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 percent — 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.
A stock option entitles its owner to buy a share of company stock at a set price over a specified period. The corporate tax savings stem from the fact that executives typically cash in stock options at a much higher price than the initial value that companies report to shareholders when they are granted.
But companies are then allowed a tax deduction for that higher price.
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.
SiriusXM did not respond to repeated requests for comment.
Dozens of other major corporations doled out unusually large grants of stock options in late 2008 and 2009 — including Ford, General Electric, Goldman Sachs, Google and Starbucks — and soon may be eligible for corresponding tax breaks.
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.”