[Congressional Record Volume 153, Number 146 (Friday, September 28, 2007)]
[Senate]
[Pages S12335-S12339]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. LEVIN:
  S. 2116. A bill to amend the Internal Revenue Code of 1986 to provide 
that corporate tax benefits based upon stock option compensation 
expenses be consistent with accounting expenses shown in corporate 
financial statements for such compensation; to the Committee on 
Finance.
  Mr. LEVIN. Mr. President, there is a growing chasm in our country 
between the amount of money paid to our corporate executives and the 
earnings of the rank and file workers.
  J.P. Morgan once said that executive pay should not exceed 20 times 
average worker pay. In the U.S., in 1990, average pay for the chief 
executive officer, CEO, of a large U.S. corporation was 100 times 
average worker pay; in 2004, the difference was 300 times; today, it is 
nearly 400 times.
  The single biggest factor responsible for this massive pay gap is 
stock options. Stock options are a huge contributor to executive pay. A 
key factor encouraging companies to pay their executives with stock 
options is a set of outdated and misguided Federal tax provisions that 
favor stock options over other types of compensation. That is why I am 
introducing today a bill to eliminate federal corporate tax breaks that 
give special tax treatment to corporations that pay their executives 
with stock options. It's called the Ending Corporate Tax Favors for 
Stock Options Act.
  This bill has been endorsed by the Consumer Federation of America, 
Citizens for Tax Justice, the Tax Justice Network--USA, OMBWatch, the 
Financial Policy Forum, and the AFL-CIO, each of which sees it as 
needed to eliminate federal tax breaks providing special tax favors for 
corporations that issue large stock option grants to their executives.
  Stock options give employees the right to buy company stock at a set 
price for a specified period of time, typically 10 years. Virtually 
every CEO in America is paid with stock options, which are a major 
contributor to sky-high executive pay.
  According to Forbes magazine, in 2006, the average pay of CEOs at 500 
of the largest U.S. companies was $15.2 million. Nearly half of that 
amount, 48 percent, came from stock options that had been cashed in for 
an average gain of about $7.3 million. In 2006, one CEO cashed in stock 
options for about $290 million; another cashed them in for about $270 
million. Forbes also published a list of 30 CEOs who, in 2006, each had 
at least $100 million in vested stock options that had yet to be 
exercised. Corporate executives are, in short, showered with stock 
options and the millions of dollars they produce.
  A key reason behind this flood of executive stock options is the tax 
code which, when combined with certain U.S. accounting rules, favors 
the issuance of stock option grants. Right now, U.S. accounting rules 
require companies to report their stock option expenses one way on the 
corporate books, while Federal tax rules require them to report the 
same stock options a completely different way on their tax returns. In 
most cases, the resulting book expense is far smaller than the 
resulting tax deduction. That means, under current U.S. accounting and 
tax rules, stock option tax deductions often far exceed the stock 
option expenses recorded by the companies.
  Stock options are the only type of compensation where the Federal tax 
code permits companies to claim a bigger deduction on their tax returns 
than the corresponding expense on their books. For all other types of 
compensation, cash, stock, bonuses, and more, the tax return deduction 
equals the book expense. In fact, companies cannot deduct more than the 
compensation expense shown on their books, because that would be tax 
fraud. The sole exception to this rule is stock options. In the case of 
stock options, the tax code allows companies to claim a tax deduction 
that can be two, three, even ten times larger than the actual expense 
shown on their books.
  When a company's compensation committee learns that stock options can 
produce a low compensation expense on the books, while generating a 
generous tax deduction that is multiple times larger, it is a pretty 
tempting proposition for the company to pay its executives with stock 
options instead of cash or stock. It is a classic case of U.S. tax 
policy creating an unintended incentive for corporations to act.
  The problem is that these mismatched stock option accounting and tax 
rules also shortchange the Treasury to the tune of billions of dollars 
each year, while fueling the growing chasm between executive pay and 
average worker pay. This same mismatch also results in companies 
reporting one set of stock option compensation expenses to investors 
and the public through their public financial statements, and a 
completely different set of expenses to the Internal Revenue Service on 
their tax returns. Such huge book-tax disparities breed confusion, 
distrust, and schemes to maximize the differences.
