Letter Sent to Forbes

Robert Willems, Lehman Brothers' tax expert, correctly points out that the employer receives a tax deduction equal to the employee's gain derived from the difference between the market value of the stock of Fantasy Systems and the strike price at the date of exercising the stock option (Microsoft's Lonely Parade, August 11, 2003). The example uses a $30 strike price and a $50 market price to give a $20 tax break for the employer and a $20 taxable gain for the employee.

Superficially this looks like a fair deal. However, as Mr. Willems highlights, the employer receives a tax deduction for a cost that never shows up on the profit-and-loss statement. This act of charity on the part of the IRS is galling. It gets worse. Consider what would happen if Fantasy Systems' stock price were to drop back to $30 and the luckless investor who initially bought the stock at $50 from the employee were to cash in his or her chips. He or she would have a $20 capital loss. The investor may set this loss off against realized capital gains. We now have two $20 tax deductions, one for the corporation and one for the investor, but only one taxable gain realized by the employee. The employer deduction is an egregious example of corporate welfare.

As per the article, if Cisco received a tax benefit of $4,790 million during the period 1999 through 2002, its employees must have realized stock option gains of approximately $13.5 billion during this period. During this same period, Cisco's pre-tax income amounted to approximately $9.4 billion, which means that its stock option related deductions far exceeded its taxable income. This fact does not show up in the income statement, but that is the whole intent, namely, to keep everyone in the dark on this one.

Consider also the juicy tax losses afforded to investors as Cisco's stock dropped from $80 to $8, when hundreds of billions were lost in market capitalization. Taxpayers are the big losers in this fascinating case study of IRS largesse toward corporate America. Not surprising Silicon executives are lobbying FASB and Congress to maintain the status quo with regard to employee stock options.

Albert J Meyer