxation at gain and would suggest
that the committee amend the Code so that the gain at exercise
of incentive stock option is no longer deemed an item of tax
preference income subject to the alternate minimum tax.
The employee taxation at sale, line eight, I would suggest
that the gain at exercise be ordinary income, rather than
capital gain and, in exchange for that, the company would be
allowed to deduct the same amount at exercise that the employee
is taxed as ordinary income when the stock is sold. That is a
timing difference, but is otherwise a matching of deduction and
personal income tax.
I see that I have run close to being out of time. In
summary, I would say that the tax compact set in the Revenue
Act of 1950 was that the employee would get capital gains only
at sale and the corporation would forego a tax deduction.
For the next 50 years, I would suggest that we change that
tax compact. We would continue to allow no taxation at exercise
of the option for the employee; the employee would only be
taxed at sale. We would permit the corporation to obtain a tax
deduction at exercise, which would remove the financial
inefficiency. And in exchange for that, the employee, when he
is subject to tax, would pay ordinary income on the value at
exercise and capital gains on the remainder.
We would continue to strongly encourage companies through
tax law to extend the benefits of stock options broadly
throughout their organization. The purpose of this is to
address the growing wage gap between the top and the bottom.
Stock options are predominantly responsible for the rising wage
gap between the top and the bottom. Instead of clamping down or
placing limits on the top, the better way is to raise up the
bottom. And raising the bottom should be done through
encouraging employees through pre-tax compensation to become
long-term stockholders of their company through stock options.
Thank you Mr. Chairman, members.
[The prepared statement follows:]
Statement of Frederic W. Cook, Chairman, Frederic W. Cook & Co., New
York, New York
Mr. Chairman, Mr. Coyne, members of the Subcommittee and
Mr. Boehner, it is a pleasure to be here today. My name is Fred
Cook. I represent the firm of Frederic W. Cook & Co., which is
management compensation consulting firm. For 30 years, our firm
and a predecessor firm have advised corporations on the design
and administration of employee stock ownership and stock option
plans. We are strong advocates of such plans and the sharing of
ownership and wealth-creation opportunities broadly in the
corporation because we believe that benefits our economy as a
whole.
My testimony today will refer to the charts which I believe
are in your folders and available at the back of the room.
Current Situation (Chart 1)
Under current tax laws affecting tax-qualified options (IRC
Sec. 422 and 423), employee contributions are made with after-
tax dollars and, if certain requirements are met, the employees
does not incur tax on gains at exercise and may claim long-term
capital gains treatment at sale if minimum holding period
requirements are met. The price for this favored treatment is
the loss of a corporate tax deduction. Many regard these plans
as financially inefficient for that reason. This has led to the
growth of ``non-qualified'' stock option plans and also to the
popularity of 401(k) plans which permit employee contributions
with pre-tax dollars.
Incentive Stock Option Situation (Chart 2)
Use of Incentive Stock Options (``ISOs''), tax-favored
under IRC Sec. 422, is a declining practice. Many companies
prefer non-qualified options (``NSOs'') for their key
employees. The reasons are that (1) ISO gains at exercise are
subject to the Alternative Minimum Tax which encourages selling
the stock in the year of exercise to avoid this onerous and
unfair tax, and (2) corporations receive no tax deduction for
the option gain at exercise. Many regard ISOs as financially
inefficient because they are giving up a full tax deduction to
provide only an incremental benefit to employees (i.e., the tax
savings between an ordinary income rate and the long-term
capital gains rate).
Incentive Stock Option Proposal (Chart 3)
Our proposals for changes in tax law to improve the
effectiveness of ISOs are to exclude the gain at exercise from
the alternative minimum tax, allow the employer a tax deduction
equal to the gain at exercise, and get this back by taxing the
employee when the shares are sold at ordinary tax rates on the
gain at exercise, with excess gains treated as a capital gain.
We advocate dropping the $100,000 annual vesting limit
currently in ISOs, and substituting a requirement that at least
half the shares granted as tax-qualified options each year
(including IRC Sec. 423 shares) would need to be granted to
``non-highly compensated employees'' as defined under IRC
Sec. 414(q). This will insure that the ISO benefits don't just
go to top management.
Employee Stock Purchase Plan Situation (Chart 4)
Tax-qualified employee stock purchase plans also have been
declining in popularity except in the high-tech sector. The
reasons seem to be that (1) employee payroll deductions are in
after-tax dollars which places these plans at a disadvantage
versus IRC Sec. 401(k) plans, and (2) the same financial
inefficiency that affects ISOs exists with these plans as well,
namely no tax deduction for option gains at exercise.
Employee Stock Purchase Plan Proposal (Chart 5)
We support the provision in Congressman Houghton's bill (HR
4972) that employee contributions to IRC Sec. 423 employee
stock purchase plans (``ESPPs'') should be permitted with pre-
tax dollars. As under present law, there should be no employee
tax at exercise. Employees should be taxed only at sale of the
stock, with ordinary income tax due based on the stock's value
at exercise, and capital gains tax on any excess gain realized.
Corporations should be allowed a tax deduction at exercise for
the same amount taxable as ordinary income to the employee at
sale. There should be no alternate tax or employment taxes
imposed on amounts treated as ordinary income. ISO and ESPP
taxation would be identical, thereby simplifying the Internal
Revenue Code.
For ESPPs, we advocate foregoing the 85 percent of market
value option price and the ``look-back'' feature in exchange
for pre-tax employee contributions and a corporate tax
deduction at exercise. We believe the 85 percent pricing
feature, while nice, is not necessary to encourage
participation. And, like many, we believe the 85 percent
``look-back'' feature is unfair to shareholders and encourages
employees to ``flip'' the stock at exercise for ordinary
income.
ESPPs should retain the requirement that essentially all
full-time U.S. employees would be eligible to participate,
except that bargaining unit employees could be excluded, just
like under 401(k) plans. These changes, taken together, would
put ESPP on an even keel with 401(k) plans and be very
positively received by companies and employees alike.
Summary Proposal (Chart 6)
The present tax situation with respect to tax-favored
employee stock option and purchase plans was put in place fifty
years ago in the Revenue Act of 1950, and has been essentially
unchanged since. Specifically, in exchange for no tax to
employees at exercise and long-term capital gains at sale,
companies are not allowed a tax deduction for option gains.
This should be changed for the twenty-first century. Employers
should be encouraged to adopt tax-qualified plans by being able
to deduct gains at exercise, now only available under non-
qualified plans and through disqualifying dispositions under
tax-qualified plans. Employees should be encouraged to
participate in ESPPs by permitting payroll deductions with pre-
tax dollars. And employees should be encouraged to hold stock
for the long run by deferring tax from option exercise to stock
sale and by eliminating gains at exercise from being subject to
employment taxes and the alternate minimum tax.
The purpose of these changes is to address the growing wage
gap between the top and the bottom. Stock options are
predominantly responsible for rising pay at the top. Instead of
clamping down or placing limits on the top, the better way is
to raise up the bottom. And raising the bottom should be done
through encouraging employees to become long-term shareholders
of their company through stock options.
Thank you for your attention to this important matter.
A. CURRENT SITUATION
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Employee Taxation Corporate Deduction
------------------------------------------------------------------------------------------------------
Design Limits Employment
At Grant At Exercise At Sale At Exercise At Sale Taxes on Gain
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Non-Qualified Options (NQOs)-- None............. None........... Ordinary Income.. Capital gain/loss Yes........... No............ Yes
IRC Sec. 83. on excess.
Incentive Stock Options --100% FMV None........... None, except gain Capital gains on No............ No............ No
(ISOs)--IRC Sec. 422. --10 yr. term is subject to full gain.
--$100,000 AMT.
vesting limit/
yr.
Employee Stock Purchase Plans-- --All ees. None........... None............. 15% discount is No............ No............ No
IRC Sec. 423. eligible ordinary income;
--Uniform terms rest of gain is
and opportunity capital gain.
--100% FMV/5 yrs.
--85% FMV/27 mos.
--$25,000 mkt.
value/yr.
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B. INCENTIVE STOCK OPTIONS (ISOs)
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Current Provision Comment
----------------------------------------------------------------------------------------------------------------
1. Employee Exercise Funds....... After tax.......... Accepted practice
2. Minimum Option price.......... 100% FMV........... Accepted practice
3. Maximum Option Term........... 10 years........... Accepted practice
4. Anti-discrimination None...............
Requirements.
5. Individual Limits............. $100,000 grant
value vesting per
year.
6. Employee Taxation at Exercise. None; gain subject AMT applicability encourages early sale
to AMT.
7. Co Deduction at Exercise...... None............... Discourages use; financially inefficient
8. Employee Taxation at Sale..... Capital gains......
9. Employment Taxes.............. None...............
----------------------------------------------------------------------------------------------------------------
B. INCENTIVE STOCK OPTIONS (ISOs)
----------------------------------------------------------------------------------------------------------------
Current Provision Proposed Change
----------------------------------------------------------------------------------------------------------------
1. Employee Exercise Funds....... After tax.......... None
2. Minimum Option price.......... 100% FMV........... None
3. Maximum Option Term........... 10 years........... None
4. Anti-discrimination None............... 50% or more shares granted per year go to Non-Highly
Requirements. Compensated Employees
5. Individual Limits............. $100,000 grant Drop; #4 change above is better
value vesting per
year.
6. Employee Taxation at Exercise. None; gain subject Exclude gain from AMT
to AMT.
7. Co Deduction at Exercise...... None............... Gain at exercise deductible
8. Employee Taxation at Sale..... Capital gains...... Gain at exercise is ordinary income; excess is capital
gain
9. Employment Taxes.............. None............... None
----------------------------------------------------------------------------------------------------------------
C. EMPLOYEE STOCK PURCHASE PLANS (ESPPs)
----------------------------------------------------------------------------------------------------------------
Current Provision Comment
----------------------------------------------------------------------------------------------------------------
1. Employee Payroll Deductions... After-tax.......... ESPPs disadvantaged vis-à-vis 401(k) plans
2. Minimum Option price.......... 85% FMV at start or ``Look-back'' feature encourages stock ``flipping''
end of period.
3. Maximum Option Term........... 27 mos. if 85% FMV Not a problem in practice
price; 5 yrs. if
100% FMV price.
4. Anti-discrimination Essentially all More stringent than Sec. 401 rules; discourages use in
Requirements. employees must be cos. with unions
eligible.
5. Individual Limits............. $25,000 grant value/ Most sign up for far less
yr..
6. Employee Taxation at Exercise. None...............
7. Co. Deduction at Exercise..... None............... Discourages use; financially inefficient
8. Employee Taxation at Sale..... 15% discount is
ordinary income;
rest of gain is
capital gain.
9. Employment Taxes.............. None...............
----------------------------------------------------------------------------------------------------------------
C. EMPLOYEE STOCK PURCHASE PLANS (ESPPs)
----------------------------------------------------------------------------------------------------------------
Current Provision Proposed Change
----------------------------------------------------------------------------------------------------------------
1. Employee Payroll Deductions... After-tax.......... Pre-Tax
2. Minimum Option price.......... 85% FMV at start or 100% FMV at grant
end of period.
3. Maximum Option Term........... 27 mos. if 85% FMV 5 years
price; 5 yrs. if
100% FMV price.
4. Anti-discrimination Essentially all Permit cos. to exclude bargaining unit employees
Requirements. employees must be
eligible.
