Georgia’s biggest companies saved at least $2.1 billion on federal taxes over the last five years by awarding their top executives and other employees billions of dollars of stock awards, according to an Atlanta Journal-Constitution analysis.
Companies are allowed to treat the stock payouts as expenses that reduce their taxable profit. They say the resulting tax savings are not only legal but justified because stock awards are a form of pay like salaries and wages.
Critics say the wholesale shift toward stock-based compensation has created a system that enriches executives at Uncle Sam’s expense, and some propose limits on how much companies can reduce their tax bills this way.
The AJC looked at tax disclosures of Georgia’s 83 largest publicly traded companies with at least $100 million in annual sales, compiled by Calcbench, a firm that helps clients analyze data from corporations’ electronically filed disclosures.
That $2.1 billion figure may be an underestimate; almost all of the companies paid out stock awards but tax break data was missing for many of them. Also, companies differ in how they report the tax breaks in their annual disclosures to investors. Some of those companies reported tax breaks from recent stock awards but not older stock awards, for instance, while others did the reverse.
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Counting both categories, the 2009-2013 tax breaks topped $2.8 billion for the Georgia companies for which data was available.
In many cases, it appears that the stock options and other awards were ultimately more lucrative for employees than the companies’ estimates for shareholders. That means the companies reaped even bigger tax breaks, helping some cut their federal tax bills to rates well below the statutory 35 percent corporate tax rate, and in some cases to zero.
Such stock options typically allow employees to buy stock for up 10 years into the future at a discount — usually the same stock price as the day they were issued. The idea is to incentivize good performance that boosts the stock price and, in turn, the value of stock awards.
Southern Co., the Atlanta-based utility, cut its taxes by $178 million from 2009 to 2013 after its executives and other employees reaped big gains from stock awards they cashed in during those years.
Southern’s federal tax bill was about $1.4 billion, or 9 percent of its $15.5 billion in pre-tax income, in 2009-2013.
Southern gave investors a comparatively modest $115 million estimate for the cost of a new round of stock awards issued in those same years, and said they will ultimately save $45 million in taxes.
A spokesperson for Southern said the company “complies with all relevant laws and regulations with regard to recognition of tax benefits.”
In addition to defending stock awards as a way to motivate performance, companies note that employees who receive them eventually pay taxes on them as income.
“There’s nothing illegal about this,” said Eric Toder, co-director of the Urban-Brookings Tax Policy Center in Washington, D.C. Although the rules could be improved, he said, companies should get tax breaks when awarding stock-based pay. “It’s basically compensation that (employees are) getting,” he said.
Critics note that stock awards now account for the bulk of top executives’ pay.
Such awards have allowed firms to reap billions of dollars in tax deductions, even though they require no cash outlays by the companies, say critics. Accounting quirks also allow them to obscure the true cost from shareholders.
“In every other case of compensation, the company is actually paying it out. In the case of stock options, that’s not true,” said Rebecca Wilkins, with Citizens for Tax Justice. The left-leaning advocacy group supports legislation proposed last year that would impose a $1 million cap on stock option tax deductions — the same limit as on executive salaries — and to require companies to use the same deductions on both their tax returns and reports to investors.
Currently, experts say, companies use very different methods to come up with those deductions, which tend to boost the profits they report to shareholders and to minimize the profits they report to the IRS.
To see how they differ, consider this quick example: As part of his pay, a company issues Joe CEO stock options that he can use to buy 1 million shares of the firm’s stock at the current price, $1, for up to 10 years. Ten years later, the share price has risen to $100, and Joe CEO cashes in his stock options, paying $1 million and getting $100 million worth of stock.
Years ago, most companies acted as though the options were worthless when they were first issued, which allowed them to report inflated profits to their investors, according to critics. But since 2006, companies have been required to estimate the value of those options and count it as a labor cost, reducing their reported profit in the year stock options are granted.
In our example, let’s say the company estimated that Joe CEO’s options were worth $5 million when they were granted. That year, the company reports a $5 million expense, reducing the profit it reports to investors.
But when dealing with the IRS, companies have a different set of rules and a different set of books. In its tax returns, Joe CEO’s company doesn’t take a deduction for the stock options until he actually exercises them in the tenth year.
By then, it’s a much bigger deduction because the stock has risen in value, making the options more valuable. Joe CEO reports a taxable income of $99 million, and his company takes a $99 million deduction as well.
That difference in how companies and the IRS treat the cost of stock-based pay has resulted in a growing gap between the profits reported to investors and those reported to the IRS, according to a 2012 Congressional Research Service report. By one estimate in the CRS report, the gap is about $50 billion.
At some companies, stock award deductions are big enough to allow them to operate tax-free for years.
When Facebook’s stock went public in 2012, company founder Mark Zuckerberg cashed in roughly $5 billion worth of stock options at 6 cents a share. The resulting tax deductions from his and other employees’ stock options have enabled Facebook to claim more that $1.5 billion worth of tax breaks since 2010, allowing the company to avoid paying taxes for years, according to data compiled by Citizens for Tax Justice.
Staff writer Sean Sposito contributed to this article.