  The bill I am introducing today would put an end to these 
contradictions and to the harmful, unintended consequences that have 
resulted. It would put a stop to the stock option book-tax disparity, 
an end to the conflicting stock option expenses reported to investors 
and Uncle Sam, and an end to the special tax treatment that currently 
fuels excessive stock option compensation.
  To understand why this bill is needed it helps to understand how 
stock option accounting and tax rules got so out of kilter with each 
other in the first place.
  Calculating the cost of stock options may sound straightforward, but 
for years, companies and their accountants engaged the Financial 
Accounting Standards Board, FASB, in an all-out, knock-down battle over 
how companies should record stock option compensation expenses on their 
books.
  U.S. publicly traded corporations are required by law to follow 
Generally Accepted Accounting Principles, GAAP, issued by FASB, which 
is overseen by the Securities and Exchange Commission, SEC. For many 
years, GAAP allowed U.S. companies to issue stock options to employees 
and, unlike any other type of compensation, report a zero compensation 
expense on their books, so long as, on the grant date, the stock 
option's exercise price equaled the market price at which the stock 
could be sold.
  Assigning a zero value to stock options that routinely produced 
millions of dollars in executive pay provoked deep disagreements within 
the accounting community. In 1993, FASB proposed assigning a ``fair 
value'' to stock options on the date they are granted to an employee, 
using a mathematical valuation tool such as the Black Scholes model. 
FASB proposed further that companies include that amount as a 
compensation expense on

[[Page S12336]]

their financial statements. Critics responded that it was impossible 
accurately to estimate the value of executive stock options on their 
grant date. A bruising battle over stock option expensing followed, 
involving the accounting profession, corporate executives, FASB, the 
SEC, and Congress.
  In the end, after years of fighting and negotiation, FASB issued a 
new accounting standard, Financial Accounting Standard, FAS, 123R, 
which was endorsed by the SEC and became mandatory for all publicly 
traded corporations in 2005. In essence, FAS 123R requires all 
companies to record a compensation expense equal to the fair value on 
grant date of all stock options provided to an employee in exchange for 
the employee's services.
  The details of this accounting rule are complex, because they reflect 
an effort to accommodate varying viewpoints on the true cost of stock 
options. Companies are allowed to use a variety of mathematical models, 
for example, to calculate a stock option's fair value. Option grants 
that vest over time are expensed over the specified period so that, for 
example, a stock option which vests over four years results in 25 
percent of the cost being expensed each year. If a stock option grant 
never vests, the rule allows any previously booked expense to be 
recovered. On the other hand, stock options that do vest are required 
to be fully expensed, even if never exercised, because the compensation 
was actually awarded. These and other provisions of this hard-fought 
accounting rule reflect painstaking judgments on how to show a stock 
option's value.
  Opponents of the new accounting rule had predicted that, if 
implemented, it would severely damage U.S. capital markets. They warned 
that stock option expensing would eliminate corporate profits, 
discourage investment, depress stock prices, and stifle innovation. 
Last year, 2006, was the first year in which all U.S. publicly traded 
companies were required to expense stock options. Instead of tumbling, 
both the New York Stock Exchange and Nasdaq turned in strong 
performances, as did initial public offerings by new companies. The 
dire predictions were flat out wrong.
  During the years the battle raged over stock option accounting, 
relatively little attention was paid to the taxation of stock options. 
Section 83 of the tax code, first enacted in 1969 and still in place 
after more than three decades, is the key statutory provision. It 
essentially provides that, when an employee exercises compensatory 
stock options, the employee must report as income the difference 
between what the employee paid to exercise the options and the market 
value of the stock received. The corporation can then take a mirror 
deduction for whatever amount of income the employee realized.
  For example, suppose a company gave an executive options to buy 1 
million shares of the company stock at $10 per share. Suppose, 5 years 
later, the executive exercised the options when the stock was selling 
at $30 per share. The executive's income would be $20 per share for a 
total of $20 million. The executive would declare $20 million as 
ordinary income, and in the same year, the company would take a 
corresponding tax deduction for $20 million. Although in 1993, Congress 
enacted a $1 million cap on the compensation that a corporation can 
deduct from its taxes, so taxpayers wouldn't be forced to subsidize 
millions of dollars in executive pay, the cap was not applied to stock 
options, allowing companies to deduct any amount of stock option 
compensation, without limit.
