In the very popular non-qualified employee stock compensation plans, when a company employee exercises a stock option, the corporation generally, and in a very largesse manner, receives a federal income tax deduction for the excess of the market price of the stock at the exercise date over the exercise price. For common stocks that have increased substantially in price, the federal income tax deduction that the corporation receives can be frankly obscene in amount.
To the extent that this excess is greater than the amount of compensation expense already recorded by the corporation, the federal income tax benefit the corporation receives from this excess is recorded by the corporation as a direct credit to Additional Paid-in Capital in the Stockholders Equity section of the balance sheet, thereby bypassing the income statement.
Some people call this excess tax benefit a windfall tax benefit to the corporation.
Frankly, I think the entire federal income tax deduction the corporation gets from stock option exercises by employees is a corporate tax loophole. This tax deduction is being triggered by an increase in the stock price. Existing stockholders do get dilution from the stock value being transferred to these stock option holders, but from a tax standpoint, the corporation hasn’t paid anything for that value accruing to the employee due to the stock price appreciating.
But after giving due consideration to the economic damage to Big Corps, my proposal here is to not remove this entire corporate tax loophole, but instead just the loophole related to the excess, or windfall, tax benefit explained earlier.
If the entire corporate tax loophole was closed, Big Corps would be receiving substantial hits to their earnings each year.
However, there is no income tax expense charge to the income statement from disallowing the US federal income tax deduction by the corporation from just this excess or windfall benefit to the corporation, since under US generally accepted accounting principles, this excess benefit presently doesn’t get reflected in the income statement, but instead goes directly to Stockholders’ Equity on the balance sheet.
If the Big Corp tax loophole were closed disallowing the entire corporate federal income tax deduction the Big Corp receives for the excess of market price over exercise price at exercise date, then my best estimate is that the additional tax revenue raised by the US Government over the next 10 years would be up to $1 trillion.
The reason for this is that any fair CBO scoring of tax revenue raised by the US Government has to factor in reasonable increases in the stock market over the next ten years. Further, the stock market has already nearly doubled in the past two plus years, and thus there are many stock options outstanding now where the current stock market price is substantially above the locked-in exercise price.
But my recommendation would be to just close a portion of this Big Corp tax loophole…just the portion of the Big Corp federal income tax deduction related to excess, or windfall, tax benefits. Given the devastating US Debt level, it is only fair that this Big Corp tax loophole be closed.
My hunch is that the additional tax raised over the next 10 years from closing just this portion of this Big Corp tax loophole, related to this excess, or windfall, tax benefit, is somewhere between $200 bil and $500 bil, depending upon what assumed stock price increases that the CBO uses in doing its scoring.
