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Heads up: New Senate bill would attack stock option expense and deduction differences

As we lurch toward our national day, if not hour, of reckoning with the federal debt ceiling, Congressional struggles have spawned what may be legislative philosopher’s stones.  One of these is Senate Bill S.1735.IS, with the descriptive title of “Ending Excessive Corporate Deductions for Stock Options Act.”

The bill, introduced July 14, 2011, and co-sponsored by Senators Carl Levin (Dem.-Michigan) and Sherrod Brown (Dem.-Ohio), is offered as a means to reduce the federal deficit by $25 billion over ten years by, yep, the action suggested by its title.  The Senators’ objection to the current state of stock option deployment is the resulting discrepancy between the expense a company books when options are granted and the deduction subsequently taken when the options are exercised.  (This discrepancy does not occur in the case of, for example, cash, bonuses, or stock, where the deduction equals the book expense.)  To use Senator Levin’s illustration, let’s say a company grants an executive options to buy 1 million shares (okay, he or she is probably the CEO) at $10 per share.  The executive exercises the options 5 years later, when the market price is $30 per share.  The executive will see a total of $20 million upon exercise, at which time the company will receive a deduction for the same amount of $20 million.  This represents a sort of corporate windfall, since the company would have earlier booked the expense of the option at $10 per share, or $10 million.  Senate Bill S.1735.IS seeks to excise this discrepancy.

More than this, Senator Levin’s aspirations for the bill include all of the following:

  • require the corporate tax deduction for stock option compensation not to exceed the stock option book expense shown on a corporation’s financial statement;
  • allow corporations to deduct stock option compensation on their tax returns in the same year it is recorded on the corporate books, without waiting for the options to be exercised;
  • ensure research tax credits use the same method for calculating stock option pay expenses when computing wages eligible for the tax credit;
  • make no changes to stock option compensation rules for individuals, or for incentive stock options under Section 422 of the tax code which may be used by start-up companies and other small businesses;
  • create a transition rule to ensure stock options granted before the enactment date are tax deductible; and
  • make stock option deductions subject to the existing $1 million cap on corporate tax deductions for compensation paid to top executives of publicly held corporations.

Note the last of these.  Stock options are the one form of compensation not yet subject to the $1 million deduction under Internal Revenue Code Section 162(m).  The Levin-Brown bill would place options under the same limiting umbrella.

Will it fly?  Well, this is Sen. Levin’s fifth at bat on the topic.  Unless something has changed, it might suffer the same fate as before.  However, we are now faced with a potentially seismic event – the downgrade of our sovereign debt – which may rearrange the deck chairs on our fiscal Titanic (here ends my threat of mixing metaphors).  The fate of the bill may be different this time.

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