  The stock option accounting and tax rules that evolved over the years 
are now at odds with each other. Accounting rules require companies to 
expense stock options on the grant date. Tax rules tell companies to 
deduct stock option expenses on the exercise date. Companies have to 
report grant date expenses to investors on their financial statements, 
and exercise date expenses on their tax returns. The financial 
statements report on all stock options granted during the year, while 
the tax returns report on all stock options exercised during the year. 
In short, company financial statements and tax returns report expenses 
for different groups of stock options, using different valuation 
methods, and resulting in widely divergent stock option expenses for 
the same year.
  To examine the nature and consequences of the stock option book-tax 
differences, the Permanent Subcommittee on Investigations, which I 
chair, initiated an investigation and held a hearing on June 5, 2007. 
Here is what we found.
  To test just how far the book and tax figures for stock options 
diverge, the Subcommittee contacted a number of companies to compare 
the stock option expenses they reported for accounting and tax 
purposes. The subcommittee asked each company to identify stock options 
that had been exercised by one or more of its executives from 2002 to 
2006. The subcommittee then asked each company to identify the 
compensation expense they reported on their financial statements versus 
the compensation expense on their tax returns. In addition, we asked 
the companies' help in estimating what effect the new accounting rule 
would have had on their book expense if it had been in place when their 
stock options were granted. At the hearing, we disclosed the resulting 
stock option data for nine companies, including three companies that 
were asked to testify. The subcommittee very much appreciated the 
cooperation and assistance provided by the nine companies we worked 
with.
  The data provided by the companies showed that, under then existing 
rules, the 9 companies showed a zero expense on their books for the 
stock options that had been awarded to their executives, but claimed 
millions of dollars in tax deductions for the same compensation. The 
one exception was Occidental Petroleum which, in 2005, began 
voluntarily expensing its stock options, but even this company reported 
massively greater tax deductions than the stock option expenses shown 
on its books. When the subcommittee asked the companies what their book 
expense would have been if the new FASB rule had been in effect, all 9 
calculated book expenses that remained dramatically lower than their 
tax deductions. Altogether, the nine companies calculated that they 
would have claimed $1 billion more in stock option tax deductions than 
they would have shown as book expenses, even using the tougher new 
accounting rule. Let me repeat that just 9 companies produced a stock 
option book-tax difference of more than $1 billion.
  KB Home, for example, is a company that builds residential homes. Its 
stock price has more than quadrupled over the past 10 years. Over the 
same time period, it has repeatedly granted stock options to its then 
CEO. Company records show that, over the past 5 years, KB Home gave him 
5.5 million stock options of which, by 2006, he had exercised more than 
3 million.
  With respect to those 3 million stock options, KB Home recorded a 
zero expense on its books. Had the new accounting rule been in effect, 
KB Home calculated that it would have reported on its books a 
compensation expense of about $11.5 million. KB Home also disclosed 
that the same 3 million stock options enabled it to claim compensation 
expenses on its tax returns totaling about $143.7 million. In other 
words, KB Home claimed a $143 million tax deduction for expenses that 
on its books, under current accounting rules, would have totaled $11.5 
million. That is a tax deduction 12 times bigger than the book expense.
  Occidental Petroleum disclosed a similar book-tax discrepancy. This 
company's stock price has also skyrocketed in recent years, 
dramatically increasing the value of the 16 million stock options 
granted to its CEO since 1993. Of the 12 million stock options the CEO 
actually exercised over the past five years, Occidental Petroleum 
claimed a $353 million tax deduction for a book expense that, under 
current accounting rules, would have totaled just $29 million. That is 
a book-tax difference of more than 1200 percent.
