Giant Cisco Didn't Pay Any Federal Income Tax
Henry C.K. Liu
hliu at SPAMmindspring.com
Mon Oct 9 19:46:10 MDT 2000
Giant Cisco Didn't Pay Any Federal Income Tax
Businesses get break on employee stock options
Kathleen Pender, Chronicle Staff Writer
Monday, October 9, 2000
SAN JOSE -- Cisco Systems, the
second-most valuable company in
America, paid no federal income taxes for
its latest fiscal year thanks to a little-known
corporate tax break on employee stock
Microsoft, which ranks No. 4 in market
value, did not pay any federal taxes either,
Like many high-tech firms, Cisco and
Microsoft are allowed to take a tax
deduction for money their employees earn
when they ``exercise'' options and buy
stock in the company at a preset price.
These options have become an increasingly
popular way for businesses to reward
employees, but they also have huge
benefits to the companies themselves.
The tax break was established decades ago,
when companies doled out stock options to
only a handful of top executives and the
tax benefit they generated was minimal.
But now that many companies -- including
Cisco, Microsoft and most other
new-economy firms -- give options to
everyone, the tax break is becoming
In Cisco's case, this benefit wiped out $1.8
billion in federal taxes, and probably more
than twice that for Microsoft.
Some people, even those who oppose
taxes, think it is unfair that wealthy
companies paid none to Uncle Sam.
For the fiscal year ended July 31, Cisco
had $23 billion in sales last year, $2.7
billion in net income, and its almost $400
billion market value is exceeded only by
``For a company that makes that kind of
money not to pay taxes raises serious
tax-equity questions,'' said Jon Coupal,
president of the Howard Jarvis Taxpayers
He also said he believes it is ``hypocritical''
for Cisco to take this ``massive tax break''
and at the same time support Proposition
39, which would make it easier to raise
property taxes on California homeowners.
Prop 39 would allow local school bonds to
be approved by a vote of 55 percent
instead of the current two-thirds.
ENTITLED TO DEDUCTION
Cisco is entitled to a deduction for stock
option income because ``in reality, that's
compensation,'' and tax law has always
treated employee compensation as a
deductible expense, said Dennis Powell,
Cisco's corporate controller.
When an employee exercises an option to
buy stock, the difference between the
strike price (what the employee pays) and
the market price (which is almost always
higher) becomes taxable income for the
employee and a tax deduction for the
Most Americans do not realize how
enormous this tax break has become,
because companies do not deduct
employee stock options from the earnings
they report to shareholders and the public.
In fact, American companies fought long
and hard to prevent employee stock
options from showing up as an expense on
their income statements, although they are
happy to consider them as an expense for
income tax purposes.
Cisco's and Microsoft's annual reports
make it appear as if they had paid billions
of dollars in income taxes.
Cisco's income statement for fiscal 2000,
which was published about a week ago,
shows net income before taxes of $4.34
billion, and a provision for income taxes of
That number includes federal, state,
foreign and deferred taxes. The firm's
actual federal tax liability, buried deep in
the report, was $1.8 billion.
But in reality, the San Jose maker of
computer networking gear paid no federal
income taxes for fiscal 2000.
That is because its employees earned more
than $7 billion exercising stock options in
fiscal 2000. That $7-plus billion deduction
generated a $2.5 billion tax benefit for
Cisco, which wiped out its entire federal
tax liability. The benefit shows up on
Cisco's cash flow statement.
STOCK OPTIONS EXERCISED
Cisco employees exercised ``an unusually
large number'' of stock options during
fiscal 2000, mainly because the company's
stock price more than doubled, said Cisco's
By comparison, Cisco's tax benefit from
employee stock options was only $837
million in 1999 and $422 million in 1998.
Unlike Cisco, which acknowledges that it
paid no federal income taxes, a Microsoft
spokeswoman would not say whether that
firm did or not.
But its annual report for fiscal 2000, which
ended June 30, shows stock option income
tax benefits of $5.5 billion, exceeding its
$4.85 billion provision for income taxes.
(Its actual federal and state tax liability for
2000 was $4.74 billion.)
``I'd say their federal income tax was next
to nothing or probably nothing,'' said
Robert Willens, a tax and accounting
analyst with Lehman Brothers in New
Willens said another company that will be
wiping out its federal tax liability is Seagate,
which is undergoing a complicated
When the deal is completed, ``all of
Seagate's options have to be exercised. The
tax deduction they're going to get is so
large, it will wipe out their income for the
year of the merger,'' with some left over,
he said. The remainder will be passed on to
Seagate shareholders as a tax-refund right.
Companies do not pay anything for stock
options, at least not in the traditional sense.
The real cost is borne by shareholders.
That is because stock options increase a
company's shares outstanding, which
reduces earnings per share. All other things
being equal, that will lower the company's
stock price unless earnings rise enough to
compensate for the additional shares.
Theoretically, employees with stock
options will want to do everything they can
to increase earnings, since they are also
shareholders who will benefit if the stock
``Shareholders have decided they want to
share some money with employees to
provide an incentive'' to increase earnings,
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