Senator Carl Levin (D-MI) introduced a bill this week to end the disparity between deductions taken by companies for stock options and the expenses that are actually reported on the companies' books for those options. Corporations sometimes compensate employees (particularly executives) with options to buy stock at a set price. The employee can wait to exercise the option until after the value of the stock has increased beyond that price, thus enjoying a substantial tax benefit.
When stock options are exercised, employees report the difference between the value of the stock and the exercise price as taxable wages. The employer reports the fair value of the option at the date it's granted in its financial statements, yet takes a deduction for the value of the option on the date it is exercised, which is often much greater. This "book-tax gap" means that how the options are valued for accounting purposes and reported to stock-holders is different from how they're valued and reported to the IRS. Levin's bill would make the amount deducted for tax purposes equal to the value accounted for in financial statements.
According to calculations made by his staff using IRS data and released in June, firms deducted $43 billion that was not included in financial books in this manner between December 2004 to June 2005. CTJ's 2004 study of corporate taxes cited stock options as one of the key reasons corporations were able to avoid taxes.