  Similar book-tax discrepancies applied to the other companies we 
examined. Cisco System's CEO exercised nearly 19 million stock options 
over the past 5 years, and provided the company with a $169 million tax 
deduction for a book expense which, under current accounting rules, 
would have totaled about $21 million. UnitedHealth's former CEO 
exercised over 9 million stock options in the past 5 years, providing 
the company with a $318 million tax deduction for a book expense which 
would have totaled about $46 million.

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Safeway's CEO exercised over 2 million stock options, providing the 
company with a $39 million tax deduction for a book expense which would 
have totaled about $6.5 million.
  Altogether, these 9 companies took stock option tax deductions 
totaling $1.2 billion, a figure five times larger than the $217 million 
that their combined stock option book expenses would have been. The 
resulting $1 billion in excess tax deductions represents a windfall for 
these companies simply because they issued lots of stock options to 
their CEOs.
  Tax rules that produce outsized tax deductions that are many times 
larger than the related stock option book expenses give companies an 
incentive to issue huge stock option grants, because they know the 
stock options will produce a relatively small hit to the profits shown 
on their books, while also knowing that they are likely to get a much 
larger tax deduction that can dramatically lower their taxes.
  The data we gathered for nine companies alone disclosed stock option 
tax deductions that were five times larger than their book expenses, 
generating over $1 billion in excess tax deductions. To gauge whether 
the same tax gap applied to stock options across the country as a 
whole, the subcommittee asked the IRS to perform an analysis of some 
newly obtained stock option data.
  For the first time last year, large corporations were required to 
file a new tax Schedule M-3 with their tax returns. The M-3 Schedule 
asks companies to identify differences in how they report corporate 
income to investors versus what they report to Uncle Sam, so that the 
IRS can track and analyze significant book-tax differences. The first 
batch of M-3 data, which became available earlier this year, applies 
mostly to 2004 tax returns.
  In analyzing this data, the IRS found that stock option compensation 
expenses were one of the biggest factors in the difference between book 
and tax income reported by U.S. corporations. The data shows that, in 
2004, stock option compensation expenses produced a book-tax gap of 
about $43 billion, which is about 30 percent of the entire book-tax 
difference reported for the period. That means, as a whole, 
corporations took deductions on their tax returns for stock option 
compensation expenses which were $43 billion greater than the stock 
option expenses actually shown on their financial statements for the 
same year. Those massive tax deductions enabled the corporations, as a 
whole, to legally reduce their 2004 taxes by billions of dollars, 
perhaps by as much as $15 billion.
  When asked to look deeper into who benefited from these stock option 
deductions, the IRS was able to determine that the entire $43 billion 
book-tax difference was attributable to about 3,200 corporations 
nationwide, of which about 250 corporations accounted for 82 percent of 
the total difference. In other words, a relatively small number of 
corporations was able to generate $43 billion in tax deductions simply 
by handing out substantial stock options to their executives.
  There were other surprises in the data as well. One set of issues 
disclosed by the data involves what happens to unexercised stock 
options. Under the current mismatched set of accounting and tax rules, 
stock options which are granted, vested, but never exercised by the 
option holder turn out to produce a corporate book expense but no tax 
deduction.
  Cisco Systems told the subcommittee, for example, that in addition to 
the 19 million exercised stock options previously mentioned, their CEO 
holds about 8 million options that, due to a stock price drop, will 
likely expire without being exercised. Cisco calculated that, had FAS 
123R been in effect at the time those options were granted, the company 
would have had to show a $139 million book expense, but would never be 
able to claim a tax deduction for this expense since the options would 
never be exercised. Apple made a similar point. It told the 
subcommittee that, in 2003, it allowed its CEO to trade 17.5 million in 
underwater stock options for 5 million shares of restricted stock. That 
trade meant the stock options would never be exercised and, under 
current rules, would produce a book expense without ever producing a 
tax deduction.
  In both of these cases, under FAS 123R, it is possible that the stock 
options given to a corporate executive would have produced a reported 
book expense greater than the company's tax deduction. While the M-3 
data indicates that, overall, accounting expenses lag far behind 
claimed tax deductions, the possible financial impact on an 
individual company of a large number of unexercised stock options is 
additional evidence that existing stock option accounting and tax rules 
are out of kilter and should be brought into alignment. Under our bill, 
if a company incurred a stock option expense, it would always be able 
to claim a tax deduction for that expense.