5. Individual Limits............. $25,000 grant value/ $10,000/yr., indexed
yr..
6. Employee Taxation at Exercise. None............... None
7. Co. Deduction at Exercise..... None............... Stock value at exercise deductible
8. Employee Taxation at Sale..... 15% discount is Stock value at exercise is ordinary income; excess is
ordinary income; capital gain
rest of gain is
capital gain.
9. Employment Taxes.............. None............... None
----------------------------------------------------------------------------------------------------------------
D. PROPOSED SITUATION
--------------------------------------------------------------------------------------------------------------------------------------------------------
Employee Taxation Corporate Deduction
------------------------------------------------------------------------------------------------------
Design Limits Employment
At Grant At Exercise At Sale At Exercise At Sale Taxes on Gain
--------------------------------------------------------------------------------------------------------------------------------------------------------
Non-Qualified Options (NQOs)-- None............. None........... Ordinary Income.. Capital gain/loss Yes........... No............ Yes
IRC Sec. 83. on excess.
Incentive Stock Options --10 yr. term None........... None, no AMT..... Gain at exercise Gain at No............ No
(ISOs)--IRC Sec. 422 --100% --$100,000 is ordinary exercise is
FMV. vesting limit/ income; excess deductible.
yr. is capital gain.
Employee Stock Purchase Plans-- --All ees. None........... None............. Stock value at Stock value at No............ No
IRC Sec. 423. eligible except exercise is exercise is
union ordinary income; deductible.
--Uniform terms excess is
and opportunity capital gain.
--100% FMV/5 yrs.
--$10,000 mkt.
value/yr. pre-
tax
--------------------------------------------------------------------------------------------------------------------------------------------------------
Chairman Houghton. Thanks very much, Mr. Cook.
Mr. Capuano, Senior Vice President of Corporate
Development, Proxicom, in Reston.
STATEMENT OF CHRISTOPHER CAPUANO, SENIOR VICE PRESIDENT,
CORPORATE DEVELOPMENT, PROXICOM, INC., RESTON, VIRGINIA
Mr. Capuano. Thank you very much, Mr. Chairman, for
inviting me to appear today. My name is Chris Capuano and I am
the Senior Vice President for Corporate Development for
Proxicom, Inc. Proxicom, a Reston-based company, is the leading
e-business consulting and development company that delivers
Internet and wireless solutions for Fortune 500 companies.
When I joined Proxicom in 1996, we were a small company of
about 40 employees with a vision around the Internet. That was
the year we implemented our broad-based stock option plan
covering all employees. Today we are a profitable firm of
approximately 1,300 employees, publicly traded, with offices
around the United States and Europe.
In a start-up company, all employees wear multiple hats;
and one of the hats I wore when I joined Proxicom was as the
creator of the Proxicom stock option plan. In designing the
plan, our philosophy was very simple: Each and every employee
is critical to the success of the company. Stock options,
therefore, were and still are provided to each and every
employee to align all of us with the success of the company and
to share in the growth.
From the receptionist who first greets our clients to the
technical consultants to our project managers, all employees
receive stock options. When the employee vests in the stock
option, the employee may exercise the option and buy the
underlying stock. As you know, on exercise of the option, our
employees must also pay tax on the difference between the
option price and the market value of the Proxicom stock, even
if the employee has not sold any shares or actually pocketed
any cash gain.
It is a tax on the paper profit only. Many of our employees
are forced to sell some of their Proxicom stock to pay this
tax. Other employees who wish to hold onto their shares are
forced to take loans. While we typically grant incentive or
qualified stock options, which would normally defer tax
payment, many of the options granted today are non-qualified
stock options due to the tax code's quantitative limits on our
ability to provide ISO's.
In any event, the impact of the alternative minimum tax
negates the benefit of the incentive stock options for many of
our employees by taxing again the paper gain before any stock
is actually sold. Many of our employees are therefore again
forced to sell shares and thereby forego a stake in our long-
term growth to pay off the AMT.
At Proxicom, our broad-based employee stock plans offer
strategic benefits. The plans improve corporate productivity
and profitability by helping to align employee and shareholder
interests while providing a tangible and very visible tool to
attract, inspire and retain our employees, something that is
especially important in today's tight labor market.
With many Proxicom employees coming from firms not offering
stock plans, our ability to directly reward our employees based
upon our overall success is key to our continued growth. From
an alignment perspective, our stock option plan is a major
component in threading together our shareholders, our corporate
strategy and the individual desires of every employee.
In a growing business like Proxicom, where resources are
very tightly managed, share ownership through stock plans keeps
our employees focused on teamwork, productivity and quality
through the sharing of resources, best practices and knowledge.
With our stock plans, our employees also fully appreciate the
importance of both the short-term or quarterly results and the
long-term. This understanding clearly drives our growth.
The Proxicom stock plans also provide significant
opportunity for individual employee financial gain. Many of our
top recruits forego larger cash-based pay packages to have the
opportunity to share in the overall success of the company over
the long-term. This translates into an opportunity for long-
term financial savings and stability for our employees.
In our opinion, the provisions of the Wealth to Workplace
Act will greatly enhance the effectiveness of stock option
plans like the Proxicom stock option plan by enabling our
employees at all levels to continue to hold on to their
company's stock after exercise, rather than selling the shares
to pay the tax due. With this important provision, our
employees will not be forced to give up the opportunity for
long-term appreciation in our stock and Proxicom will grow
stronger by having more dedicated, long-term employee
shareholders.
I also note for your consideration that the alternative
minimum tax has a broad negative impact at Proxicom, depriving
many of our employees of the tax deferral benefits of the
qualified stock options. Proxicom also applauds the efforts
behind the Universal Employee Stock Option Act. Because at
Proxicom we fully appreciate the benefits of broad-based
employee stock ownership, we can foresee implementing such a
plan for our employees in addition to our current stock
programs.
In general, in our opinion, the more tools that are at our
disposal to increase broad-based employee stock ownership, the
better. In conclusion, the broad-based provision of stock
options for Proxicom employees reflect and reinforce the
entrepreneurial beginnings, spirit and culture of our company.
The employee culture is one of teamwork and common goals,
driving to the success of the overall business. This was true
for Proxicom as a start-up and it is especially true for us
today as a maturing organization.
The Proxicom stock plans are very important tools in
establishing and maintaining this culture. They serve as a very
visible means for all employees to share in the long-term
growth and success of our company.
Thank you.
[The prepared statement follows:]
Statement of Christopher Capuano, Senior Vice President, Corporate
Development, Proxicom, Inc., Reston, Virginia
Mr. Chairman and Members of the Subcommittee, thank you for
inviting me to join you today to present testimony on the
Federal tax treatment of employee stock option plans under
current law and proposals, such as the Wealth Through the
Workplace Act and the Universal Employee Stock Option Act of
2000, that are aimed at amending such law. It is a pleasure to
be here.
My name is Christopher Capuano, and I am the Senior Vice
President for Corporate Development for Proxicom, Inc.
Proxicom, based in Reston, Virginia, is a leading e-
business consulting and development company that delivers
innovative Internet and wireless solutions for Fortune 500
companies and other global, forward-thinking businesses. Our
strategy, creative and technology professionals provide
specialized e-business development expertise across a number of
industries including Automotive, Financial Services, Energy,
Media and Telecommunications.
Proxicom has developed and built internet-based solutions
for such blue-chip companies as America Online, General
Electric, General Motors, Merrill Lynch, Marriott International
and NBC, among many others.
Raul Fernandez, our entrepreneur-founder and Chief
Executive Officer, started Proxicom in 1991 with $40,000 he had
saved originally to purchase a home. When I joined Proxicom in
1996 we were a small, high-energy company of about 40 employees
with a vision about the Internet. That was the year we
implemented our broad-based stock option plan covering all
employees. Today, we are a profitable firm of approximately
1,300 employees that is publicly traded on NASDAQ (``PXCM''),
with offices across the United States and Europe.
As Senior Vice President for Corporate Development, I am
responsible for management of our employee stock plans, as well
as business development, mergers and acquisitions, and
international expansion. Over the course of my service with
Proxicom I have also served as the General Counsel and a member
of the Board of Directors.
Prior to my joining Proxicom I was a lawyer in private
practice, a consultant at Price Waterhouse, and an Adjunct
Professor of Law at Georgetown University Law Center, teaching
a course on taxation and compensation issues.
On behalf of Proxicom, I would like to thank the
Subcommittee for holding this important hearing. These are
important issues that will play a critical role in growing
businesses and helping employees realize the benefits available
from company ownership through employee stock plans.
Stock Options at Proxicom
In a start-up company, all employees wear multiple hats.
One of the many hats I wore when I joined Proxicom was as
creator of the Proxicom Stock Option Plan and later the
Proxicom Employee Stock Purchase Plan. In designing the plans,
our philosophy was very simple: each and every employee is
critical to the success of the company. Stock options,
therefore, were and still are provided to each and every
employee to align all of us with the success of the company,
and share in the growth. From the receptionist who first greets
our clients, to our technical consultants, to the project
managers, all employees receive stock options.
Under our stock option plan, an employee receives a stock
option on his/her starting date with the company. The option
vests, or becomes exercisable, over 4 years; the option itself
has a life of 10 years so that as long as you remain an
employee, you have 10 years to exercise the option. The focus
is on the long term.
The price of the option is the fair market value of the
stock when the individual joins the company. When we were a
private company, we calculated the price based on the value of
the business at various points in time, typically when we took
in venture capital. As a public company it is very simply
determined as the closing price of our stock on the day before
the grant date.
Proxicom employees also receive additional stock option
grants every year they are with the company. These refresh
grants also vest over the four years following the date of the
refresh grant, thereby continuing to provide long term growth
opportunities to our employees.
When the employee vests in the stock option (for example,
after the first year of employment), the employee may exercise
the option and buy the underlying stock. As you know, on
exercise of the option, our employees must also pay tax on the
difference between the option price and the market value of the
Proxicom stock, even if the employee has not sold any shares or
actually pocketed any cash gain. It is a profit on paper only.
Many of our employees are forced to sell some of their Proxicom
stock to pay this tax; others who wish to hold onto the shares
long term are forced to take out loans to pay the tax.
While we offer qualified stock options, which would defer
the tax payment, most of the options granted today are
nonqualified stock options due to the tax code limits on
qualified stock options. In any event, the impact of the
alternative minimum tax negates the benefit of qualified stock
options for many of our employees by taxing the paper gain
before any stock is sold. Again, many of our employees are
forced to sell shares, and thereby forego a stake in our long-
term growth, or take loans to pay off this tax on their
exercised options.
The Proxicom option process is fully internet-enabled, with
the stock option plan document and all of the employee's
specific option information, from vesting dates, to pricing to
taxes, contained on the employee's personal web site and
available any time day or night.
Impact of the Proxicom Stock Option Plan
The impact of the Proxicom stock plans on our company and
our employees is positive on many fronts. In short, share
ownership through our stock plans promotes teamwork and
provides a specific incentive for all our employees to
understand and grow with our business through the long
term. The
stock plans bring strategic benefits to Proxicom, financial and
personal benefits to employees, and overall contribute to the
long-term growth of our company.
