[Congressional Record Volume 157, Number 105 (Thursday, July 14, 2011)]
[Senate]
[Pages S4616-S4620]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. LEVIN (for himself and Mr. Brown of Ohio):
  S. 1375. 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, today I am introducing a bill with my 
colleague, Senator Sherrod Brown, to eliminate the federal tax break 
that gives special tax treatment to corporations that pay their 
executives with stock options. The bill is called the Ending Excessive 
Corporate Deductions for Stock Options Act, and it has been endorsed by 
the AFL-CIO, Citizens for Tax Justice, Consumer Federation of America, 
OMB Watch, and Tax Justice Network-USA. According to the Joint 
Committee on Taxation, eliminating this corporate tax break would bring 
in almost $25 billion over 10 years.
  The existing special treatment of corporate stock options forces 
ordinary taxpayers to subsidize the salaries of corporate executives. 
The subsidy is a consequence of the current mismatch between U.S. 
accounting rules and tax rules for stock options, which have developed 
along divergent paths and are now out of kilter. Today, U.S. accounting 
rules require corporations to report stock option expenses on their 
books when those stock options are granted, while federal tax rules 
provide that they use another method to claim a different--and 
typically much higher--deduction on their tax returns when the stock 
options are exercised. The result is that corporations can claim larger 
tax deductions for stock options on their tax returns than the actual 
expense they show on their books, creating a tax windfall for those 
corporations.
  Stock options are the only type of compensation where the tax code 
lets a corporation deduct more than the expense shown on their books. 
For all other types of compensation--cash, stock, bonuses, and more--
the tax return deduction equals the book expense. In fact, if 
corporations took tax deductions for compensation in excess of what 
their books showed, it could constitute tax fraud. The sole exception 
to that rule is stock options. It is an exception we can no longer 
afford.
  When corporate compensation committees learn that stock options can 
generate tax deductions that are many times larger than their book 
expense, it creates a huge temptation for corporations to pay their 
executives with stock options instead of cash. Why? Because 
compensating executives with stock options instead of cash can produce 
a huge tax windfall for the corporation. By taking advantage of federal 
tax laws that have not been updated for four decades, corporations can 
claim tax deductions at rates that are often 2 to 10 times higher than 
the stock option expense shown on their books.
  Stock options are paid to virtually every chief executive officer, 
CEO, in America and are a major contributor to sky-high executive pay. 
Stock options give the recipients the right to buy company stock at a 
set price for a specified period of time, typically 10 years.
  Since the 1980s, CEO pay has increased at a torrid pace. In 2010, 
according to Forbes magazine, executives at the 500 largest U.S. 
companies received pay totaling $4.5 billion, averaging $9 million per 
CEO. Thirty percent of that pay was comprised of exercised stock 
options which were cashed in for an average gain of about $2.7 million, 
bringing total pay to its highest level since before the recession. The 
highest paid executive in 2010 was the CEO of United Health Group, who 
received $102 million in total pay. Of that pay, almost all of it--$98 
million--came from exercising stock options.
  During the recession from 2007 to 2009, while many stock prices 
dropped in value, 90 percent of corporations awarded stock options to 
their executives. Because of the depressed stock prices at the time, 
most of those stock options were recorded on the corporations' books as 
a relatively small expense. Fast forward to 2010, and even in this 
struggling economy, as stock prices have begun to increase, those same 
stock options are seeing major jumps in their value, far above their 
book expense.
  For example, in a recent study conducted by the Wall Street Journal, 
the CEO of Oracle Corporation was granted stock options in July 2009, 
with an estimated value of $62 million. Two years later, those options 
are estimated to be worth over $97 million, a gain of $35 million in 
just two years. Other corporate executives have experienced similar 
increases in their stock option holdings. For example, according to the 
Wall Street Journal analysis, the CEOs of Abercrombie and Fitch Inc., 
Nabors Industries, Ltd., and Starbucks Corporation all saw jumps in the 
value of stock options awarded during the financial crisis of more than 
$60 million each. The former CEO of Occidental Petroleum, Ray R. Irani, 
received a compensation package valued at $76.1 million, including 
stock option awards valued at $40.3 million.
  These huge increases in the dollar value of the stock option awards 
mean skyrocketing tax deductions for corporations doing so well that 
their stock prices have climbed. The deductions will reduce the taxes 
being paid by these successful companies, depriving the U.S. treasury 
of needed revenues.
  The average worker, by the way, has not experienced any increase in 
pay. From 2009 to 2010 alone, CEOs at the 500 biggest U.S. corporations 
saw a 12 percent increase in compensation, but median income has been 
stagnant. According to the Bureau of Labor Statistics, only 8 percent 
of workers in private industry received stock options as part of their 
compensation package. For CEOs, however, more than 90 percent of those 
in the S&P 500 received stock options in the 12 months starting October 
1, 2008.
  The financial tycoon J.P. Morgan once said that executive pay should 
not exceed 20 times average worker pay. But since 1990, CEO pay has 
increased to a level that is now nearly 300 times greater than the 
average worker's salary. The single biggest factor fueling that massive 
pay gap is stock options which are, in turn, generating huge tax 
deductions for the corporations that doled them out.
  This bill would end the loophole that allows a corporation to deduct 
on its taxes more than the stock option expense shown on its books. 
Over a 5 year period, from 2005 to 2009, the latest year for which data 
is available, IRS tax return data shows that corporate stock option tax 
deductions have exceeded corporate book expenses by billions of dollars 
every year, with the size of the excess tax deductions varying from $12 
billion to $61 billion per year. These excessive deductions mean 
billions of dollars in reduced taxes for

