Conglomerate Blog: Business, Law, Economics & Society

Yesterday I told my Corporate Tax class that we could teach a whole course on the tax implications of the Facebook IPO. I wasn't kidding. Here are a few of the interesting issues that highlight current debates in the taxation of corporations and their shareholders. (Gregg Polsky has also covered some of these on The Faculty Lounge.)

Mark Zuckerberg's stock: CEO Zuckerberg holds almost 414 million shares of stock. At the time of the IPO, he owes no taxes on that stock until a recognition event, such as sale. When and how did he acquire this stock? Most likely, much of it is "founder's stock." This is friend of the Glom Vic Fleischer's territory (See Taxing Founder's Stock). Zuckerberg probably contributed the algorithms and code for Facebook in return for stock as a nontaxable event either as a contribution to a corporation by a control group or (as Vic explains), making an election to have the stock distribution a taxable event, with the valuation of the stock as equal to the contribution. Even though the stock is more accurately described as consideration for Zuckerberg's labor, it will be taxed at some point as capital gains, which is now 15% and considerably less than the ordinary income rate. Gregg argues that this isn't that bad because the corporation doesn't get a deduction for it, so no deduction plus 15% is better than 35% deduction and 35% taxation, if you look at it from the point of view of the public fisc. I think Vic is looking at it from the point of view of regular folks who contribute labor for stock versus founders. Interesting debate.

Zuckerberg's and others stock options: From reports in the media, it seems that the stock options that Zuckerberg holds (and probably others) are nonqualifying stock options. The S-1 describes a 2005 stock option plan that issued incentive stock options, but stock options issued before then or under a different plan don't seem to be qualifying options. Should holders of nonqualifying stock options exercise those options at or after the IPO, they will encounter a taxable event regardless of whether they sell the stock. Zuckerberg has over 120 million stock options giving as compensation, which he plans to exercise. His exercise price is 6 cents. So, at something like $30/share,that's about $3.6 billion (say it like Mike Myers) of taxable ordinary income (the spread between exercise price and price at conversion). Zuckerberg's tax bill (federal and California) may well be one of the biggest tax bills ever. Apparently, he plans to sell enough shares to pay his taxes, which may reach $2 billion. Other holders will also face the same dilemma of having a tax bill even if they don't have any additional cash on hand. Those who exercise qualifying ISOs will not have a current tax liability if they do not sell. (I have now wandered away from things I know about, so I will stop.)

But, for each option that is exercised that is taxable as compensation, Facebook gets a deduction, even though no cash is (or has ever) gone out of the company for that expense. So, Facebook calculates that it will have tax refunds for awhile given the billions of dollars in compensation expense it will enjoy.

Restricted Stock Units: Starting in 2008, Facebook began granting service providers RSUs instead ot stock options, probably to avoid the 500 shareholder threshold for registration under 12(g) of the Securities Exchange Act. These RSUs are scheduled to vest six months after the IPO. The recipients will be taxed at ordinary rates for the difference between the FMV of the stock at the time and the price paid for the grant (if any). (Though, recipients could make an 83(b) election at the time of the grant when valuation is both less and less clear, but this may be a risky move.) Finally, Facebook has to withhold cash for that. Facebook has listed this as a risk factor in its S-1:

We anticipate that we will expend substantial funds in connection with the tax liabilities that arise upon the initial settlement of RSUs following our initial public offering and the manner in which we fund that expenditure may have an adverse effect.

Whew. That's enough.

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Yesterday I told my Corporate Tax class that we could teach a whole course on the tax implications of the Facebook IPO. I wasn't kidding. Here are a few of the interesting issues that highlight current debates in the taxation of corporations and their shareholders. (Gregg Polsky has also covered some of these on The Faculty Lounge.)

Mark Zuckerberg's stock: CEO Zuckerberg holds almost 414 million shares of stock. At the time of the IPO, he owes no taxes on that stock until a recognition event, such as sale. When and how did he acquire this stock? Most likely, much of it is "founder's stock." This is friend of the Glom Vic Fleischer's territory (See Taxing Founder's Stock). Zuckerberg probably contributed the algorithms and code for Facebook in return for stock as a nontaxable event either as a contribution to a corporation by a control group or (as Vic explains), making an election to have the stock distribution a taxable event, with the valuation of the stock as equal to the contribution. Even though the stock is more accurately described as consideration for Zuckerberg's labor, it will be taxed at some point as capital gains, which is now 15% and considerably less than the ordinary income rate. Gregg argues that this isn't that bad because the corporation doesn't get a deduction for it, so no deduction plus 15% is better than 35% deduction and 35% taxation, if you look at it from the point of view of the public fisc. I think Vic is looking at it from the point of view of regular folks who contribute labor for stock versus founders. Interesting debate.

Zuckerberg's and others stock options: From reports in the media, it seems that the stock options that Zuckerberg holds (and probably others) are nonqualifying stock options. The S-1 describes a 2005 stock option plan that issued incentive stock options, but stock options issued before then or under a different plan don't seem to be qualifying options. Should holders of nonqualifying stock options exercise those options at or after the IPO, they will encounter a taxable event regardless of whether they sell the stock. Zuckerberg has over 120 million stock options giving as compensation, which he plans to exercise. His exercise price is 6 cents. So, at something like $30/share,that's about $3.6 billion (say it like Mike Myers) of taxable ordinary income (the spread between exercise price and price at conversion). Zuckerberg's tax bill (federal and California) may well be one of the biggest tax bills ever. Apparently, he plans to sell enough shares to pay his taxes, which may reach $2 billion. Other holders will also face the same dilemma of having a tax bill even if they don't have any additional cash on hand. Those who exercise qualifying ISOs will not have a current tax liability if they do not sell. (I have now wandered away from things I know about, so I will stop.)

But, for each option that is exercised that is taxable as compensation, Facebook gets a deduction, even though no cash is (or has ever) gone out of the company for that expense. So, Facebook calculates that it will have tax refunds for awhile given the billions of dollars in compensation expense it will enjoy.

Restricted Stock Units: Starting in 2008, Facebook began granting service providers RSUs instead ot stock options, probably to avoid the 500 shareholder threshold for registration under 12(g) of the Securities Exchange Act. These RSUs are scheduled to vest six months after the IPO. The recipients will be taxed at ordinary rates for the difference between the FMV of the stock at the time and the price paid for the grant (if any). (Though, recipients could make an 83(b) election at the time of the grant when valuation is both less and less clear, but this may be a risky move.) Finally, Facebook has to withhold cash for that. Facebook has listed this as a risk factor in its S-1:

We anticipate that we will expend substantial funds in connection with the tax liabilities that arise upon the initial settlement of RSUs following our initial public offering and the manner in which we fund that expenditure may have an adverse effect.

Whew. That's enough.

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