Strategic Benefits to Proxicom
At Proxicom, our broad-based employee stock plans offer
strategic benefits to Proxicom. The plans improve corporate
productivity and profitability by helping to align employee and
shareholder interests while providing a tangible and very
visible tool to attract, inspire, and retain employees--
especially in our tight labor market. With many Proxicom
employees coming from firms not offering stock plans, our
ability to directly reward our employees based upon our overall
success is a key to our continued growth.
From an alignment perspective, our stock option plan is a
major component in threading together our shareholders, our
corporate strategy, and the individual desires of every
employee. In a growing business like Proxicom, where resources
are very tightly managed, share ownership through the stock
plans keeps our employees focused on teamwork, productivity,
and quality through the sharing of resources, best practices,
and knowledge. Our employees understand that any other
performance would only serve to sub-optimize the whole
business.
For example, in addition to their daily responsibilities,
Proxicom employees design and deliver thousands of hours of
internal training per year to help fellow employees learn and
grow their skills as the company grows. Our employees regularly
volunteer their free time to identify and implement improvement
programs in each office.
As a tool to attract, inspire, and retain employees, it has
always been our philosophy that the employees should ``act and
be treated as owners.'' The stock plans support this philosophy
by providing the opportunity for personal wealth (attraction);
rewarding employees for corporate success (inspiration); and
encouraging long-term employment, learning, and collaboration
(retention). ``Owners'' focus on improvement, results, the
company as a whole and the success of others, instead of their
specific piece of the pie.
Benefits to Proxicom Employees
The Proxicom stock plans provide a significant opportunity
for individual employee financial gain. Many of our top
recruits forego larger cash base pay packages to have the
opportunity to share in the overall success of the company over
the long term. This translates into an opportunity for long-
term financial savings and stability. This ownership link
between company and individual success is the cornerstone to
our ability to attract, inspire and retain talent while
delivering superior results to our clients.
In addition to volunteering for internal projects and
working on weekends, it is not uncommon for employees to
support non-profit endeavors as a way to help the company
succeed. Rather than contribute cash, many of our employees
contribute stock purchased through the stock option plans to
charitable causes, which, of course, benefits the community as
well.
The law as it currently stands erodes the financial benefit
of certain stock options and lessens their positive impact for
our employees. The current proposals before you, however, would
help to restore the value of such options and allow every
employee to fully share in the long-term success of the company
at which they choose to work.
Impact on Proxicom's Growth
Because we are a ``people business,'' our broad-based plans
aimed at our employees are critical in helping Proxicom grow.
Growth is achieved not only by aligning employee and corporate
interests and promoting teamwork, but also by offering long-
term incentives to employees to deliver quality work over time.
With our stock plans in place, our employees understand the
importance of short-term (quarterly) and long-term success.
This understanding clearly helps to drive our continued growth.
Current law reduces the long-term benefit of certain stock
options by forcing our employees, in many cases, to sell stock
before they wish to in order to pay taxes. This affects the
majority of our employees, and most often the less financially
stable employees who cannot not afford to pay the tax unless
the shares are sold. The current proposals would help alleviate
this need to sell and instead restore the long-term performance
incentives and long-term savings benefit of such stock options,
thus benefiting both employees and companies on which the
strength of the economy is based.
The Proposals
In our opinion, the provisions of the Wealth Through the
Workplace Act will greatly enhance the effectiveness of stock
plans like the Proxicom Stock Option Plan by enabling our
employees at all levels to continue to hold on to their company
stock after exercise, rather than selling the shares to pay the
tax due on the stock's paper gain. With this important
provision, our employees will not be forced to give up the
opportunity for long-term appreciation in our stock, and
Proxicom will grow stronger by having more dedicated, long-term
employee shareholders. Also favorable is the provision
preserving the ability of the company to take the deduction.
This is a financially sound approach for business that shows
long term thinking by this Committee.
I also note for your consideration that the alternative
minimum tax has a broad negative impact at Proxicom, depriving
many of our employees of the tax deferral benefits of the
qualified stock options, thus forcing our employees to sell
their stock to pay the tax.
Proxicom also applauds the efforts behind the Universal
Employee Stock Option Act of 2000. Because Proxicom fully
appreciates the benefits of employee stock ownership, we can
foresee implementing such a plan for our employees in addition
to the current stock programs offered. In general, the more
tools at our disposal to increase employee stock holdings, the
better.
Conclusion
The broad based provision of stock options for Proxicom
employees reflects and reinforces the entrepreneurial
beginnings, spirit and culture of our company. The Proxicom
culture is one of teamwork and common goals, driving to the
success of the business. This was true for Proxicom as a start
up and it is true today for us as a maturing organization. The
Proxicom stock plans are very important tools in establishing
and maintaining this culture. They serve as a very visible
means for all employees to share in the long-term growth and
success of the company.
We strongly support the enactment of provisions that will
facilitate employee stock ownership and restore the long-term
value of such options, thus allowing every employee to fully
share in the long-term success of the company at which they
choose to work.
Thank you for asking me to join you today. On behalf of
Proxicom, I thank you for holding this hearing and I stand
ready to answer any questions you might have.
Chairman Houghton. Thanks very much, Mr. Capuano.
Now, Miss Wilma Schopp, the Human Resources Leader, Global
Compensation and Benefits at Monsanto.
STATEMENT OF WILMA SCHOPP, HUMAN RESOURCE LEADER, GLOBAL
COMPENSATION AND BENEFITS, MONSANTO COMPANY, ST. LOUIS,
MISSOURI, ON BEHALF OF THE AMERICAN BENEFITS COUNCIL
Ms. Schopp. Good morning and thank you, Mr. Chairman, for
the opportunity to appear. I am Wilma Schopp, Human Resource
Leader for Global Compensation and Benefits at Monsanto, a
subsidiary of Pharmacia Corporation. I am here representing the
American Benefits Council, formerly APPWP. I want to thank you,
Mr. Chairman, for holding this hearing and for your leadership
in creating a positive environment for extending the benefits
of stock ownership to American workers, as exemplified by your
introduction of the Universal Stock Options Act of 2000.
Broad-based stock ownership programs, which have become
increasingly prevalent in the U.S., provide value to both
employees and employers. They enable workers to become owners
of their companies and provide a significant vehicle of wealth
accumulation. Employers value stock option ownership programs
as an important recruitment, retention and motivational tool in
a competitive labor market.
Moreover, a recent Rutgers University study found that
companies with broad-based stock plans have significantly
higher productivity levels and growth rates than companies
without such plans. At Monsanto, both the company and our
employees are firm believers in the benefits of equity
ownership. We provide stock options to all of our employees
worldwide. We also have an employee stock purchase plan, an
employee stock ownership plan and offer Monsanto stock as an
investment option in our 401(k) plan.
However, many Americans lack the opportunity to participate
in an employer-sponsored stock plan. We believe a top priority
for the next Congress should be to build on your efforts, Mr.
Chairman, to provide enhanced incentives for broad-based stock
plans. Your legislation, H.R. 4972, would provide employers
with a significant new incentive to offer stock ownership plans
and will encourage employee equity ownership by coupling the
power of payroll deduction with increased tax incentives.
Employees would be empowered to hold stock for longer
periods, facilitating capital appreciation and a continued
ownership stake in the corporation, since shares will be taxed
at sale rather than exercise. Moreover, the bill's accelerated
deduction for employers will encourage the establishment of new
broad-based plans.
We note that legislation introduced by Representative John
Boehner, H.R. 3462, contains many of the same positive
features.
Mr. Chairman, we hope you will pursue your legislation in
the new Congress and continue your efforts to encourage broad-
based stock plans. As you do, we offer the following items for
your consideration:
We believe that it will be important to clarify that any
new stock option or stock purchase design will not displace or
lead to adverse consequences for existing arrangements.
While it is appropriate to include coverage requirements in
any new stock plan legislation that provides substantial tax
advantages, we feel such requirements should be carefully and
flexibly crafted so as not to preclude employers from using the
new incentives.
Finally, we recommend that, as with your bill, any
legislation establishing a new stock plan design be placed
within the Internal Revenue Code, as has been the historical
practice.
As you look to future legislative initiatives in this area,
we would also ask you to address the following barriers that
have the potential to erode employee stock ownership programs
even as you seek to expand them. First, we are very concerned
about the recent change in position by the IRS that payroll
taxes should be imposed whenever options are exercised under a
Section 423 employee stock purchase plan.
The IRS has also taken the view that Federal income tax
withholding is required on disqualifying dispositions under
employee stock purchase plans. Moreover, the IRS had sought to
impose these withholding obligations retroactively, despite
clear and directly contradictory guidance.
Mr. Chairman, we appreciate your efforts to point out that
these new tax obligations will create substantial burdens for
employers and will make employees less likely to retain shares
after exercise because they will have to sell them to cover the
additional tax liability. We are very concerned that the IRS
and Treasury are nonetheless poised to issue guidance that
could support the imposition of employment tax withholding on
employee stock purchase plans and perhaps even incentive stock
option transactions.
Because of the counterproductive results of such an
approach for employees and employers alike, we believe that
legislation will likely be needed to clarify that income and
payroll tax withholding obligations do not apply for employee
stock purchase plans and incentive stock options.
Second, because the application of the alternative minimum
tax to stock option transactions discourages workers from
holding company stock, the council strongly supports
legislation to exempt the exercise of stock options from the
alternative minimum tax.
Third, as provided under H.R. 1102, the pending retirement
savings legislation, an employer tax deduction should be
allowed for dividends employees reinvest in unleveraged ESOPs,
encouraging the accumulation of retirement savings.
Fourth, with many U.S. companies, such as Monsanto,
operating overseas, the council urges the Congress to help
promote more uniform treatment for employees of U.S. companies
by investigating the special problems of offering equity
ownership to American employees working in other countries.
I want to thank you, Mr. Chairman, Ranking Member Coyne and
the other members of the subcommittee for your interest and
dedication to promoting equity ownership by American workers.
[The prepared statement follows:]
Statement of Wilma Schopp, Human Resource Leader, Global Compensation
and Benefits, Monsanto Company, St. Louis, Missouri, on Behalf of the
American Benefits Council
Good morning and thank you, Mr. Chairman, for the
opportunity to appear today. I am Wilma Schopp, Human Resource
Leader for Global Compensation and Benefits at Monsanto
Company. I am here representing the American Benefits Council
(the Council--formerly APPWP), of which Monsanto is a member.
The Council is a public policy organization representing
principally Fortune 500 companies and other organizations that
assist employers of all sizes in providing benefits to
employees. Collectively, the Council's members either sponsor
directly or provide services to employee benefit plans covering
more than 100 million Americans.
I want to thank you, Mr. Chairman, for holding these
hearings on stock option and other stock benefit plans, and for
your leadership in creating a positive environment for
extending the benefits of stock ownership to American workers,
as exemplified by your introduction of H.R. 4972, the Universal
Stock Options Act of 2000. Employee stock option plans are an
important part of the benefits package offered by many of our
member companies, and we support the goal of expanding these
plans. In fact, a recent American Benefits Council survey
revealed that a clear majority of our members support providing
additional tax incentives for broad-based equity ownership
plans.\1\ My testimony today will briefly review the national
trends in stock ownership, highlight the many advantages of
stock plans for employers and employees alike, provide
commentary on H.R. 4972, and describe several other pressing
stock ownership issues that the Council believes also merit
congressional attention. We are pleased to offer our voice on
this important policy issue, and we appreciate your
consideration of our views.
---------------------------------------------------------------------------
\1\ The full survey and its results can be found on the web site of
the American Benefits Council at www.americanbenefitscouncil.org.