[[Page S4617]]

corporations wealthy enough to provide substantial stock option 
compensation to their executives, all at the expense of ordinary 
taxpayers.
  We cannot afford to continue this multi-billion dollar loss to the 
U.S. Treasury, and tax fairness means ordinary taxpayers should not 
continue to be asked to subsidize corporate executive salaries. That is 
why the bill I am introducing today would change the tax code so that 
corporations can deduct only the stock option expense actually shown on 
their books.
  To get a better understanding of why this bill is needed, it helps to 
have a clear understanding of how stock option accounting and tax rules 
fell out of sync over time.
  Calculating the cost of stock options may sound straightforward, but 
for years, companies and their accountants engaged the Financial 
Accounting Standards Board, or 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, or GAAP, which are issued by 
FASB which is, in turn, 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 produced 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 were 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, or 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.
  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, end stock option compensation, depress stock 
prices, and stifle innovation. But none of that happened.
  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 options to an executive 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 could take a tax 
deduction for $20 million.
  The two main problems with this approach are, first, that the 
deduction amount is out of sync--and usually significantly greater 
than--the expense shown on the corporate books years earlier and, 
second, the $20 million in ordinary income obtained by the executive 
did not come from the corporation itself. In fact, rather than pay the 
executive the $20 million, the corporation actually received money from 
the executive who paid to exercise the option and purchase the related 
stock.
  In most cases, the $20 million was actually paid by unrelated parties 
on the stock market who bought the stock from the executive. Yet the 
tax code currently allows the corporation to declare the $20 million 
paid by third parties as its own business expense and take it as a tax 
deduction. The reasoning behind this approach has been that the 
exercise date value was the only way to get certainty regarding the 
value of the stock options for tax deduction purposes. That reasoning 
lost its persuasive character, however, once consensus was reached on 
how to calculate the value of stock option compensation on the date the 
stock options are granted.
  So U.S. stock option accounting and tax rules are now at odds with 
each other. Accounting rules require companies to expense stock options 
on their books on the grant date. Tax rules require companies to deduct 
stock option expenses on the exercise date. Companies 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 the stock options granted during the year, while the tax 
returns report on the stock options exercised during the year. In 
short, company financial statements and tax returns use different 
valuation methods and value, resulting in widely divergent stock option 
expenses for the same year.
  To examine the nature and consequences of that stock option book-tax 
difference, the Permanent Subcommittee on Investigations, which I 
chair, initiated an investigation and held a hearing 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. The Subcommittee very 
much appreciated the cooperation and assistance provided by the nine 
companies we worked with. At the hearing, we disclosed the resulting 
stock option data for those companies, including three companies that 
testified.
  The data provided by the companies showed that, under then existing 
rules, eight of the nine 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 ninth company, Occidental Petroleum, had begun 
voluntarily expensing its stock options in 2005, but also 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 FAS 123R had been in effect, all 
nine calculated book expenses that remained dramatically lower than 
their tax deductions. Altogether, the nine companies calculated that 
they would have claimed about $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 and excess tax deductions 
of about $1 billion.

