Originally created 05/11/02

There could be tax changes regarding stock options

WASHINGTON - When stock options expanded from the executive suite to rank-and-filers from the barista at the corner Starbucks to the last of the Silicon Valley dot-commers, Uncle Sam got in on the act.

Fed by scandals at Enron and other former high-rollers that stand accused of using options to pump up stock prices and mask their financial conditions from shareholders and regulators, reformers want to change the way options are accounted for on corporate balance sheets - and treated by Uncle Sam.

The way stock options work now, employes get the future right to buy shares at a pre-determined price. When the stock hits that "strike" price, the employee exercises the option and collects the difference between the option price and the market price.

Current rules don't require options to be subtracted from company earnings until the options are exercised, and employees aren't taxed unless or until they claim the capital gain. Meantime, the employer deducts options it awards from its tax bill, fueling company income.

Plans to change those rules have stirred a firestorm. On the table are two key proposals to change stock options' tax status, one that would pinch workers' wallets and another that would bite the company bottom line:

- Starting in 2003, the federal government plans to collect Social Security and other employment taxes on incentive stock options awarded employees, a move that in theory affects every worker with stock options, from CEO to custodian.

But because Social Security's 6.2 percent payroll tax on workers and bosses stops being collected on pay above $84,900 this year, "that would hit rank-and-file workers and small businesses harder than executives," says Harris Miller, head of the Information Technology Association of America, the high-tech lobby leading the charge.

The U.S. Treasury says it has no choice but to collect employment taxes unless the current legal definition of "taxable income" is changed. Legislation to do so passed the House and is pending in the Senate, where Sen. Jeff Bingaman, D-N.M., has served notice on Secretary Paul O'Neill that the change runs counter to Congress' intent.

- Implosions by Enron, Global Crossing and others that made generous use of stock options have revived legislation, which business interests thought they killed at the height of the '90s boom, to make companies choose: Take the up-front tax break, or lose it if you don't treat stock options as a cost.

Senate sponsors Carl Levin, D-Mich., and John McCain, R-Ariz., say options are "stealth compensation" for executives that create a "double standard" that misleads shareholders and regulators alike, and Federal Reserve Chairman Alan Greenspan has the problem high on his "to-do" list.

But President Bush so far is siding with business, saying that options should be denied tax breaks only where securities fraud or other wrongdoing is found.

Options proponents point to Microsoft, Intel, Dell and FedEx as examples of start-ups that used stock options to become household names.

They also see them as a way to help entrepreneurs who are long on ideas and short on cash. "Stock options bring the focused, highly-motivated sense of shared purpose" in the face of start-up risks, says Mark Heesen of the National Venture Capital Association, in Washington's high-tech corridor.

Even low-tech, high-concept firms can point to stock option successes: Since Starbucks founder Howard Shultz first announced their adoption in 1991, the "beanstock" program helped the firm grow from a small Seattle coffeehouse chain with 1,000 employees to a global powerhouse 54,000 employees strong and $1.59 billion in sales the last quarter.

Still, stock options have their downside, even among proponents. Tony Meyers, for one, is working for a nonprofit as a condition of holding onto his Cisco Systems stock options until he gets recalled by the San Jose, Calif., computer stalwart. Given his smaller paycheck, he says, "I wish the stock would hit my strike price so I can exercise my options and cash in to tide me over in the meantime."

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