---------------------------------------------------------------------------
Stock Ownership Programs Are Varied and Growing
No longer just a prerogative of executives, stock ownership
programs in a wide variety of forms are increasingly becoming
part of the benefits package of non-managerial, unionized, and
hourly employees. The diversity in stock plan design is
reflective of both the goals and employee demographics of
individual companies. Many employers, including many Council
member companies, extend the benefits of stock ownership to
their employees through stock option programs, employee stock
ownership plans (ESOPs), employee stock purchase plans (ESPPs),
use of company stock in 401(k) plans, and other innovative
equity participation arrangements. Looking just at stock
options, recent surveys show that approximately 6 million non-
management employees are accumulating wealth through stock
options,\2\ and 39 percent of major companies now have stock
option plans that cover over half of their workforce, up from
17 percent in 1993.\3\ Most notably, this growth in stock
option holdings has spread to rank-and-file employees. In fact,
in a 1998 survey of 389 companies that granted stock options,
34 percent made grants to such employees.\4\
---------------------------------------------------------------------------
\2\ Current Practices in Stock Option Plan Design, National Center
for Employee Ownership, 2000.
\3\ Broad-Based Stock Options--1999 Update, William M. Mercer,
Inc., 1999.
\4\ The 1998 Stock Plan Design and Administration Survey,
PricewaterhouseCoopers, 1998.
---------------------------------------------------------------------------
While some think of stock ownership programs as being
particular to start-up and high technology firms, stock
ownership and participation arrangements are actually found
across the whole spectrum of American industry. A glance at the
50 largest U.S. companies with broad-based stock option plans
demonstrates that companies in such fields as manufacturing,
banking, shipping, household products, aviation, insurance,
food products, retail, rail transport, and cable TV are
offering stock options to their rank-and-file employees.\5\ The
depth and breadth of stock ownership programs reflected in the
figures I have cited indicates that the extension of equity to
rank-and-file employees is becoming an increasingly common
business practice.
---------------------------------------------------------------------------
\5\ Employee Ownership Report, National Center for Employee
Ownership, May/June 1999.
---------------------------------------------------------------------------
Benefits of Stock Ownership Programs
Broad-based stock ownership programs prove valuable to both
employees and employers. Foremost, they enable workers to
become owners of their company, creating a personal stake on
the part of employees in the corporate venture and often
providing workers with a greater sense of commitment to the
company's mission. Such programs also provide a significant
vehicle of wealth accumulation for many workers. Two recent
studies put the average annual value of stock option grants to
employees at roughly $1,700.\6\ This wealth accumulation aspect
can contribute meaningfully to employees' retirement security.
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\6\ Employee Ownership Report, National Center for Employee
Ownership, January/February 2000, and David Lebow et al., Recent Trends
in Compensation Practices, Board of Governors of the Federal Reserve
System, Finance and Economics Discussion Series, No. 1999-32, July
1999.
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Employers appreciate stock ownership programs as an
important recruitment, retention, and motivational tool in a
competitive labor market. Moreover, a recent study found that
there is evidence that companies with broad-based stock plans
have significantly higher productivity levels and annual growth
rates as compared to companies without broad-based stock
plans.\7\ This latter effect may translate into a benefit for
the general economy as the number of companies with broad-based
stock ownership plans increases.
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\7\ Public Companies with Broad-Based Stock Options: Corporate
Performance from 1992-1997, National Center for Employee Ownership and
Blasi, Kruse, Sesil, and Kroumava, 2000.
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While many American workers feel fortunate to have stock
ownership plans, other workers lack this opportunity because
their employers cannot, for a variety of reasons, provide such
benefits. We believe that a top priority for the next Congress
should be to build on your efforts, Mr. Chairman, to provide
enhanced incentives for broad-based stock plans and to remove
the existing barriers that can deter employers from extending
the opportunity for employee equity ownership.
The Monsanto Experience
At Monsanto, both the company and our employees are firm
believers in the benefits of equity ownership. We provide stock
options to all of our employees, worldwide. For rank-and-file
workers, we grant a fixed number of options per employee at
each grant occasion. For management employees, the number of
options we grant is tied to the individual manager's role and
responsibilities within the company. For our employees in the
United States, Monsanto will also allow workers to purchase
shares of Monsanto stock through an employee stock purchase
plan. We also have an employee stock ownership plan (ESOP) and
offer Monsanto stock as an investment option in our 401(k)
plan. As you can see, equity ownership is central to our vision
of how to reward Monsanto employees. We are grateful, Mr.
Chairman, for your efforts to make this system one that will
work even more effectively for employees and employers alike.
H.R. 4972, The Universal Stock Options Act of 2000
Turning to a discussion of your bill, Mr. Chairman, the
Council believes that H.R. 4972 marks a major step forward in
the debate on improving our nation's compensation and benefits
policy. Your bill would provide employers with a significant
new incentive to offer stock ownership plans. If enacted, the
bill would accelerate and enhance the existing trend toward
providing broad-based employee stock option and stock purchase
plans and could create a large new generation of employee stock
owners. The potential improvements in productivity, employee
economic well-being, and employment satisfaction for millions
of Americans could be substantial.
H.R. 4972 would accomplish these important goals by
encouraging employees to use tax-favored payroll deductions to
purchase employer stock. Employees would be able to deduct
amounts from their pay, up to the annual limit specified by
Internal Revenue Code section 402(g), and all contributions, as
well as any shares purchased by such contributions, would be
placed in a trust. Employees would be taxed neither on amounts
saved through payroll deduction nor on the value of the shares
of stock when purchased. Employers would be allowed a deduction
when options are exercised and the shares are transferred to
the employee, and the deduction would be equal to the fair
market value of the stock at the time of exercise. Upon sale of
the stock, the employee recognizes ordinary income equal to the
stock's fair market value at exercise and capital gain
treatment on the amount, if any, that exceeds the exercise
price.
The bill encourages both employee savings and equity
ownership by coupling the power of payroll deduction with
increased tax incentives. Our members can testify to the
powerful effect in the 401(k) context of combining payroll
deduction and pre-tax deferrals, and we believe that similarly
positive results would occur with stock plans. We also believe
that employees and employers will respond in a positive way to
the tax incentives contained in H.R. 4972. The chief benefit of
these incentives will be that employees will no longer have to
sell stock as soon as they purchase it in order to cover their
tax liability. Rather, they will be empowered to hold stock for
longer periods, allowing an opportunity for long-term
appreciation in value and a continued ownership stake in the
corporation. Moreover, the Council supports the bill's
accelerated deductions for employers as an important tool to
encourage the establishment of new broad-based plans.
H.R. 3462, The Wealth Through the Workplace Act
In addition to H.R. 4972, the current Congress saw the
introduction by Representative John Boehner (R-OH) of H.R.
3462, the Wealth Through the Workplace Act. H.R. 3462 creates a
new broad-based stock option design that combines positive
elements of both qualified and non-qualified stock options.
H.R. 3462 would generally allow workers to defer taxation on
their stock options until they sell their shares and then to
have their gains taxed at capital gains rather than ordinary
income rates. These are benefits that employees with qualified
(or ``incentive'') stock options currently enjoy. At the same
time, employers would be able to take a tax deduction for the
increased value of the stock option upon the employee's
exercise of the option (as sponsors of traditional non-
qualified stock options may currently do).
H.R. 3462 would encourage employees to save for the future
by providing that the bill's favorable capital gains tax
treatment applies only to stock options that are held for two
years from the grant date and one year from the exercise date.
By providing favorable rules for employees who hold their stock
options for the specified periods, H.R. 3462 not only provides
a vehicle for workers to accumulate wealth, but also encourages
workers to take the long-term view with respect to their own
financial security. In this way, the bill encourages employees
to remain ongoing stakeholders in our economy and helps them
achieve retirement security.
The Future for Stock Option Incentives
Mr. Chairman, the Council recognizes that, notwithstanding
the strong merits of H.R. 4972 and H.R. 3462, it is highly
unlikely that these bills will be enacted in the closing days
of the 106th Congress. However, these bills provide an
important starting point for deliberations by the new Congress.
As an aside, Mr. Chairman, we understand that you and
Representative Boehner have discussed possible joint
initiatives in the future concerning stock options, and we
would certainly applaud and encourage such cooperation. As you
and others look to continue your efforts to encourage and
facilitate broad-based stock option plans, we wish to add to
our comments above the following items for the Subcommittee's
consideration:
The Council believes that it will be important to
clarify that any new stock option or stock purchase design will
not displace or lead to adverse consequences for existing
arrangements. Clear protection of existing programs will help
new stock plan legislation gain broad-based support from the
business and benefits communities.
While we believe it is appropriate to include
coverage requirements in any new stock plan legislation that
provides substantial tax advantages, we feel such requirements
should be carefully and flexibly crafted so as not to preclude
employers from making use of the new incentives or designs.
Historically, equity arrangements like stock
option plans have been established within the Internal Revenue
Code and regulated by the Treasury Department and Internal
Revenue Service. We strongly recommend that any future
legislation continue this historical practice rather than
placing stock plans within the Employee Retirement Income
Security Act (ERISA) and subjecting them to regulatory
oversight by the Department of Labor.
We understand that some Members of Congress may be
concerned about preventing substitution of stock options for
existing wages. We believe this concern is misplaced. Employers
make determinations about workers' wages and benefits in the
context of the appropriate level of total compensation and
decide upon the relative place of cash wages and other benefits
based on what is competitive in the marketplace. These
competitive pressures will not allow companies to reduce cash
compensation below what workers demand and what competitor
firms provide. We believe, therefore, that legislation to
prevent the substitution of options for wages is unnecessary
(and would in any case be highly unworkable).
Other Public Policy Issues Related to Stock Ownership Programs
Mr. Chairman, there are a number of other pressing issues
related to stock ownership programs that I would like to
address in my testimony this morning. As a champion of
extending equity ownership to more American workers, Mr.
Chairman, you have been sensitive to these issues, and we at
the Council appeal to you and other members of this
Subcommittee to devote your substantial energies to addressing
these matters. The barriers and burdens I will describe today
have the potential to erode employee stock ownership programs
even as you seek to expand them.
Tax Withholding Obligations under Stock Option Plans--A
disqualifying disposition of stock under a qualified Incentive
Stock Option (ISO) plan results in income to the employee.
However, the IRS has provided consistent guidance for nearly 30
years that the employer that grants the ISO does not have any
income tax withholding obligation with regard to that income,
nor is such income from either a qualifying or disqualifying
disposition considered wages for FICA or FUTA withholding
purposes. Since the same statutory provisions interpreted by
the IRS guidance also apply to employee stock purchase plans
(ESPPs) governed by section 423 of the Internal Revenue Code
and since the IRS has provided similar guidance for ESPPs,
employers generally have not paid employment taxes or withheld
income on ESPP income.
In contrast, and despite the historic IRS guidance, the IRS
has recently taken the position that FICA and FUTA taxes should
be imposed whenever options are exercised under an ESPP. The
amount of such tax would be based on the difference between the
option price and the fair market value of the stock at the time
of exercise. The IRS has also taken the view that Federal
income tax withholding is required on disqualifying
dispositions under ESPPs. Moreover, the IRS has sought to
impose these withholding obligations retroactively despite
clear and directly contradictory guidance in the ISO area.
