[Congressional Record Volume 155, Number 111 (Wednesday, July 22, 2009)]
[Senate]
[Pages S7880-S7884]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. LEVIN (for himself and Mr. McCain):
  S. 1491. 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, Senator McCain and I are 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 is called the Ending excessive Corporate Deductions for Stock 
Options Act, and it has been endorsed by OMB Watch, the Consumer 
Federation of America, the Tax Justice Network-USA, and the AFL-CIO.
  We are in a financial crisis. We are spending hundreds of billions of 
taxpayer dollars to try to stop the housing bust and prop up Wall 
Street. Too many of the middle class are watching the American dream 
slip away, while executives are getting mutli-million dollar 
compensation packages.
  At the same time, mismatched stock option accounting and tax rules 
are shortchanging the Treasury to the tune of billions of dollars each 
year, while fueling the growing chasm between executive pay and average 
worker pay. The mismatch is this: companies are allowed to report 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, IRS, on their tax 
returns. Put simply, our precious tax dollars are being wasted by an 
outdated and unfair corporate tax loophole that encourages corporations 
to hand out massive stock option grants to their executives. It is time 
to put an end to the excessive tax deductions being reaped by 
corporations at taxpayers' expense.
  J.P. Morgan once said that executive pay should not exceed 20 times 
average worker pay. In the United States, in 1990, average pay for the 
chief executive officer of a large U.S. corporation was 100 times 
average worker pay. Recently, CEO pay was nearly 400 times that of the 
average worker.
  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 the misguided Federal tax system that favors stock options 
over other types of compensation. Stock options give employees the 
right to buy company stock at a set price for a specified period of 
time, often 5 or 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 2008, the CEOs at the 500 largest U.S. 
companies took home a combined $5.7 billion, averaging $11.4 million 
each.
  For example, according to an Equilar Inc. analysis of 2008 filings 
with the Securities and Exchange Commission, SEC, Oracle Corporation's 
CEO was granted options estimated in value at more than $71 million 
just last year. That grant was on top of the pay he received from 
vested and exercised stock options given to him by his company in the 
past. In 2008 alone, those stock options amounted to a personal gain of 
more than $543 million. That is $543 million in stock option gains in a 
single year. Stunningly, his company gets to deduct this outlandish 
``compensation'' from its taxes--even though the company never paid him 
that amount, and even though the existing tax code generally limits 
corporate deductions for executive pay to $1 million per executive.
  Oracle's CEO was not alone. Equilar has identified dozens of U.S. 
executives who obtained tens of millions or even hundreds of millions 
of dollars from stock options in 2008. For example, the CEO of Qualcomm 
Inc., had $209 million in stock options gains in 2008, while the CEO of 
Occidental Petroleum had gains of $184 million.

  Between the repricing of some stock options and grants being made 
while stock prices are low, the recent stock market recovery will 
likely mean that many executives will continue to reap astronomical 
stock option-related compensation, and their companies will continue to 
reap unwarranted tax deductions from stock options gains.
  Why do corporate executives have so many stock options to cash in? A 
key reason is that U.S. accounting rules allow 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 taken by corporations often far exceed the recorded 
stock option expenses shown on the companies' books. The result is a 
tax windfall.
  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, ten or one hundred times larger than the 
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 creates a 
temptation 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 in a 
particular way.
  This bill is particularly timely given the new administration's 
stated goals to close unfair corporate tax loopholes, strengthen tax 
fairness, and reign in excessive executive compensation. Given the 
current financial crisis, staggering health care costs, and ongoing 
defense needs, now more than ever, we cannot afford this multi-billion 
dollar loss to the Treasury.
  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 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 produce huge 
amounts of 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 
mathematical valuation tools. FASB proposed further that companies 
include that amount as a compensation expense on their financial 
statements. A 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

[[Page S7881]]

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. 
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 wrong. Stock option expensing has been fully implemented without 
any detrimental impact to the markets.
  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 four 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.
  The two main problems with this approach are that: the deduction 
amount is significantly greater than the value of what the company gave 
away, often years earlier, and the $20 million in income obtained by 
the executive did not come out of the company's coffers. In most cases, 
the $20 million was paid by unrelated parties on the stock market. Yet 
the tax code allowed the corporation to declare the $20 million as a 
business expense and take it as a tax deduction. The reasoning was that 
the exercise date value was the only way to get a clear figure for 
stock option tax deduction purposes. That reasoning lost its persuasive 
character, however, once consensus was reached on how to calculate 
stock option expenses when granted.

  Stock option accounting and tax rules have evolved separately over 
the years and are now at odds with each other. Accounting rules require 
companies to expense stock options on their books on the grant date. 
Tax rules provide that companies deduct stock option expenses on the 
exercise date. Companies have to report the grant date expense to 
investors on their financial statements, and the exercise date expense 
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 identify 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 2 years ago, in 
June 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 9 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 nine companies showed a zero expense on their books for that 
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 Occidential Petroleum which, in 2005, began 
voluntarily expensing its stock options, but even this company reported 
significantly 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 nine calculated book expenses that remained dramatically 
lower than their tax deductions. Altogether the 9 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 nine 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 had more than quadrupled over the past 10 years. Over the 
same time period, it had repeatedly granted stock options to its then 
CEO. Company records show that, over five 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's a tax deduction 12 times bigger than the book expense.
  Occidental Petroleum disclosed a similar book-tax discrepancy. This 
company's stock price had also skyrocketed, 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 a five-
year period, Occidental Petroleum claimed a $353 million tax deduction 
for a book expense that, under current accounting rules, would have 
totaled just $29 million. That's 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 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 5 years, providing the 
company with a $318 million tax deduction for a book expense which 
would have totaled about $46 million. 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 nine companies took stock option tax deductions 
totaling $1.2 billion, a figure 5 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

