In annual shareholder financial reports, companies record an expense for the value of the stock options granted to executives. This book expense is based on assumptions about when the options will be exercised and the stock's trading price on those future dates.
Companies do not take the deduction for executive stock options on their tax returns until their executives exercise the options, usually years later. The amount of compensation the executive gets on the exercise date is "often substantially more than the book expense of the options that was originally estimated," the report says. Because the tax deduction is based on the trading price of the stock on the actual exercise date, the tax deduction is often much more than the book expense that was recorded by the companies.
"They do not write off the added option expense on the profit statement for shareholders," IPS says. "The result: Earnings reported to shareholders end up overstated and taxes end up reduced."
The Ending Excess Corporate Deductions for Stock Options Act, introduced recently in the U.S. Senate, would limit corporate tax deductions to the amount expensed for financial statement purposes at the time of the option grant. Closing this loophole would add $25 billion to federal tax revenues over 10 years, supporters say.
Another of the loopholes pointed out in the IPS report: "To prevent corporations from deducting excessive executive pay off their taxes, Congress in 1993 set a $1 million cap on the individual executive pay corporations could deduct. But that cap did not apply to 'performance-based' pay, a giant loophole that exempted stock options and other pay incentives from the cap."