Mr. Chairman, you have been an articulate advocate for
ESPPs and have pointed out the many adverse consequences that
will result from the IRS' recent change of position regarding
withholding obligations. You have recognized that imposition of
these tax obligations will create new and substantial burdens
on employers, acting as a deterrent to the sponsorship of
broad-based stock purchase programs. Moreover, if withholding
is applied, you have noted that employees, particularly rank-
and-file employees, are less likely to retain shares after
exercise of ESPP options because they will have to sell the
stock to cover the additional tax liability. This hinders
employee wealth accumulation and frustrates the opportunity for
long-term appreciation in share value. In addition, the new
demand for tax withholding increases tax and administrative
costs and discourages employers from offering stock options to
rank-and-file employees.
As you know, Mr. Chairman, these withholding issues are
currently being litigated in the Federal Court of Claims, and
the Council has urged the IRS to return to its long-standing
position that income and payroll tax withholding obligations
for ESPPs should parallel those for ISOs. We have greatly
appreciated your leadership in urging the IRS to desist from
its current enforcement efforts and return to its prior
practice. We are very concerned, however, that the IRS and
Treasury are poised to issue guidance that could support the
imposition of employment tax and withholding obligations on
certain ESPP and perhaps even ISO transactions.\8\ Because of
the counter-productive results of such an approach for
employees and employers alike, we believe that legislation will
likely be needed to overturn the agency guidance and clarify
that income and payroll tax withholding obligations do not
apply for ESPPs and for ISOs.
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\8\ While we expect to take issue with the substance of any
forthcoming guidance reaching such a conclusion, we feel strongly that,
at a minimum, such guidance should be prospective in nature and should
be issued in proposed rather than final form. Issuance of retroactive
guidance and/or denying the public an opportunity to comment would
impose an unfair burden on the many employers who have reasonably
relied on the IRS' long-standing and contrary position.
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Alternative Minimum Tax--A major obstacle to extending
equity ownership to working Americans has been the application
of the alternative minimum tax (AMT) to stock option
transactions. Upon exercise of an ISO option, the difference
between the fair market value of the stock and the exercise
price is includible in AMT income even though this amount is
not includible in ordinary income. The application of the AMT
to stock options discourages workers from holding company stock
and thereby frustrates many of the goals of stock ownership
programs. The Council strongly supports legislation to make
clear that the AMT would not apply with respect to the exercise
of options under ISOs.
Employee Classification Issues--Employee stock purchase
plans (ESPPs) are generally required to cover all common law
employees of the corporation. However, employers may exclude
certain narrowly defined groups of workers based upon their
status as part-time, short service, highly compensated or new
employees. Litigation has arisen over whether temporary and
part-time workers are entitled to participate in ESPP plans,
and questions also exist with respect to whether certain
foreign employees must be covered under these plans. Employers
who sponsor ESPPs and other stock ownership programs need
flexibility in managing benefits for a workforce with changing
demographics. This needed flexibility would be impaired by
legislating aggressive new coverage mandates (as some Members
of Congress have proposed), the result of which would be fewer
stock plans that include rank-and-file workers. Particularly in
light of the already broad coverage requirements of ESPPs, we
urge Congress to stand firm against such mandates and to
continue to allow employers needed flexibility in administering
their benefit programs.\9\
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\9\ There are also ways in which the existing ESPP rules work to
exclude workers inappropriately from participation in these plans. The
current rules require that in order to participate in an ESPP, an
employee must work for a corporation (rather than for a partnership or
limited liability company (LLC)) and that at least 50 percent of that
corporation must be owned by the firm sponsoring the ESPP. Both of
these rules exclude workers from ESPP participation, particularly in
start-up firms that often take the form of partnerships or LLCs and in
joint ventures where the 50 percent ownership threshold is not met. We
urge Congress to review these rules.
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ESOP Dividends Reinvestment--Employee stock ownership plans
(ESOPs) allow employees to share in the benefits of equity
ownership through the vehicle of a tax-qualified retirement
plan. The Comprehensive Retirement Security and Pension Reform
Act, H.R. 1102--of which many members of this Subcommittee are
cosponsors--includes an important change in the tax treatment
of ESOP dividends that would provide employees with a greater
opportunity for enhanced retirement savings and stock
ownership. Under Code section 404(k), employers may take a tax
deduction on dividends paid on employer stock in an unleveraged
ESOP only if the dividends are paid to employees in cash; thus,
the deduction is denied if the dividends remain in the ESOP for
reinvestment. Under H.R. 1102, deductions would also be allowed
when employees choose to leave the dividends in the plan for
reinvestment, encouraging the accumulation of retirement
savings through the employee's ownership interest in the
employer. This provision will make ESOPs even more effective
retirement savings plans. This important ESOP dividend
reinvestment provision is but one of the many reasons the
Council is working actively with Congress to see H.R. 1102
enacted into law in the remaining days of this congressional
session.
Information Reporting of Stock Option Transactions--
Nonqualified stock option plans are the most common type of
stock option plan in use by employers. Upon exercise of such
options, the employee receives income equal to the excess of
the fair market value of the stock over the option exercise
price, and such income is reported on the employee's Form W-2.
The employee typically sells the stock on the same day that the
option was exercised (unless a restriction applies). The broker
handling these transactions is required to report on Form 1099-
B the payments of gross proceeds to individuals from such same-
day sales (even though typically no gain or loss is realized).
The end result is that the employee receives duplicative
reporting for the same transaction (on both the W-2 and the
1099-B), which can cause confusion. Moreover, if the employee
has not provided a certified taxpayer identification number on
Form W-9, the broker is required to backup withhold 31 percent
from the gross proceeds of the sale in addition to withholding
employment taxes. For many employees, particularly those
working abroad, unintentional errors in W-9 reporting can lead
to unfairly large tax burdens. The Council recommends that the
Congress examine these issues and explore ways in which the
reporting requirements of the Code can be simplified and
streamlined in order to minimize confusion and reduce needless
tax burdens.
The Effect of Auditor Independence Rules on Stock Plan
Participation--We also wanted to bring to the Subcommittee's
attention the effect that the Securities and Exchange
Commission's (SEC) requirement that accountants be independent
of their corporate clients can have in the stock plan context.
These independence rules require that no dependents of the
accountant may own shares in a company that the accounting firm
audits. These rules are incredibly complex to apply and often
exclude the spouses and children of accountants from the stock-
related plans their employers offer. The result has been not
only a burden on the non-accountant working spouses (who must
sacrifice valuable benefits their employers provide) but also a
barrier to attracting the best and brightest to the accounting
profession (as potential candidates choose other professional
paths rather than navigate these rules and sacrifice the
attendant economic benefits). While independence rules are
essential to maintaining the integrity of corporate audits, we
believe the effect of these rules in the stock plan context is
worthy of examination. As Congress continues its oversight of
the SEC's revision of the auditor independence rules, we urge
attention to the issue of stock plan participation by auditor
family members.
International Concerns--Many U.S. companies operating
internationally find that offering stock and stock options to
employees overseas is difficult because of the differing tax
treatment of stock offerings, dividend distributions, and sales
of shares across different countries. The Council urges the
Congress to help promote more uniform treatment for employees
of U.S. companies by investigating the special problems of
offering equity ownership to U.S. workers working in other
countries.
Conclusion
I want to thank you, Mr. Chairman, Ranking Member Coyne,
and the other members of the Subcommittee for your interest and
dedication to promoting equity ownership by American workers.
We look forward to continuing to work with you and other
interested Members to enact new incentives to extend broad-
based stock plans to more American employees and to develop and
advance solutions to the barriers and burdens confronting stock
plans today. Both steps will help us to maintain the positive
trend in our economy toward broad-based employee stock
ownership.
Thank you, and I would be pleased to answer any questions
you may have.
Chairman Houghton. All right. Fine. Thanks very much, Ms.
Schopp.
Now, Ms. Sussman, who is the Executive Director of the
National Association of Stock Plan Professionals.
STATEMENT OF SANDRA L. SUSSMAN, EXECUTIVE DIRECTOR, NATIONAL
ASSOCIATION OF STOCK PLAN PROFESSIONALS, SILVER SPRING,
MARYLAND
Ms. Sussman. Good morning, Mr. Chairman. Thank you for the
opportunity to appear before the subcommittee on behalf of my
organization and its members. My name is Sandra Sussman. I am
the Executive Director of the National Association of Stock
Plan Professionals, which is a professional association for
individuals who are involved directly or indirectly with the
design and administration of employee stock plans.
The NASPP was formed in January of 1993 and currently has a
little over 6,000 members who are in-house securities and tax
attorneys, human resources professionals, accountants,
compensation and benefits professionals and stock plan
administrators, as well as outside providers of stock plan-
related services, such as outside counsel, compensation
consultants, software vendors, brokerage firms, third-party
plan administrators, communications professionals and web-based
service professionals.
Our membership represents roughly 2,500 public companies of
all sizes and industries, all of which have one-or-more
employee stock plans in place. Based in part on the results of
our biannual plan design and administration surveys, we believe
that the current applicable corporate tax treatment of equity
based compensation and awards has led most companies to grant
non-qualified stock options to employees; that is, because non-
qualified awards ultimately involve a tax deduction for the
company, as my colleagues have already expressed.
We also believe, perhaps more importantly, that the current
tax treatment has resulted in most companies not discouraging
disqualifying dispositions of stock acquired through the
exercise of incentive stock plans or through Section 423
employee stock purchase plans, even though employee equity
ownership is most certainly becoming desirable.
While our members have not to date expressed any real
opinion about either Representative Houghton's proposal, that
is, the Universal Employee Stock Option Act of 2000, H.R. 4972,
or Representative Boehner's Wealth Through the Workplace Act,
H.R. 3462, we do believe our member companies would very much
appreciate the availability of an alternative approach that
would provide for more favorable tax treatment for companies
and their employees alike, thereby encouraging greater employee
ownership.
Toward that end, the NASPP would strongly encourage the
reintroduction next year of legislation that would improve the
tax advantages of employee stock options. Going forward, we
will be pleased to provide input to the staff drafting the
legislation based upon the views of our regional leadership,
which we will indeed solicit.
Thank you again for this opportunity. I am happy to take
any questions that you have.
[The prepared statement follows:]
Statement of Sandra L. Sussman, Executive Director, National
Association of Stock Plan Professionals, Silver Spring, Maryland
Good morning, Mr. Chairman. Thank you for the opportunity
to appear before the Subcommittee on behalf of my organization
and its members. My name is Sandra Sussman. I am the Executive
Director of the National Association of Stock Plan
Professionals, which is a professional association for
individuals involved, directly or indirectly, in the design and
administration of employee stock plans. The NASPP was formed in
January of 1993 and currently has over 6,000 members who are
in-house securities and tax attorneys, accountants, human
resources professionals, compensation and benefits
professionals and plan administrators, as well as outside
providers of stock plan related services, such as outside
counsel, compensation consultants, software vendors, brokers,
third party administrators, communications professionals and
web-based services professionals.
Our membership represents roughly 2,500 public companies,
of all sizes and industries, which have one or more employee
stock plans in place. We believe that the current applicable
corporate tax treatment of equity-based compensation and awards
has led most companies to grant non-qualified stock options to
employees, that is, because non-qualified awards ultimately
involve a tax deduction for the company. We also believe,
perhaps more importantly, that current tax treatment has
resulted in most companies not discouraging disqualifying
dispositions of, say, stock acquired through Section 423
employee stock purchase plans, even though employee equity
ownership apparently is becoming more desirable.