  A second set of issues brought to light by the data focuses on the 
fact that the current stock option tax deduction is typically claimed 
years later than the initial book expense. Normally, a corporation 
dispenses compensation to an employee and takes a tax deduction in the 
same year for the expense. The company controls the timing and amount 
of the compensation expense and the corresponding tax deduction. With 
respect to stock options, however, corporations may have to wait years 
to see if, when, and how much of a deduction can be taken. That is 
because the corporate tax deduction is wholly dependent upon when an 
individual corporate executive decides to exercise his or her stock 
options.
  UnitedHealth, for example, told the subcommittee that it gave its 
former CEO 8 million stock options in 1999, of which, by 2006, only 
about 730,000 had been exercised. It does not know if or when he will 
exercise the remaining 7 million options, and so cannot calculate when 
or how much of a tax deduction it will be able to claim for this 
compensation expense.
  Right now, stock options are the only form of compensation in which 
the book expense and tax deduction often take place in different years, 
and the timing of the deduction is under the control of the employee, 
rather than the employer. Under current law, it is not unusual for a 
stock option tax deduction to be claimed 3, 5, or even 10 years after 
the year in which the stock option compensation was granted. Our bill 
would completely eliminate this delay and uncertainty, by requiring 
stock option expenses to be deducted in the same year as they appear on 
the company books.
  If the rules for stock option tax deductions were changed as 
suggested in our bill, companies would typically be able to take the 
deduction years earlier than they do now, without waiting to see if and 
when particular options are exercised. Companies would also be allowed 
to deduct stock options that are vested but never exercised. In 
addition, by requiring stock option expenses to be deducted in the same 
year they appear on the company books, stock options would become more 
consistent with how other forms of compensation are treated in the tax 
code.
  Right now, U.S. stock option accounting and tax rules are mismatched, 
misaligned, and out of kilter. They allow companies collectively to 
deduct billions of dollars in stock option expenses in excess of the 
expenses that actually appear on the company books. They disallow tax 
deductions for stock options that are given as compensation but never 
exercised. They often force companies to wait years to claim a tax 
deduction for a compensation expense that could and should be claimed 
in the same year it appears on the company books.
  The bill we are introducing today would cure these problems. It would 
bring stock option accounting and tax rules into alignment, so that the 
two sets of rules would apply in a consistent manner. It would 
accomplish that goal simply by requiring the corporate stock option tax 
deduction to equal the stock option expenses shown on the corporate 
books each year. Stock option deductions would no longer exceed the 
expenses recorded on a company's publicly available financial reports. 
Stock option expenses for both accounting and tax purposes would be the 
same.
  Specifically, the bill would end use of the current stock option 
deduction under Section 83 of the tax code, which allows corporations 
to deduct stock option expenses when exercised in an amount equal to 
the income declared by the individual exercising the option, replacing 
it with a new Section 162(q),

[[Page S12338]]

which would require companies to deduct the stock option expenses shown 
on their books each year.
  The bill would apply only to corporate stock option deductions; it 
would make no changes to the rules that apply to individuals who have 
been given stock options as part of their compensation. Individuals 
would still report their compensation on the day they exercised their 
stock options. They would still report as income the difference between 
what they paid to exercise the options and the fair market value of the 
stock they received upon exercise. The gain would continue to be 
treated as ordinary income rather than a capital gain, since the option 
holder did not invest any capital in the stock prior to exercising the 
stock option and the only reason the person obtained the stock was 
because of the services they performed for the corporation.
  The amount of income declared by the individual after exercising a 
stock option will likely often be greater than the stock option expense 
booked and deducted by the corporation who employed that individual. 
That is in part because the individual's gain often comes years later 
than the original stock option grant, and the underlying stock will 
usually have gained in value. In addition, the individual's gain is 
typically provided, not by the corporation that supplied the stock 
options years earlier, but by third parties active in the stock market.
