"Use of Stock Options Gives Many Firms Big Breaks on Taxes"
from today's Wall Street Journal, 5/13/97.
In April 1996, the Treasury Department noticed an unexpected $25 billion surge in individuals' tax payments on 1995 income. It was a thrilling discovery. A team of tax analysts set out to find where the money was coming from, in order to gauge whether it would show up again.
After months of poring over individual tax returns, they believed they found the source: stock options. The sustained bull market had brought windfalls for thousands of corporate employees. As they exercised the options and sold their shares at big profits, their tax bills soared as well. Delighted Treasury officials projected that billions more would flow in this year.
Not so fast. On closer inspection, the economists sheepishly realized that the options weren't really bringing in extra money after all. That is because the companies that granted the options were getting tax deductions for them.
"The exercise of stock options itself doesn't raise tax receipts," says a rueful Eric Toder, the Treasury's former chief economist for tax analysis, who left before the analysis was complete. "It transfers the revenue from one pocket to another."
Compensation Cost
Here's how that works. As a company's stock rises, employees -- primarily top executives -- start to exercise options, buying stock from the company at below-market prices. They usually owe ordinary income tax on their gain, the difference between the value of the stock and the options' exercise price. But the companies get a deduction, because the gains count as employee compensation, a deductible expense.
Interestingly, they get the tax deduction even though they needn't spend any money to provide the stock -- nor need to show any cost in their earnings reports. "It's the best of both worlds," says Richard Burnes, a venture capitalist with Charles River Ventures in Boston.
At Cisco Systems Inc., a hot networking company in San Jose, Calif., whose stock has risen more than fortyfold since 1990, the tax saving was $198 million for the fiscal year ended last July 28, its financial reports show. The deductions have cut 25% off Cisco's tax bills over the past 3 1/2 years, and now equal nearly one-fifth of the company's cash flow from operations, its operating profits before certain payments such as interest and taxes.
Handy Shelter
Cisco Chief Financial Officer Larry Carter likens the tax savings to a "social policy" that rewards successful companies, noting that "this only occurs when the stock has done well." Roger McNamee, a venture capitalist with Integral Capital Partners in Menlo Park, Calif., adds: "I am delighted to know that these companies are able to shelter a little income."
etc etc. PepsiCo has given options to all full-time employees.Last year, employees exercised options for about 23 million shares, which gave PepsiCo a deduction that slashed its tax bill by $145 million.
Microsoft's tax bill was cut by about 32%., saved $352 million in taxes.
Intel saved $196 million in taxes.
It is obvious, Agouron executives are not the only ones exercising stock options. Also Compaq, 3Com, Sun MIcro, Walt Disney etc. |