While our members have not, to date, expressed an opinion
about Representative Houghton's proposal (that is, the
Universal Employee Stock Option Act of 2000, H.R. 4972), we
believe our member companies would very much appreciate the
availability of an alternative approach that would provide more
favorable tax results for companies and their employees,
thereby encouraging greater employee ownership. Toward that
end, we would strongly encourage the re-introduction next year
of legislation to improve the tax advantages of employee stock
options.
We would be pleased to provide input to the staff drafting
the legislation, based upon the views of our regional
leadership that we will solicit.
Thank you. I am happy to take any questions you might have.
Chairman Houghton. Thank you, Ms. Sussman.
Now, Mr. Butler is the Principal, Practice Leader of
Employee Ownership Programs at Hewitt Associates.
STATEMENT OF MICHAEL J. BUTLER, PRINCIPAL AND PRACTICE LEADER,
EMPLOYEE OWNERSHIP PROGRAMS, HEWITT ASSOCIATES, ROWAYTON,
CONNECTICUT, ON BEHALF OF THE U.S. CHAMBER OF COMMERCE
Mr. Butler. Mr. Chairman and members of the subcommittee,
Mr. Boehner, thank you for the opportunity to participate in
this hearing. My name is Michael Butler. I'm a principal with
Hewitt Associates, a global management consulting firm
specializing in all aspects of employee benefits, compensation
and human resource solutions.
Hewitt Associates has extensive experience with broad-based
employee ownership and equity compensation programs, both
domestic and global. I presently serve as Hewitt's Global
Practice Leader for Employee Ownership Consulting Services.
Hewitt Associates is a member of the U.S. Chamber of Commerce,
where we serve on the Employee Benefits Committee. I am here
today at the request of the Chamber to share our perspective on
employee stock options and other forms of broad-based employee
ownership based on our experience working with literally
hundreds of client organizations on all aspects of employee
ownership.
In recent years, as has been noted, we have seen a
significantly heightened interest in stock options as an
innovative way to compensate and reward employees. I am pleased
that Congress and this committee in particular have taken an
interest in this issue and I applaud your leadership and Mr.
Boehner's in this important area.
In my remarks today, I would like to touch on four primary
observations that I think may be helpful in framing your
consideration of this issue. The first deals with the explosion
in popularity of employee ownership. As has already been noted,
there has been a dramatic increase in practice in the use of
both stock options and stock purchase plans. The National
Center for Employee Ownership estimates that somewhere between
seven to ten million Americans are receiving stock options
today.
A 1999 survey by the same organization indicates that there
were approximately 4,000 stock purchase plans covering
approximately 16 million U.S. participants at the end of 1998,
and those numbers are certainly higher today. Add in ESOPs and
the use of company stock within 401(k) plans and other
mechanisms and the numbers jump even higher.
In other words, employee ownership in the U.S. is thriving
today under existing law. While additional tax and other
incentives such as those contemplated by your legislation and
Mr. Boehner's would certainly be welcomed by employers and
would certainly be productive in the sense of creating
additional mechanisms for extending ownership, a key goal that
we hear from our clients is basically retaining the overall
simplicity and flexibility that is inherent in today's
structures.
One of the reasons that the United States is leading in
this area globally is that our laws permit the kind of
adaptation, flexibility and experimentation that are difficult
to pursue elsewhere. We are seeing very interesting experiments
currently among our clients with things like accelerated
vesting provisions, indexation of options to reflect broader
industry performance and the inclusion of performance-oriented
features to reward specific kinds of achievement.
Any provision that adds additional tax incentives will
certainly be welcomed and appreciated, but we need to be
careful not to hamper the kind of flexibility that currently is
so important in driving the success we have seen in this area
so far. Echoing your comments, Mr. Chairman, I think it is
important also to note that the extension of employee ownership
certainly has contributed to the remarkable performance of our
economy over the past 10 years.
The study by Rutgers noted earlier, as well as other
research we have done in conjunction with Northwestern
University and other studies clearly indicate that there is a
strong correlation between the broad sharing of employee
ownership and superior economic results. I do not think it is
too far-fetched to suggest that the effective use of employee
ownership strategies is contributing to the overall
competitiveness of U.S. business and has, in fact, been a
factor in the remarkable performance of our economy recently.
The point really is the effective use of ownership. Simply
extending ownership without changing other corporate practices,
we have found to be of limited value. As a couple of the prior
witnesses noted, the extension of employee ownership in the
context of teamwork, broader sharing of information, broader
encouragement of empowerment among the broad workforce is
really what drives these results. Ownership in and of itself is
certainly desirable. Ownership in conjunction with enlightened
corporate practices is really what we see driving results.
The third point I would like to touch on is the
international perspective. This explosion in interest in
employee ownership programs is not strictly a U.S. phenomenon.
We have worked with over 20 major U.S. employers to extend
broad-based option and purchase plans to literally hundreds of
thousands of employees in well over 100 countries. We have also
worked with dozens of non-U.S. employers in implementing broad
equity programs for employees in their home countries and
increasingly for their employees around the world.
At the present time, we are actively working with clients
in more than one dozen countries outside the U.S. and are aware
of activity in several more. In considering legislative
initiatives to encourage and expand employee ownership
practices, I think we need to look beyond our borders to
understand the global context within which these plans
increasingly operate.
A program that confers tax or other advantages in the U.S.,
but might lead to some degree of inflexibility and make a
program unsuitable for global implementation, could cause some
difficulties for the growing number of U.S. multi-nationals
that are extending employee ownership to their people around
the world, as well as non-U.S. employers looking to extend
ownership to their employees in the United States.
In summary, employee ownership is a significant and growing
force here and abroad. Used effectively, it certainly has a
demonstrable connection with superior economic results and the
utility of this approach is increasingly being recognized
around the world. The U.S. has been a pioneer in this area
largely because of the flexibility of our broad ownership
mechanisms. There are certainly opportunities to build on this
success by creating new opportunities and new mechanisms, but
we must be careful not to trigger unhealthful side effects by
adding too much complexity or burdensome regulatory
requirements in our quest to improve on what is already a very
successful array of practices.
Thank you for the opportunity to testify today. I would be
happy to respond to any questions and follow up with the
committee staff with further information.
[The prepared statement follows:]
Statement of Michael J. Butler, Principal and Practice Leader, Employee
Ownership Programs, Hewitt Associates, Rowayton, Connecticut, on Behalf
of the U.S. Chamber of Commerce
Mr. Chairman and members of the subcommittee, thank you for
the opportunity to participate in this hearing. My name is
Michael Butler. I am a Principal with Hewitt Associates, a
global management consulting firm specializing in all aspects
of employee benefits, compensation, and human resources
solutions. Hewitt Associates has extensive experience with
broad-based employee ownership and equity compensation
programs, both domestic and global. I presently serve as
Hewitt's global practice leader for employee ownership
consulting services.
Hewitt Associates is a member of the U.S. Chamber of
Commerce, where we serve on the Employee Benefits Committee. I
am here today at the request of the Chamber to share our
perspective on employee stock options and other forms of broad-
based employee ownership, based on our experience working with
hundreds of client organizations on all aspects of ownership
programs.
In recent years, we have seen a significantly heightened
interest in stock options as an innovative way to compensate
and reward employees. I am pleased that Congress is taking an
interest in this issue as well.
In my remarks today, I will outline four observations that
may be helpful in framing your consideration of the stock
option issue:
Growth in Popularity of Stock Options in the U.S.
There has been an explosion of interest and activity in
this area over the past ten years. The National Center for
Employee Ownership conservatively estimates that seven to ten
million U.S. employees are receiving stock options. A 1999
survey by the NCEO indicates that there were more than 4,000
stock purchase plans with approximately 16 million U.S.
participants at the end of 1998. Those numbers are certainly
higher today. Add in employee stock purchase plans (ESOPs),
company stock in 401(k) plans and other mechanisms, and the
numbers jump dramatically.
In other words, employee ownership in the U.S. is thriving
under existing law. While additional tax and other incentives
would certainly be welcomed by employers, and could stimulate
and channel activity in this area, a key goal should be
retention of the overall simplicity and flexibility inherent in
today's environment.
There is a great deal of experimentation going on today as
employers adapt to meet competitive pressures and extend their
plans globally. For example, over the last several years in
Silicon Valley, it has become popular to utilize a very rapid
vesting schedule for stock options. Whereas prior to the late
1990s, a three or four year vesting schedule was typical, now
it is common to have 50 percent of options vest at one year,
with the remainder vesting monthly after that.
Tax or other incentives that come with provisions that
hamper this creativity or limit employer flexibility would be a
mixed blessing at best, and quite possibly counterproductive.
Desirability of Stock Option Plans
Maintaining the vitality of the existing environment is an
issue for our economy as a whole, not just employers and
participants in these plans. There is a considerable and
growing body of research, from a variety of sources, strongly
supporting the proposition that, all else being equal,
organizations providing a meaningful equity stake to the broad
workforce generally outperform those that do not, especially
when combined with participative workplace practices. For
example, researchers at Rutgers University have documented a 16
percent improvement in productivity and two percent improvement
in return on assets by firms beginning a broad-based stock
option plan.
In light of these findings, it is not too farfetched to
suggest that effective use of employee ownership strategies is
contributing to the overall competitiveness of U.S. business,
and has been a factor in the remarkable performance of our
economy over the past decade.
Broader employee ownership may be desirable as a matter of
social policy for a number of reasons. But, from a business
perspective, it is the effective use of these mechanisms that
matters. In evaluating different approaches, keep in mind that
there is a distinction between simply incenting employee
ownership, and use of broad employee participation and
involvement as a source of competitive advantage. For example,
Hewitt research has shown that there are three necessary
components to using stock options to enhance productivity:
Explaining to employees their role in the company
and what the company needs to do to stay competitive, should
not be left to the board room, but instead, should be broadly
disseminated;
Fostering an environment that encourages
individual and collective success, provides a steady flow of
relevant business information, and empowers employees; and,
Sharing equity in the company.
My point here is that broad employee ownership is desirable
not only in terms of fairness and broader sharing of wealth,
but also as a matter of national competitiveness. Governments
from the U.K. to China have explicit policy objectives aimed at
increasing employee ownership, because they see a connection
between our practices in this area and the extraordinary
productivity of our economy. In considering legislative
alternatives aimed at fostering greater employee ownership, we
must not lose sight of the connection to results.
The International Perspective
As noted earlier, the stock option explosion is not just a
U.S. phenomenon. Hewitt Associates has worked with over 20
major U.S. employers to extend broad-based stock option and
stock purchase plans to hundreds of thousands of employees in
well over 100 countries. We have also worked with dozens of
non-U.S. employers in implementing broad equity programs for
employees in their home countries, and increasingly, for their
employees around the world. At the present time, we are
actively working with clients based in at least a dozen
countries outside of the U.S., and are aware of activity in
many more.
In considering legislative initiatives to encourage and
expand employee ownership practices, we need to look beyond our
borders to understand the global context within which these
plans exist. A program that confers tax or other advantages in
the U.S., but which is inflexible or structurally unsuitable
for global implementation could cause serious difficulties for
the growing number of U.S. multinationals extending ownership
world wide, as well as for non-U.S. employers looking to extend
equity participation to their U.S. employees.