  Consider, for example, an executive who exercises options to buy 1 
million shares of stock at $10 per share, obtains the shares from the 
corporation, and then immediately sells them on the open market for $30 
per share, making a total profit of $20 million. The individual's 
corporation didn't supply the $20 million. Just the opposite. Rather 
than paying cash to its executive, the corporation received a $10 
million payment from the executive in exchange for the 1 million 
shares. The $20 million profit from selling the shares was paid, not by 
the corporation, but by third parties in the marketplace who purchased 
the stock. That's why it makes no sense for the company to declare as 
an expense the amount of profit that an employee, or sometimes a former 
employee, obtained from unrelated parties in the marketplace.
  The bill we are introducing today would put an end to the current 
approach of using the stock option income declared by an individual as 
the tax deduction claimed by the corporation that supplied the stock 
options. It would break that old artificial symmetry and replace it 
with a new symmetry more consistent with other tax code provisions, one 
in which the corporation's stock option tax deduction would match its 
book expense.
  I consider the current approach to corporate stock option tax 
deductions to be artificial, because it uses a construct in the tax 
code that, when first implemented over thirty years ago, enabled 
corporations to calculate their stock option expense on the exercise 
date, when there was no consensus on how to calculate stock option 
expenses on the grant date. The artificiality of the approach is 
demonstrated by the fact that it allows companies to claim a deductible 
expense for money that generally does not come from a company's 
coffers, but from third parties in the stock market. Now that U.S. 
accounting rules provide a detailed rule for calculating stock option 
expenses on the grant date, however, there is no longer any need to 
rely on an artificial construct that calculates corporate stock option 
expenses on the exercise date using third party funds.
  Our bill would eliminate the existing grant date-exercise date 
disparity between U.S. accounting and tax rules, and eliminate the 
stock option double standard by ensuring that companies' stock option 
tax deductions are equal to, and not greater than, the actual stock 
option expenses shown on their books.
  It is also important to note that the bill would not affect in any 
way current tax provisions that provide favored tax treatment to so-
called Incentive Stock Options under Sections 421 and 422 of the tax 
code. Under these sections, in certain circumstances, corporations can 
surrender their stock option deductions in favor of allowing their 
employees with stock option gains to be taxed at a capital gains rate 
instead of ordinary income tax rates. Many start-up companies use these 
types of stock options, because they don't yet have taxable profits and 
don't need a stock option tax deduction. So they forfeit their stock 
option corporate deduction in favor of giving their employees more 
favorable treatment of their stock option income. Incentive Stock 
Options would not be affected by our legislation and would remain 
available to any corporation providing stock options to its employees.
  And again, as mentioned earlier, the bill would have no effect on the 
tax treatment of stock options for individuals; the bill would affect 
only corporations.
  The bill would make one other important change to the tax code as it 
relates to corporate stock option tax deductions. Right now, Section 
162(m) of the tax code applies a $1 million cap on corporate deductions 
for the compensation paid to the top executives of publicly held 
corporations. The purpose of this cap is to eliminate any taxpayer 
subsidy for compensation that exceeds $1 million annually and is paid 
to a top corporate executive. As currently written, however, the cap 
does not apply to compensation paid in the form of stock options. By 
exempting stock option compensation from the $1 million cap, the 
provision creates a significant incentive for corporations to pay their 
executives with stock options. The bill would eliminate this favored 
treatment of executive stock options by making deductions for this type 
of compensation subject to the same $1 million cap that applies to 
other forms of compensation covered by Section 162(m).
  The bill also contains several technical provisions. First, it would 
make a conforming change to the research tax credit so that stock 
option expenses claimed under that credit would match the stock option 
deductions taken under the new tax code section 162(q). Second, the 
bill would authorize the Secretary of the Treasury to adopt regulations 
governing how to calculate the deduction for stock options issued by a 
parent corporation to the employees of a subsidiary.
  Finally, the bill contains a transition rule for applying the new 
Section 162(q) stock option tax deduction to existing and future stock 
option grants. This transition rule would make it clear that the new 
tax deduction would not apply to any stock option exercised prior to 
the date of enactment of the bill.