[[Page S7882]]

a tax windfall for these companies simply because they issued lots of 
stock options to their CEOs.
  Tax rules that produce huge tax deductions that are many times larger 
than the related stock option book expenses give companies an incentive 
to issue massive 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 in 2004, 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.
  This data shows that, for corporate tax returns filed form July 1, 
2005 to June 30, 2006, the first full year in which it was available, 
companies' stock option tax deductions totaled about $61 billion more 
than their stock options expenses on their books. Similar data for July 
1, 2006 to June 30, 2007, showed that the excess stock option tax 
deductions totaled about $48 billion. In addition, the IRS data shows 
that nearly 60 percent of the excess tax deductions in 2007 were 
attributable to only 100 corporations; 75 percent were attributable to 
only 250 corporations. The IRS also determined that stock options were 
one of the most important factors why corporations reported different 
income on their books compared to their tax returns.

  Claiming these massive stock option tax deductions enabled U.S. 
corporations, as a whole, to legally reduce payment of their taxes by 
billions of dollars, perhaps as much as $10 billion, $15 billion, even 
$20 billion per year.
  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 
held about 8 million options that, due to a stock price drop, would 
likely expire without being exercised. Cisco calculated that, had FAS 
123R been in effect a 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.
  Another set of issues brought to light by theIRS 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.
  Our bill would require that, when the company gives away something of 
value, it reflects that expense on its books and claims that same 
expense on its tax return. The company, and the government, should not 
have to wait to see whether the stock options given to executives later 
increased in value and were exercised. As with any other form of 
compensation, the company should determine the value of what it is 
giving away, and take the appropriate tax deduction at that time.
  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 did not know if or when its former 
CEO would exercise the remaining 7 million options, and so could not 
calculate when or how much of a tax deduction it would be able to claim 
for this compensation expense.

  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 
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 Levin-McCain 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 be no greater than the stock option 
expenses shown on the corporate books each year.
  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), 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's in part because the individual's gain often comes years later 
than the original

[[Page S7883]]

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 the same example discussed earlier of 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 toal 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 is why it 
makes no sense for the company to declare as an expense the amount of 
profit that an employee--or 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--one in which the corporation's stock option tax 
deduction would match its book expense.
  I describe the current approach to corporate stock option deductions 
as artificial, because it uses a construct in the tax code that, when 
first implemented 40 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 comes not 
from company coffers, but from third parties in the stock market. Now 
that U.S. accounting rules require the calculation of stock option 
expenses on the grant date, however, there is no longer any need to 
rely on an artificial construct that calculated corporate stock option 
expenses on the exercise date using third party funds.
  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 those 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.
  The bill would make one other important change to the tax code as it 
relates to corporate stock option tax deductions. In 1993, Congress 
enacted a $1 million cap on the compensation that a corporation can 
deduct from its taxes, so taxpayers would not be forced to subsidize 
excessive executive pay. However, the cap was not applied to stock 
options, allowing companies to deduct any amount of stock option 
compensation, without limit.
  By not applying the $1 million cap to stock option compensation, the 
tax code created a significant incentive for corporations to pay their 
executives with stock options. Indeed, it is very common for executives 
to have salaries of $1 million, while simultaneously receiving millions 
of dollars more in stock options. It is effectively meaningless to cap 
deductions for executive salary compensation but not also for stock 
options.
  Further, while corporate directors may be comfortable diluting their 
shareholders' interests and doling out massive amounts of stock 
options, that does not mean that the taxpayers should subsidize it. 
This 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 is 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 accounting and tax rules for stock 
options make no sense.
  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 are usually many times larger than the actual stock 
option expenses shown on their books, at the expense of the Treasury 
(i.e., other taxpayers). Companies are incentivized to dole out 
excessive options packages, producing outsized executive pay, while 
being allowed to reflect much smaller ``expenses'' on their books. They 
get to avoid paying their fair share to Uncle Sam by simply giving 
their executives the rights to huge sums of money from the financial 
markets.
  Right now, stock options are the only compensation expense where the 
tax code allows companies to deduct more than their book expenses. In 
the last year for which the data is available, companies used the 
existing book-tax disparity to claim $48 billion more in stock option 
tax deductions than the expenses shown on their books. In these times 
of financial crisis, we cannot afford this multi-billion dollar loss to 
the Treasury, not only because of the need to finance the mounting 
costs of rescuing the economy, but also because this stock option book-
tax difference contributes to the anger and social disruption caused by 
the ever deepening chasm between the pay of executives and the pay of 
average workers.

[[Page S7884]]

  The Obama administration has pledged itself to closing unfair 
corporate tax loopholes and to returning sanity to executive pay. It 
should start with supporting the ending of excessive stock option 
corporate deductions. I urge my colleagues to join Senator McCain and 
me in enacting this bill into law this year.
  Mr. President, I ask unanimous consent that the text of the bill and 
a bill summary be printed in the Record.
  There being no objection, the text of the bill was ordered to be 
printed in the Record, as follows:

                                S. 1491

       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 Excessive Corporate 
     Deductions 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.
                                  ____


Summary of the Ending Excessive Corporate Deductions for Stock Options 
                                  Act


                         Section 1--Short Title

       ``Ending Excessive Corporate Deductions 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 
     a subsidiary's 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, or for incentive stock options that qualify 
     under section 422 of the tax code.


        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. This approach mirrors that taken in the 
     Economic Emergency Stabilization Act to address the financial 
     crisis.
                                 ______