For example, one common obstacle we often face in a number
of other countries is the inability to modify or eliminate a
stock option program once it has been put into place. This is
not a problem in the U.S. because of flexible law that enables
companies to adapt to the changing business environment on an
ongoing basis.
In another instance, one U.S. multinational employer has
established a global stock purchase plan, complete with payroll
deductions and an employer match. While not fully aligned with
the U.S. plan, due to differences in the law, the goals of the
foreign and domestic plans are the same: to encourage employee
equity in the company. Flexibility in U.S. law has enabled
employers to mimic plans in other countries, expanding the
global reach of employee ownership.
Refrain from ERISA-like Regulation
In considering legislation to expand the use of stock
options, I urge Congress to keep stock option plans separate
and distinct from qualified benefit plans that are regulated
under the Employee Retirement Income Security Act (ERISA).
Requirements such as nondiscrimination testing, contribution
limits, compensation limits, that are at the heart of ERISA
will create an enormous disincentive for employers to offer
stock options on a broad basis to their workers.
In summary, employee ownership is a significant and growing
force here and abroad. Used effectively, it has a demonstrable
connection with superior economic results, and the utility of
this approach is increasingly being recognized around the
world. The U.S. has been a pioneer in this area, largely
because of the flexibility of our broad ownership mechanisms.
There are certainly opportunities to build on this success by
creating new vehicles and enacting new incentives, but we must
be careful not to trigger unhelpful side effects by adding too
much complexity in our quest to improve an already very
successful array of practices.
Thank you for the opportunity to testify before the
Subcommittee today. I'd be happy to respond to any questions or
follow up with further information.
Chairman Houghton. Thanks very much, Mr. Butler.
Now I would like to ask Mr. Coyne to inquire.
Mr. Coyne. Thank you, Mr. Chairman.
Mr. Cook, based on your long experience in this field that
you outlined earlier, what do you consider is the key to
getting employees to participate in these stock option plans?
Mr. Cook. Sir, the question was what is the key to getting
employees to participate. I believe the key, as identified in
Chairman Houghton's bill, would be to permit employee
contributions to be made on a pre-tax basis. They now are
required to be made on a post-tax basis. That puts employee
stock purchase plans at a disadvantage versus Section 401(k)
plans, where pre-tax contributions are made. That is my answer,
sir.
Mr. Coyne. Ms. Sussman, I wonder if you could profile what
types of employees currently participate in these plans.
Ms. Sussman. What types of employees currently participate
in all sorts of plans?
Mr. Coyne. Yes. Who are the ones that generally take
advantage of this? Is there a profile to these employees?
Ms. Sussman. We don't have a profile, per se. But based
again on the surveys that we conduct every other year, what we
have seen is plans are typically a little bit more top-heavy,
but over the last couple of years plans have been pushed
further down into the ranks. So, at this time, I still think
there are more higher-level employees that are involved in
employee stock plans, the incentive stock options, the
restricted stock awards, those types of things. But broad-based
plans are becoming a little bit more prevalent and they tend to
participate in employee stock purchase plans, non-qualified
options. But management versus rank-and-file is really where we
see the differences in employees. Does that answer your
question?
Mr. Coyne. Yes.
Mr. Capuano, is that the experience you have seen in your
company?
Mr. Capuano. Proxicom is generally considered to be part of
the high-tech industry and we do not have a culture of
management and rank-and-file. In the high-tech industry,
everybody participates. The participation creates a passion
that exists within the company, to succeed. High-technology is
a very competitive industry. It is a global industry, and these
options create a real sense of ownership and passion in our
employees to succeed, to have the company succeed.
So, because it is a competitive industry and we need this
passion to succeed, there is no management and rank-and-file,
and everybody typically participates.
Mr. Coyne. So, you don't see this separation from the
higher-paid employees versus the lower-paid employees in taking
advantage of these stock options?
Mr. Capuano. Oh, absolutely not. Absolutely not. Everybody
needs to be incented across the board in this industry.
Absolutely not. Everybody participates.
Mr. Coyne. Thank you.
Chairman Houghton. Mr. Boehner?
Mr. Boehner. Well, thank you, Mr. Chairman. Again, thank
you for having the hearing and thank you for inviting me to
come. Let me thank the witnesses for what I think was very
excellent and helpful testimony.
Mr. Capuano, the purpose of stock options is obviously to
help employees think like owners. But, as you described, when
workers exercise their option, the current tax treatment of
many of those options really does, in fact, force them to sell
their shares.
I guess my concern is what happens to the employee? What
happens to the management team in terms of the incentives for
the employee to be a strong member of the team, as opposed to
the idea that we have been discussing about encouraging
employees to hold their shares for longer periods of time?
Mr. Capuano. The employees, by being forced to sell shares
of stock in a company such as Proxicom that they have a passion
to build, creates a couple feelings. There is a sense almost of
disappointment, and I have had and I have seen, as the
employees come knocking on my door, trying to figure a way of
how they should deal with this situation, a true sense of
disappointment that they have to sell shares in a company that
they are passionate about building.
In the bigger scheme of things, we feel it creates an
unnecessary risk that our shareholder employees are becoming
detached from the long-term success of the company. We want all
of our shareholder employees to be long-term holders. That is
not to say that they are not going to sell over time, but it
definitely creates an unnecessary division between long-term
ownership and the success of the company. I hope that answered
your question.
Mr. Boehner. Well, let me expand on that just a bit. Can
you paint a picture for me of what you think would happen to
your fellow employees if, in fact, the company got a deduction
for the value of the stock option, if the employee had no tax
treatment until such time as they actually sold the shares, but
not at exercise, and, thirdly, if, in fact, they held those
shares for at least a year, they got capital gains treatment?
What you think the advantages or disadvantages to both the
company and to your employees would be?
Mr. Capuano. The real advantage to the company will be very
strategic. The employees, again because they are--especially in
this very competitive industry--very, very excited about being
owners of our company, they will hold the stock. I am not going
to say everybody will. But I know the Proxicom employees. They
will hold the stock. They will be shareholder owners and it
will drive our growth that much more.
What we sacrifice by having them sell early is up-side to
both the company and the employees. And it is real and you see
it when you have the employees knocking on your door,
disappointed about having to sell early. They want to share in
the up-side. They want to drive the up-side of the company.
So, you have two areas of concern. Again, from a strategic
perspective, we see a real value in having our employees be
long-term shareholders. We know that drives our bottom line,
profitability. From our employees, we also see that they
sacrifice gain. And I have seen it from a very real perspective
when they are forced to sell early and the stock has
appreciated.
Mr. Boehner. To Ms. Schopp and Mr. Butler, my interest in
this is trying to find a way to encourage more companies to
offer stock options to a wide array of their employees.
Clearly, I would hope that companies that would take advantage
of this idea, if it becomes law, would encourage them to all of
their employees.
My question is do you think that--either the package--and
not that I want to get into a debate about my package versus
Mr. Houghton's--but do you believe that the concept that we are
both talking about would encourage more employers to offer a
wide array--offer stock options to a wider array of their
employees?
Ms. Schopp. It has merit for both employers and employees.
I think the bills provide the flexibility for employers to be
able to pick the elements that make sense within their strategy
and their focus and it allows employees to really have the
opportunity to take an ownership interest in their company. I
think from a real example perspective, Monsanto first granted
broad-based stock options to all employees worldwide in 1996.
So, we have had the opportunity over that time frame to see
the real impact that that has had on our people. As we go to
our plants around the world and we see our hourly technicians
really taking a real interest in the performance of Monsanto
and the stock price and what they can be doing on a day-to-day
basis to make Monsanto a better place to work and more
economically viable, it has really been a real learning
experience for us in the design of our programs.
So, I would really encourage continued emphasis on the
areas that you have been both focusing on, because I think that
they both have a real place in the ownership needs of companies
and employees going forward.
Mr. Butler. If I can add to that, yes--I think the simple
answer is yes, additional tax incentives will tend to
accelerate the trend that we are already seeing playing out.
There are larger forces at work in terms of competitiveness,
the shift to a knowledge-based economy and so forth that are
leading employers to look to alternative forms of compensation
like this already.
I think making it more attractive from a tax perspective on
both the employer and employee sides will certainly accelerate
and extend that trend. One additional point, though, I think
there is an important distinction to keep in mind and it points
to a common area of confusion for people delving into this area
for the first time, and that is simply the nomenclature of
stock options versus stock purchase plans.
Obviously, there is a good deal of overlap and there are
good reasons that the term "stock options'' is often used in
the context of stock purchase plans, but there is a fundamental
structural difference between the two. If we are looking for
the broadest application and the broadest participation in
company equity, generally speaking, that leads you towards a
true stock option kind of alternative.
We see that being used for broad-based programs, where
companies are extending options to very broad populations on
essentially an automatic basis. There is no payroll deduction
required. There is typically no out-of-pocket money required,
and therefore it is very easy for a company to say we are going
to essentially extend this practice to all employees or some
other very broad definition.
When you are dealing with a voluntary, contributory kind of
plan, typically stock purchase plans, where you are asking
people to sign up for payroll deduction (and this gets to the
point Mr. Coyne was mentioning before), you do tend to see
somewhat skewed participation because the simple reality is you
are asking people to allocate a limited pool of discretionary
dollars.
So, you do see participation in voluntary plans like stock
purchase plans somewhat skewed towards the higher end of the
pay scale because the simple reality is lower-paid people do
not necessarily have the additional discretionary income to
participate. So, extending the plan is one thing; actually
getting a broad cross-section of the population participating
is another, and the broadest participation tends to come with
options rather than purchase plans because it is simply easier
to do that on an automatic basis.
Ms. Schopp. If I could add one item; over the years,
employees have really now understood the advantage of pre-tax
contributions and payroll deductions, I think as Mr. Cook
mentioned earlier. And I think that the features in the
employee stock purchase plan that would add those features to
stock purchase plans would really be valuable and I think
employees would understand them very quickly because they are
used to those kind of features in 401(k) plans.
Chairman Houghton. Thanks very much.
Mr. Weller?
Mr. Weller. Thank you, Mr. Chairman, and I want to commend
you for conducting what I think is an important hearing; and,
of course, I also salute you and Mr. Boehner for your
leadership on initiatives to promote what I label worker
capitalism. I am a strong believer in giving the workers equity
and giving them an opportunity to have a stake in the success
of a company; and I certainly believe it not only rewards
workers, but it motivates workers to move their company and
their organization forward.
Mr. Butler, I would like to direct my first question to
you. I am one who believes that our tax code has an impact on
global competitiveness. I believe our tax code has an impact on
our ability not only to compete overseas, but also to attract
and keep employment here in America, whether it is our outdated
depreciation treatment of various assets or other tax issues.
But the question I have for you, you have indicated that
your company does business around the world.
Mr. Butler. Yes.
Mr. Weller. And I was just wondering, from your
perspective, do you believe encouraging employee ownership and
giving employees a greater personal ownership stake in
individual companies helps the United States from a global,
competitive standpoint?
Mr. Butler. Not only do I believe that, certainly our
clients believe that; and interestingly so do an increasing
number of foreign governments. There are specific policy
initiatives in the U.K. and China, for example, that are
explicitly aimed at increasing the level of employee ownership
because they understand--they believe very firmly--that one of
the components of our economic success has been our ability to
use these kinds of broad ownership mechanisms very effectively
to drive economic performance.