  The bill would also allow the old Section 83 deduction rules to apply 
to any option which was vested prior to the effective date of Financial 
Accounting Standard, FAS, 123R, and exercised after the date of 
enactment of the bill. The effective date of FAS 123R is June 15, 2005 
for most corporations, and December 31, 2005, for most small 
businesses. Prior to the effective date of FAS 123R, most corporations 
would have shown a zero expense on their books for the stock options 
issued to their executives and, thus, would be unable to claim a tax 
deduction under the new Section 162(q). For that reason, the bill would 
allow these corporations to continue to use Section 83 to claim stock 
option deductions on their tax returns.
  For stock options that vested after the effective date of FAS 123R 
and were exercised after the date of enactment, the bill takes another 
tack. Under FAS 123R, these corporations would have had to show the 
appropriate stock option expense on their books, but would have been 
unable to take a tax deduction until the executive actually exercised 
the option. For these options, the bill would allow corporations to 
take an immediate tax deduction, in the first year that the bill was in 
effect, for all of the expenses shown on their books with respect to 
these options. This ``catch-up deduction'' in the first year after 
enactment would enable corporations, in the following years, to begin 
with a clean slate so that their tax returns the next year would 
reflect their actual stock option book expenses for that same year.
  After that catch-up year, all stock option expenses incurred by a 
company each year would be reflected in their annual tax deductions 
under the new Section 162(q).
  The current differences between stock option accounting and tax rules 
make no sense. They require companies to show one stock option expense 
on their books and a completely different expense on their tax returns. 
They require corporations to report one set of

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figures to their investors and a different set of figures to the IRS.
  The current book-tax difference is the historical product of 
accounting and tax policies that have not been coordinated or 
integrated. The resulting mismatch has allowed companies to take tax 
deductions that, usually, are many times larger than the actual stock 
option book expenses shown on their books, which not only shortchanges 
the Treasury, but also provides a windfall to companies doling out huge 
stock options, and creates an incentive for those companies to keep 
right on doling out those options and producing outsized executive pay.
  Right now, stock options are the only compensation expense where the 
tax code allows companies to deduct more than their actual expenses. In 
2004, companies used the existing book-tax disparity to claim $43 
billion more in stock option tax deductions than the expenses shown on 
their books. We cannot afford this multi-billion dollar loss to the 
Treasury, not only because of deep federal deficits, but also because 
this stock option book-tax difference contributes to the ever deepening 
chasm between the pay of executives and the pay of average workers.
  I urge my colleagues to join me in enacting this bill into law this 
year.
  I ask unanimous consent that the text of thje bill and a bill summary 
be printed in the Record.
  There being no objection, the material was ordered to be placed in 
the Record, as follows:

                                S. 2116

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``Ending Corporate Tax Favors 
     for Stock Options Act''.

     SEC. 2. CONSISTENT TREATMENT OF STOCK OPTIONS BY 
                   CORPORATIONS.

       (a) Consistent Treatment for Wage Deduction.--
       (1) In general.--Section 83(h) of the Internal Revenue Code 
     of 1986 (relating to deduction of employer) is amended--
       (A) by striking ``In the case of'' and inserting:
       ``(1) In general.--In the case of'', and
       (B) by adding at the end the following new paragraph:
       ``(2) Stock options.--In the case of property transferred 
     to a person in connection with the exercise of a stock 
     option, any deduction by the employer related to such stock 
     option shall be allowed only under section 162(q) and 
     paragraph (1) shall not apply.''.
       (2) Treatment of compensation paid with stock options.--
     Section 162 of such Code (relating to trade or business 
     expenses) is amended by redesignating subsection (q) as 
     subsection (r) and by inserting after subsection (p) the 
     following new subsection:
       ``(q) Treatment of Compensation Paid With Stock Options.--
       ``(1) In general.--In the case of compensation for personal 
     services that is paid with stock options, the deduction under 
     subsection (a)(1) shall not exceed the amount the taxpayer 
     has treated as an expense with respect to such stock options 
     for the purpose of ascertaining income, profit, or loss in a 
     report or statement to shareholders, partners, or other 
     proprietors (or to beneficiaries), and shall be allowed in 
     the same period that the accounting expense is recognized.
       ``(2) Special rules for controlled groups.--The Secretary 
     shall prescribe rules for the application of paragraph (1) in 
     cases where the stock option is granted by a parent or 
     subsidiary corporation (within the meaning of section 424) of 
     the employer corporation.''.
