Date: March 7, 1997 Source: United States Senate, S.20 Targeted Investment and Economic Growth Act of 1997: Performance Stock Options Summary Reviving a concept first proposed in 1993, Sen. Tom Daschle (D-SD) has introduced legislation that would create a Performance Stock Option (PSO) The PSO would be similar in concept to existing Incentive Stock Options (ISOs) by providing preferred tax treatment on option gains when holding period requirements are met PSOs would be subject to nondiscrimination requirements, however, to encourage the distribution of options to non-highly compensated employees The proposed Section 424 of the Internal Revenue Code (requiring renaming of current Section 424 "Definitions and Special Rules" to Section 425) would also require that PSOs be granted "upon the attainment of performance goals established by the entity" Unlike the PSOs proposed under the Equity Expansion Act of 1993 which provided for capital gains treatment on option gains, the new version of PSOs would exclude half of the gain from taxable income, resulting in a maximum tax rate of 19.8% Like ISOs and the formerly proposed PSOs, gains qualifying for this preferred tax treatment would not be deductible by the employer CPM Observations This latest initiative to encourage broader distribution of stock options provides a significant advantage over ISOs: rather than taxation of gains at the 28% rate -- which is above some lower-paid employees' marginal income tax rate -- the 50% exclusion would bring the tax rate well below the capital gains rate, even with the proposed reduction of this rate to 20% A PSO held for the required periods could result in the gain being taxed at rates as low as 7.5% for the lowest paid employees In addition, the gain would not be subject to the Alternative Minimum Tax, which renders many ISOs of no advantage at all given the non-indexed AMT calculation method While ISOs have always been expensive for employers due to the lack of a corporate tax deduction realized with nonqualified options, the opportunity to provide performance based compensation at significantly lower tax rates may result in the first time that the aggregate tax effects for employees and the employer produce an advantage for using a tax-qualified type of stock option Index: alleeso.004 Recently in "Performance Bytes"... August 22, 1997 "Management Pay -- Unintended Consequences" The Economist, August 22, 1997 [strategy.002] March 7, 1997 "Performance Stock Options" Congressional Record, January 21, 1997 [alleeso.004] February 24, 1997 "Most EDS Employees To Get Stock Options..." Wall Street Journal, February 24, 1997 [alleeso.003] January 29, 1997 "American Air Pilots Asked to Agree to Arbitration" Wall Street Journal, January 29, 1997 [union.001] January 24, 1997 "A Tale of Two Compensation Strategies: (Eastman Kodak & AlliedSignal)" Fortune, January 13, 1997 [strategy.001] January 8, 1997 "Small Concerns Are More Likely to Pay Directors in Stock Than Large Firms" Wall Street Journal, January 8, 1997 [bdcomp.001] December 31, 1996 California Qualified Stock Options (CQSOs) State of California, Secretary of State (AB 3194) [alleeso.002] December 27, 1996 "All about EVA" CFO Magazine, November, 1996 [perfmeas.001] December 18, 1996 "Stock Options to Be Given to 69,000 Staff Members" (Chase Manhattan Corp.) Wall Street Journal, December 18, 1996 [alleeso.001]