Some of my colleagues are currently working with senior
officials in the Ministry of Finance in China, providing
technical advice on creating a framework for stock options in
China. So, yes, I firmly believe it. Our clients firmly believe
it, and increasingly people who have looked at the issue around
the world believe that an effective structure that not only
permits, but promotes broad employee ownership is absolutely a
contributing factor to economic success.
Mr. Weller. Well, China and many of these other companies
are competitors of ours on an economic front; and obviously we
want free and fair trade with them. Of course, with the
enactment of permanent normal trade relations with China, we
have made that commitment to our friends in China. Let me ask
you this. These other countries that you are helping develop
policies to encourage greater employee-and worker-ownership of
companies, do they have policies that we do not have which are
better and that are working there?
Mr. Butler. Let me give you the two specific examples I
mentioned, the U.K. and China. In the U.K., there actually is
new legislation just passed this summer that creates a vehicle
that in many ways reflects elements of both Mr. Boehner's and
Mr. Houghton's bills. It is essentially a pre-tax payroll
deduction, stock purchase opportunity with a matching feature
that resembles these proposals in many respects.
So, yes, in the U.K. in particular, there is a program in
place it is expected to contribute significantly to the
extension of employee ownership. They have a long tradition of
it already and it is generally felt in the ownership community
that the new legislation will, in fact, promote broader use of
these approaches.
In China and lots of other less-developed countries, the
issues are rather different. It is not so much do they have
programs that we do not or tax or other structures that we do
not that would encourage it. In fact, in a number of countries
like China, the real barrier to effective use of these programs
is that they do not have a well-developed structure of property
rights and contract rights and clarity around tax and
securities treatment.
Increasingly, that is being addressed around the world and
I mentioned the other countries--
Chairman Houghton. Can I just interrupt, Mr. Butler? We
really do have a time crunch here. So, if you could shorten
those answers so Mr. Weller can ask some other questions.
Mr. Weller. I will let him finish answering the question
and then I will be done. How about that, Mr. Chairman?
Chairman Houghton. Thank you.
Mr. Butler. The point is really that around the world an
increasing number of countries are in the early stages--
primarily outside of Europe--in the early stages of developing
an infrastructure that will allow for the further development
of these kinds of practices. I think it is fair to say the U.S.
is head and shoulders above the rest of the world. The U.K. and
France have fairly well-developed practices. But outside of
those two examples, we clearly have been the pioneers, are
continuing to be the leaders. And with these kinds of
initiatives, I think we will maintain our leadership position.
Mr. Weller. Thank you. May I ask one more?
Chairman Houghton. Yes.
Mr. Weller. Thank you, Mr. Chairman. Actually, let me
direct my last question--I know we have a vote here and we are
a little limited on time--to Ms. Sussman, from the perspective
of the National Association of Stock Plan Professionals. The
public perception of stock options is that it is a new-economy
thing. You hear of these high-tech start-ups that are a few
days old and they are offering stock options to attract talent
to come to work for them.
What is, from your perspective, the more traditional,
older, established old-economy companies? Are you seeing more
and more of the older, more-established companies looking at
setting up stock option plans and what are some of the
challenges that they have converting to that type of employee
benefit?
Ms. Sussman. I think older, more-established companies have
always had stock option plans. I think they have typically been
more geared toward the higher-level employees, senior
executives, key employees, even though all employees are
technically eligible to participate. I think, as the new-
economy companies have come into being, the challenges for the
older, more-established companies has been to offer more,
bigger option packages and push those further down into the
company so that they can, in fact, retain the workers that
would otherwise be going to the .coms.
It has become a big issue. It is a big challenge for the
bigger companies and what we have seen are different types of
option programs coming into being that pretty much can compete
with the .com companies. There are other restricted stock
awards that have come into play; gosh, all sorts of other
things, huge bonuses and retention packages, all of those
things that are keeping people or are trying to keep people
from going off to the .coms.
But I think they have always had them. They have just had
to take on a different face in order to compete successfully
and keep those workers.
Mr. Weller. So, the older, more-established companies, from
what you are saying, are now looking at not just giving this
benefit to their senior management, but also to the assembly
line worker and their clerical help and administrative help in
the offices?
Ms. Sussman. Yes, even though it may be a token sort of
plan. I mean, we have seen a lot of that, too; 100 shares for a
founder's grant or 100 shares annually or 100 shares every
three years or something like that. I mean, they are very token
plans in many cases and very simple; and they set them up so
that they are very simple to administer. But, yes, there seems
to be sort of a trend toward that.
Mr. Weller. Will Chairman Houghton's legislation, as well
as Mr. Boehner's legislation, would that help these older,
more-established companies make this kind of conversion so that
the little guys and little girls in the old-economy companies
will also be able to participate?
Ms. Sussman. To the extent that most of the broad-based
plans that I have seen are non-qualified in any event, it is
not clear to me how that would really make that much of a
difference. I think, for employee stock purchase plan
participation, some of the initiatives to make that a pre-tax
payroll deduction, greater tax incentives along those lines--I
think would help that sort of plan. The broad-based plans that
I have seen are typically non-qualified anyway, which companies
are happy to do because of the tax deduction that that
involves. So, it is not really clear to me how that would play
out.
Mr. Weller. What is the biggest challenge these old-economy
companies have in making that kind of conversion, to giving
their employees further down the pecking order the opportunity
to participate? What is the biggest roadblock?
Ms. Sussman. Administration. The bigger the company, the
bigger the administrative issues are involved. You know, you
get an IBM or any other huge company that has got 30,000 or
40,000 employees here and abroad to grant a one-time grant of
100 stock options to every employee worldwide and it becomes
sort of an administrative challenge, especially if it is going
to be just a one-time thing or if everybody is going to be
cashing out immediately through a cashless exercise sort of
mechanism.
I would say that that is probably the biggest issue.
Mr. Weller. Thank you.
Thank you, Mr. Chairman, for holding this hearing.
Chairman Houghton. Not a bit. Thanks very much, Mr. Weller.
We have got a time crunch. You have never heard that
before--have you--because we have got to go over and vote now.
But let me just sum up in my own mind here. If I understand
what you are saying, that the basic building blocks of either
Mr. Boehner's or my bill does what you want; in other words,
all employees, virtually all employees are eligible; the tax
consequences in terms of pre-tax contributions for employees
are what you want; the deduction at fair market value the day
of exercise for employers is right; and have no implications
for the AMT on the exercise of these options.
Am I summing that up right? Are there any other things--
because if I am and we want to keep in touch with you, then we
are going to go right ahead and plow through this. Have you got
any comments?
Mr. Cook. Mr. Chairman, I think that is an excellent
summary. I would merely only add one, and that is that the
legislation should address the employment tax, FICA and
Medicare obligations on employees when they pay ordinary income
tax. That would be a very important feature, too. The AMT
broad-based participation, pre-tax and corporate tax deduction,
as you summarize, those are the foundations of encouraging
companies to offer these plans more and to encourage the
employees to participate at a greater level of participation.
Chairman Houghton. Well, look, I am sorry that time is
running out and I really appreciate this. I think this is very,
very, very important stuff and we are only going to begin this
process now. If we can get this thing through, we can do other
things which are important in terms of trying to narrow this
gap between the very, very top-paid individuals and the people
who are down the line.
So, thanks so much.
[Whereupon, at 11:28 a.m., the hearing was adjourned.]
[A submission for the record follows:]
Amazon.com, Inc.
Seattle, Washington 98108-1226
October 18, 2000
The Honorable Amo Houghton
Chairman, Subcommittee on Oversight of the
Committee on Ways and Means
United States House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
1Re: Hearing on Employee Stock Option Plans
Dear Chairman Houghton:
We appreciate the opportunity to comment on proposed changes in the
Federal tax treatment of employee stock option plans. In short,
Amazon.com would strongly support any proposals that would encourage
widespread employee stock ownership and promote vigorous competition by
innovative new enterprises.
Amazon.com must attract, retain, and motivate the most talented and
versatile employees if it is to succeed in its drive to become the
earth's most customer-centric merchandiser. It offers its employees an
opportunity for challenge, growth, and hard work in an exciting and
rewarding environment as part of a team of unusually talented
individuals.
The intensely competitive nature of Amazon.com's business, its
emphasis on rapid growth, and the demands of a global Internet business
require that employees make a serious commitment of time and energy to
it. Amazon.com believes that all full-time employees should be
"owners'' of the business, in order to align incentives, encourage
responsible and owner-like commitment, and to ensure that any rewards
that result from building stockholder value are shared throughout the
company. It is committed to the philosophy of employee ownership and to
fostering a work environment grounded in mutual respect. Accordingly,
all regular full-time employees of Amazon.com currently receive stock
options upon their hire.
While Amazon.com offers both qualified and nonqualified stock
options, the majority of the options issued are nonqualified, because
of the Federal income tax limitations placed on qualified options.
Under Amazon.com's stock option plan, an employee receives stock
options on his employment start date. The options vest, or become
exercisable, over 5 years and are generally exercisable over 10 years,
provided that the employee remains an employee of Amazon.com during
such time.
The price of the option is determined on the employee's start date
and is equal to the fair market of the stock at that date. The fair
market value is the average of the high and low price at which the
stock was traded on the NASDAQ exchange on the employee's start date.
Once an employee's options vest, the employee may exercise his
options and acquire Amazon.com stock at the exercise price provided in
the option. If the options at issue are nonqualified stock options, the
employee recognizes compensation income upon exercise. If the options
are qualified options, and there is no disqualifying disposition, the
employee recognizes no income upon exercise of the option. In either
case, on the exercise date, the employee has received no cash. Thus, in
order to pay the tax assessed at the exercise date for nonqualified
options, an employee must sell some of his Amazon.com stock or take out
a loan. A similar result occurs with respect to the alternative minimum
tax on qualified options.
As noted above, Amazon.com relies on its stock option plans to
attract, reward, and retain employees in a very tight labor market.
Additionally, cash is always at a premium for a start-up company.
Absent the ability to offer equity-based compensation, Amazon.com could
not compete with established companies in cash-rich industries for the
premier talent necessary to help it achieve its overall business goals.
The barriers to entry for a company in an Internet environment are low,
resulting in significant competition for scarce resources. The lure of
the upside equity potential has been the single most effective tool
enabling Amazon.com to attract experienced financial and technical
personnel to work in the dynamic and fast-paced environment in which it
operates. Moreover, the employees are truly owners, and their
compensation is tied to the success of the company. Employees accept
less cash compensation than they could get elsewhere, in return for the
opportunity to share in the future success of the company through stock
options.
Of course, the fact that Amazon.com is allowed a Federal income tax
deduction with respect to the exercise of nonqualified options may one
day help us to minimize cash expenditures, in the form of income tax
payments. This deduction, however, is not a tax subsidy, in that it
accurately reflects the employer's net income under Federal income tax
principles. In other words, the employer is compensating its employees
by carving out and granting them a portion of its equity. It could
achieve the same economic effect by selling its shares and using the
cash proceeds to compensate its employees. In that economically
indistinguishable case, no one would deny that a compensation deduction
was warranted.
We appreciate this opportunity to express our support for changes
in the Federal income tax law that will encourage employee stock
ownership and facilitate a long-term ownership commitment on the part
of both employers and employees.
Sincerely,
Robert D. Comfort
Vice President of Tax and Tax Policy
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