  KB Home, for example, is a company that builds residential homes. Its 
stock price had more than quadrupled over the 10 years leading up to 
2006. Over the same time period, it had repeatedly granted stock 
options to its then CEO. Company records show that, over 5 years, KB 
Home gave him 5.5 million stock options of which, by 2006, he had 
exercised more than 3 million.

[[Page S4618]]

  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. That 
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 5-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 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 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 about $1.2 billion, a figure nearly 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 
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 it is highly 
likely the stock options will produce a relatively small hit to the 
profits shown on their books, and are likely to produce a much larger 
tax deduction that can dramatically lower their taxes.
  The data we gathered for just nine companies found excess stock 
option tax deductions of $1 billion. 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 what, back then, 
was newly available stock option data.
  The data is taken from tax Schedule M-3, which corporations were 
required to file for the first time in 2004, 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 M-3 data showed that, for corporate tax returns filed from July 
1, 2004 to June 30, 2005, the first full year in which it was 
available, companies' stock option tax deductions totaled about $43 
billion more than their stock options expenses on their books. Similar 
data over the next 5 years, with the latest available data from tax 
returns filed from July 1, 2008 to June 30, 2009, showed that corporate 
stock option tax deductions as a whole exceeded their book expenses 
every year by billions of dollars, with the size of the excess tax 
deductions varying from $12 billion to $61 billion per year. These 
excessive deductions meant billions of dollars in reduced taxes for the 
relevant corporations each year.
  In addition, the IRS data showed that the bulk of the stock option 
deductions were taken by a relatively small number of corporations 
nationwide. For example, in 2005, 56 percent of the excess tax 
deductions were taken by only 100 corporations, while 76 percent were 
taken by 250 corporations. In fact, over the 5 years of data, just 250 
corporations took two thirds to three quarters of all of the stock 
option deductions claimed in those years. That is just 250 corporations 
out of the more than 5 million corporations that filed tax returns each 
year. In other words, the IRS data proves that the corporate stock 
option tax loophole actually benefits a very small number of 
corporations.
  Claiming massive stock option tax deductions enabled those 
corporations, as a whole, to legally reduce payment of their taxes by 
billions of dollars each year. Moreover, under current tax rules, if a 
stock option deduction is not useful in the year it is first available, 
the corporation is allowed to add the deduction to its net operating 
losses and use the deduction to reduce its taxes for up to the next 20 
years, an unbelievable windfall. It is a corporate loophole that just 
keeps going.
  There were other surprises in the stock option 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 at the time those options were granted, the company 
would have had to show a $139 million book expense, but would never 
have been able to claim a tax deduction for this expense since the 
options would never have been 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 current accounting rules, 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 with 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 the stock option 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's 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 in the same year on its tax return. The company, and the 
government, would not have to wait to see if and when the stock options 
given to executives were exercised. As with any other form of 
compensation, the company would use the FASB accounting rules to 
determine the value of what it is giving away, and take the equivalent 
tax deduction in the year the compensation was provided.
  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

[[Page S4619]]