       (b) Consistent Treatment for Research Tax Credit.--Section 
     41(b)(2)(D) of the Internal Revenue Code of 1986 (defining 
     wages for purposes of credit for increasing research 
     expenses) is amended by inserting at the end the following 
     new clause:
       ``(iv) Special rule for stock options.--The amount which 
     may be treated as wages for any taxable year in connection 
     with the issuance of a stock option shall not exceed the 
     amount allowed for such taxable year as a compensation 
     deduction under section 162(q) with respect to such stock 
     option.''.
       (c) Application of Amendments.--The amendments made by this 
     section shall apply to stock options exercised after the date 
     of the enactment of this Act, except that--
       (1) such amendments shall not apply to stock options that 
     were granted before such date and that vested in taxable 
     periods beginning on or before June 15, 2005,
       (2) for stock options that were granted before such date of 
     enactment and vested during taxable periods beginning after 
     June 15, 2005, and ending before such date of enactment, a 
     deduction under section 162(q) of the Internal Revenue Code 
     of 1986 (as added by subsection (a)(2)) shall be allowed in 
     the first taxable period of the taxpayer that ends after such 
     date of enactment,
       (3) for public entities reporting as small business issuers 
     and for non-public entities required to file public reports 
     of financial condition, paragraphs (1) and (2) shall be 
     applied by substituting ``December 15, 2005'' for ``June 15, 
     2005'', and
       (4) no deduction shall be allowed under section 83(h) or 
     section 162(q) of such Code with respect to any stock option 
     the vesting date of which is changed to accelerate the time 
     at which the option may be exercised in order to avoid the 
     applicability of such amendments.

     SEC. 3. APPLICATION OF EXECUTIVE PAY DEDUCTION LIMIT.

       (a) In General.--Subparagraph (D) of section 162(m)(4) of 
     the Internal Revenue Code of 1986 (defining applicable 
     employee remuneration) is amended to read as follows:
       ``(D) Stock option compensation.--The term `applicable 
     employee remuneration' shall include any compensation 
     deducted under subsection (q), and such compensation shall 
     not qualify as performance-based compensation under 
     subparagraph (C).''.
       (b) Effective Date.--The amendment made by this section 
     shall apply to stock options exercised or granted after the 
     date of the enactment of this Act.
                                  ____

     Section 1--Short title
       ``Ending Corporate Tax Favors for Stock Options Act''
     Section 2--Consistent treatment of stock options by 
         corporations
       Eliminates favored tax treatment of corporate stock option 
     deductions, in which corporations are currently allowed to 
     deduct a higher stock option compensation expense on their 
     tax returns than shown on their financial books--(1) creates 
     a new corporate stock option deduction under a new tax code 
     section 162(q) requiring the tax deduction to be consistent 
     with the book expense, and (2) eliminates the existing 
     corporate stock option deduction under tax code section 83(h) 
     allowing excess deductions.
       Allows corporations to deduct stock option compensation in 
     the same year it is recorded on the company books, without 
     waiting for the options to be exercised.
       Makes a conforming change to the research tax credit so 
     that stock option expenses under that credit will match the 
     deductions taken under the new tax code section 162(q).
       Authorizes Treasury to issue regulations applying the new 
     deduction to stock options issued by a parent corporation to 
     subsidiary employees.
       Establishes a transition rule applying the new deduction to 
     stock options exercised after enactment, permitting 
     deductions under the old rule for options vested prior to 
     adoption of Financial Accounting Standard (FAS) 123R (on 
     expensing stock options) on June 15, 2005, and allowing a 
     catch-up deduction in the first year after enactment for 
     options that vested between adoption of FAS 123R and the date 
     of enactment.
       Makes no change to stock option compensation rules for 
     individuals.
     Section 3--Application of executive pay deduction limit
       Eliminates favored treatment of corporate executive stock 
     options under tax code section 162(m) by making executive 
     stock option compensation deductions subject to the same $1 
     million cap on corporate deductions that applies to other 
     types of compensation paid to the top executives of publicly 
     held corporations.
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