Congress wants more workers' stock
in companies to be a less taxing option
By Kay Bell • Bankrate.com

June 9, 2000 -- Most people don't have company stock options -- yet.

Congress wants to change that and give more workers the chance to own a piece of their employers. Better still, lawmakers say the tax bite on this type of benefit should be eased.

Taking a cue from the New Economy practice of companies giving all workers shares in a company, the Wealth Through the Workplace Act would create a "super stock" option that companies could offer rank-and-file workers.

And by reducing tax costs of super stock options, Congress hopes these new company part-owners will be more inclined to hang onto the stock, building long-term wealth when a company succeeds.

Taking stock in your employer
A stock option gives an employee the right to buy shares of company stock at a predetermined price after meeting certain requirements, usually involving length of time on the job. Less than a generation ago, this opportunity was viewed as a bonus reserved for the suits on the top floor.

These executive stock programs, generally known as incentive stock option plans, still exist. But in today's business world, a growing number of large, publicly traded firms have stock option plans for employees at all levels. This trend is especially prevalent in start-up companies, particularly those in biotech, software and Internet-related businesses.

In these companies, more-inclusive plans called non-qualified stock options are used increasingly as recruiting and employee retention tools. On the worker side, options are a way to turn commitment to a new venture into big bucks.

Here's how it works. As an employee of XYZ Corp., you are given non-qualified options after a year to buy company stock at $10, regardless of what its trading value is on the open market. When you exercise the options -- that is, purchase the stock -- XYZ Corp. is selling for $20, meaning you've immediately doubled your investment.

But you, a new XYZ Corp. stockholder, aren't the only one making money on this deal.

Twice the tax
Thanks to the tax code, Uncle Sam is going to get a bit of your newfound, non-qualified stock wealth immediately.

By exercising 100 XYZ Corp. options at $10, you paid $1,000 rather than the $2,000 non-employees paid that day to buy the stock. Tax law says the difference in what you paid with your options vs. the actual stock price -- $1,000 -- is a taxable as income at regular rates. Depending on what your other income is, that rate could go as high as 39.6 percent. If you're in the 28 percent bracket, the exercise of your options would make your final tax bill that year $280 higher.

And it doesn't end there. When you do sell your shares, any profit you make will be taxed again, this time as capital gains. In this case, you do have some control over the tax rate. If you hold the shares for more than a year, the money earned on the sale will be taxed as long-term capital gains at a maximum 20 percent rate.

But if you sell a year or less after buying the shares, the money you make on the sale is considered a short-term capital gain and is taxed at the higher, ordinary income tax rates.

Quick sales can mean lost earnings
Many workers who buy stock with non-qualified options, however, decide to sell their newly-purchased stock sooner rather than later.

Already strapped by coming up with the money to exercise the options in the first place, they find they need to sell the shares to raise cash to pay the added taxes. And the current tax law actually encourages immediate sales in what's called a cash-less exercise:

1. The employee exercises stock options and the value (in this case $1,000) is taxed as ordinary income.
2. Since this gain is now taxed as income, the employee can adjust the basis of the stock to the current market value of $20 per share, a total of $2,000.
3. The employee sells the stock immediately at the $20 per share price. Because the sales price is the same as the new adjusted basis, there is no gain to tax.

While quick selling may reduce some stock options tax headaches, it cheats workers of potentially larger earnings in the future, says Wealth Through the Workplace sponsor Rep. John Boehner, R-Ohio.

Looking to long-term wealth
Despite the get-rich-quick stories often associated with stock options, share ownership is most valuable to employees over the long term, Boehner told his Employer-Employee Relations Subcommittee colleagues during initial consideration of H.R. 3462.

To encourage workers to hang onto company stocks for the long haul, Boehner's bill would create a third stock options category -- the super stock -- that would allow workers to defer all taxation on their options until they sell their shares. The elimination of an exercisable option income tax would be an immediate boon to employees. And it would give workers the incentive to hang onto the stock for more than a year so that when they do sell, the gain would be at the lower long-term rate.

Incentive and non-qualified options would remain, says Boehner spokesman Dave Schnittger, but the super stock would be a combination of the benefits of both plans. The super stock option would be available to a broader base of employees like existing non-qualified systems, but it would have the tax advantage of incentive plans where no tax is charged when options are exercised.

And it would retain the tax incentives that businesses enjoy when they offer stock options to workers.

Determining how broad-based
Currently, businesses get a tax break of their own from options plans. When options are exercised, a company can deduct the value of the shares purchased.

That corporate tax benefit would continue under the super stock plan, but only if a business offered options to at least 50 percent of its workers. Bill supporters believe that this, coupled with the added employee tax-deferral incentive, will make the super stock options appealing to businesses looking for creative ways to keep employees happy in a tight job market.

Democrats, while supporting the tax relief for workers offered by the Republican-sponsored H.R. 3462, want the super stock option available for companies that offer it to 90 percent of employees. There also is disagreement between lawmakers as to the length of time that employees must work for a company -- one or two years -- before qualifying for the tax deferral option.

In addition, labor leaders are concerned that the bill would prompt some employers to drop participants from existing stock benefit plans to switch to the super stock category. The new options supporters do not see that as a threat. Rather, they expect companies would move all employees to the super stock program.

Fine-tuning super stock options
Following the subcommittee hearing, both sides agreed to fine-tune the legislation and are optimistic that a compromise can be worked out for an early July hearing before the full House Education and the Workforce Committee. Once it clears that panel, the Ways and Means Committee must sign off since the bill involves changes to the tax laws.

And what is the prospect for ultimately making it into law? Schnittger acknowledges that is still a bit down the legislative road, but is optimistic.

In a political atmosphere where both parties immediately fire warning shots across the aisle at the other side's proposals, he notes that "we take it as a promising sign that the Administration hasn't announced any opposition."

--Posted June 9, 2000