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 provided 
for in our bill, companies would typically take the deduction years 
earlier than they do now, without waiting to see if and when particular 
options are 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 bill being introduced today would cure those 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 reflect the stock option expenses as 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 as 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 
receive stock options as part of their compensation. Those individuals 
would still report their compensation in the year they exercise 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 an individual after exercising a 
stock option will likely be greater than the stock option expense 
booked and deducted by the corporation which employed that individual. 
That's in part because the individual's gain often comes years after 
the original stock option grant, during which time the underlying stock 
will usually have gained in value. In addition, the individual will 
typically exercise the option and immediately sell the stock and 
therefore receive income, not just from the corporation that supplied 
the stock options years earlier, but also from the third parties 
purchasing the resulting shares.
  Consider the same example discussed earlier of an executive who 
exercised options to buy 1 million shares of stock at $10 per share, 
obtained the shares from the corporation, and then immediately sold 
them on the open market for $30 per share, making a total profit of $20 
million. The individual's corporation didn't supply that $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--often a former employee--obtained from unrelated parties in 
the marketplace.
  The executive who exercised the stock options must still treat any 
resulting profit as ordinary income for the reasons given earlier: the 
executive received the shares at a below market cost, solely because of 
work that the executive performed for the corporation in return for the 
stock option compensation.
  The bill we are introducing today would put an end to the current 
approach of allowing a corporation to take a mirror deduction equal to 
the ordinary income declared by its executive. It would break that old 
artificial illogical symmetry and replace it with a new logical 
symmetry--one in which the corporation's stock option tax deduction 
would match its book expense.
  I call the current approach a case of artificial symmetry, 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 corporations to 
claim a deductible expense for money that comes not from company 
coffers, but from third parties in the stock market. Now that an 
accounting consensus determines how to calculate 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.
  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 Section 422 of the tax code. Under 
that section, 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 that other taxpayers wouldn't be forced to 
subsidize corporate executive pay. That cap was not applied to stock 
options, however, instead allowing companies to deduct any amount of 
stock option compensation from their tax obligations, without limit.
  By not applying the $1 million cap to stock option compensation, the 
tax code created a significant tax incentive for corporations to pay 
their executives with stock options. Indeed, it is common for 
executives to have salaries of $1 million, while simultaneously 
receiving millions of dollars more in stock options. History has 
subsequently shown that the $1 million cap--established to stop 
ordinary taxpayers from being forced to subsidize enormous paychecks 
for corporate executives--is effectively meaningless without including 
stock options.
  Further, while corporate directors may be comfortable diluting their 
shareholders' interests while doling out massive amounts of stock 
options, that still does not mean that ordinary taxpayers should be 
forced to subsidize the large amounts of stock option compensation 
involved. The bill would eliminate this unwarranted, 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). It is also worth 
noting that, if the cap were applied to stock options, it would not 
prevent stock option pay from exceeding $1 million--it would simply 
ensure that those stock option awards were not made at the expense of 
ordinary taxpayers.
  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).

[[Page S4620]]

Second, the bill would authorize the Secretary of the Treasury to adopt 
regulations governing how to calculate the deduction for stock options 
in unusual circumstances, such as when a parent corporation issues 
options on its shares to the employee of a subsidiary or another 
corporation in a consolidated group, or when one corporation issues 
options on its shares to employees of a joint venture.
  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. Essentially, this transition rule would ensure that 
stock options issued prior to the enactment date of the legislation 
would remain tax deductible and ensure all corporations can start 
deducting stock option expenses on a yearly schedule.
  The transition rule has three parts. First, it would allow the old 
Section 83 deduction rules to apply to any option which was vested 
prior to the effective date of the new stock option accounting rule, 
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 those 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).
  This transition rule is a generous one, but even with it, the Joint 
Committee on Taxation has estimated that closing the corporate stock 
option tax deduction loophole would produce $24.6 billion in corporate 
tax revenues over 10 years.
  Over the last 5 years, the stock option book-tax gap has ranged from 
$12 billion to $61 billion per year, generating deductions far in 
excess of corporate expenses. Corporations have avoided paying their 
fair share to Uncle Sam by simply giving their executives the right to 
tap huge sums of money from the stock market. It is a tax policy that 
forces ordinary taxpayers to subsidize outsized executive compensation 
and that favors corporations doling out stock options over paying their 
executives in cash.
  Right now, stock options are the only compensation expense where the 
tax code allows companies to deduct more than their book expense. In 
these times of financial distress, we cannot afford this multi-billion 
dollar loss to the Treasury, not only because of the need to reduce the 
deficit, but also because the stock option tax deduction contributes to 
the anger and social disruption caused by the ever deepening chasm 
between the pay of executives and the pay of average workers.
  The Obama administration has pledged itself to closing unfair 
corporate tax loopholes and to returning sanity to executive pay. It 
should start with supporting an end to excessive stock option corporate 
deductions. I urge my colleagues to include this legislation in any 
deficit reduction package this year, or to pass it separately.

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