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Friday, December 30, 2011

NY Times: Tax Benefits From Options as Windfall for Businesses

New York Times, Tax Benefits From Options as Windfall for Businesses:

The stock market’s rebound from the financial crisis three years ago has created a potential windfall for hundreds of executives who were granted unusually large packages of stock options shortly after the market collapsed.

Now, the corporations that gave those generous awards are beginning to benefit, too, in the form of tax savings.

Thanks to a quirk in tax law, companies can claim a tax deduction in future years that is much bigger than the value of the stock options when they were granted to executives. This tax break will deprive the federal government of tens of billions of dollars in revenue over the next decade. And it is one of the many obscure provisions buried in the tax code that together enable most American companies to pay far less than the top corporate tax rate of 35% — in some cases, virtually nothing even in very profitable years.

In Washington, where executive pay and taxes are highly charged issues, some critics in Congress have long sought to eliminate this tax benefit, saying it is bad policy to let companies claim such large deductions for stock options without having to make any cash outlay. Moreover, they say, the policy essentially forces taxpayers to subsidize executive pay, which has soared in recent decades. Those drawbacks have been magnified, they say, now that executives — and companies — are reaping inordinate benefits by taking advantage of once depressed stock prices. ...

For example, in the dark days of June 2009, Mel Karmazin, chief executive of Sirius XM Radio, was granted options to buy the company stock at 43 cents a share. At today’s price of about $1.80 a share, the value of those options has risen to $165 million from the $35 million reported by the company as a compensation expense on its financial books when they were issued.

If he exercises and sells at that price, Mr. Karmazin would of course owe taxes on the $165 million as ordinary income. The company, meanwhile, would be entitled to deduct the full $165 million as compensation on its tax return, as if it had paid that amount in cash. That could reduce its federal tax bill by an estimated $57 million, at the top corporate tax rate. ...

Executive compensation experts say that barring another market collapse, the payouts to executives — and tax benefits for the companies — will run well into the billions of dollars in the coming years. Indeed, of the billions of shares worth of options issued after the crisis, only about 11 million have thus far been exercised, according to data compiled by InsiderScore, a consulting firm that compiles regulatory filings on insider stock sales.

“These options gave executives a highly leveraged bet that stock prices would rebound from their 2008 and 2009 lows, and are now rewarding them for rising tides rather than performance,” said Robert J. Jackson Jr., an associate professor of law at Columbia who worked as an adviser to the office that oversaw compensation of executives at companies receiving federal bailout money. “The tax code does nothing to ensure that these rewards go only to executives who have created sustainable long-term value.” ...

Some corporate watchdog groups, and a few members of Congress, call the corporate tax deduction an expensive loophole. Many tax lawyers and accountants counter that the tax deduction is justifiable because the options represent a real cost to the company. And because the executives who exercise their options are taxed at high individual rates, the companies say that a change would result in an unfair form of double taxation.

Yet even those who support the existing tax policy say it was opportunistic for executives to avail themselves of big increases in stock options — which are supposed to be a performance-based reward — when a marketwide collapse meant that most companies’ stock price seemed destined to go up. ...

To be sure, some executives whose option values have skyrocketed can point to notable accomplishments. Howard Schultz, chief executive of Starbucks, was granted options valued at $12 million in November 2008 that are today worth more than $100 million. In the years since, Starbucks has laid off thousands of employees, closed hundreds of stores and retooled its business plan. The strategy reversed the company’s slide in earnings. Shares of Starbucks, which traded in the $30s during much of 2008 and fell below $8 after the near collapse, closed Thursday at $46.45.

But other companies whose executives have already cashed in some options issued during the crisis have not performed particularly well compared with their peers. The oil drilling company Halliburton is one.

Update: Dan Shaviro (NYU), New York Times Article on Corporate Stock Options.

http://taxprof.typepad.com/taxprof_blog/2011/12/ny-times--2.html

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Comments

"If he exercises and sells at that price, Mr. Karmazin would of course owe taxes on the $165 million as ordinary income."

Note the "of course." OF COURSE the NY Times isn't advocating that the employees taxes be limited to the accounting expense as well -- just the employer's deduction!

Posted by: anon | Dec 30, 2011 3:08:53 PM

Per the NY times, when my employer pays me 100k salary, I have $100k of income and my employer has the same deduction, the Fed Govt is deprived of funds? It doesn't really follow.

Posted by: Yo Gabba Gabba | Dec 30, 2011 3:38:19 PM