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Facebook earned about $1.1 billion in their first year as a public corporation. The corporate income tax rate is 35%. That means Facebook should have forked over about $385 million in taxes, but instead is getting a tax refund of about $429 million.

In order to pay for that $814 million subsidy, the Federal Government would have to fire more than 10,000 workers.

To put this in perspective, Facebook employs about 3500 workers.

When the government writes a check to Facebook for $429 million, that is government spending. How come this spending isn't on the chopping block?

While I'm at it, let's examine why Facebook gets this tax refund. It is because they handed out massive stock options to executives, the value of which they get to deduct when exercised.

It is true that exercising stock options creates a taxable event for the executive, but that income is a capital gain taxed at the rate of 15% for 2012. So the executive gets to pay only 15% (assuming they have no way of avoiding, which I wouldn't necessarily assume given Mitt Romney's $100 million IRA) on the value of the options, but the corporation gets to deduct that same value at a savings of 35% on their tax bill. So, the act of a corporate executive exercising a stock option creates an obligation on behalf of taxpayers to pay a net 20% of the value of those options to the issuing corporation. Pretty sweet deal!

To pay for this sweet deal, Republicans propose we fire government workers, cut services and income to the poor and the elderly, and literally take food out of the mouths of hungry children.

Worse still, they are getting away with it.

1:23 PM PT: Comments suggest the value of stock options are taxed as ordinary income, not capital gains. My bad. I dispute the concept of the value of stock options being a company expense. That is an accounting trick. There is no expense to the company, other than the time it takes accountants to make entries on a keyboard. The value of stock options is wealth created out of thin air, becuase the market price for a stock happens to be more than the option price.

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Comment Preferences

  •  So, what you are saying is you don't even (8+ / 0-)

    Have to try to be a tax cheat if you're rich.  

    •  It's not really cheating when (8+ / 0-)

      it's the law.

      "It is easier to fool people, than to convince them they've been fooled" - Mark Twain

      by Sarge in Seattle on Tue Feb 26, 2013 at 11:42:35 AM PST

      [ Parent ]

      •  Corporate capitalism... (6+ / 0-)

        it's a beautiful thing.

        "Do what you can with what you have where you are." - Teddy Roosevelt

        by Andrew C White on Tue Feb 26, 2013 at 11:50:02 AM PST

        [ Parent ]

      •  Sarge - stock option income isn't taxed at (4+ / 0-)
        Recommended by:
        nextstep, Balto, Lujane, johnny wurster

        capital gains rates. There is no way to structure stock options, to qualify for capital gains treatment for big company senior executives. The notion that stock option income is eligible for long term capital gains tax rates is an idea that echos through the Internet and it is not true. However, we have very different set of circumstances at Facebook which I will explain.

        When high tech startups are first incorporated the lawyers form a shell and the founders are allocated shares, typically at the par value or ten for a penny. The founders purchase the shares and own them outright. These are NOT stock options. At this point we have a shell with a few thousand dollars representing the purchase of the founders shares. The founders then contribute whatever intellectual property they have been working on into the shell. Now we have a legally organized company holding the fundamental ideas of the company and they start looking for investors who will set the real value for the company with their initial investment. Early in the company's life, when the value of the company is low, new employees will be given stock options to purchase common shares with a feature called "early exercise" which means you can buy the shares at the option price subject to vesting over the next several years. By purchasing the stock you can start the clock for capital gains treatment. This early exercise option, and the financial ability to exercise quickly diminishes as the company increases in value for two reasons. The options granted to executives change from ISOs to Non-Qualified options and the amount cash it would take to early exercise and the tax treatment make it uneconomical. What we had at Facebook were founders and early employees selling shares they had owned for several years and therefore qualified for long term capital gains treatment AND more recent employees and executives exercising stock options and paying earned income rates.

        For large companies, like Facebook is today, executive stock options are routinely exercised and sold on the same day, and the compensation is all taxed at earned income rates.

        The reason that the corporation receives a tax deduction is that the exercise of the options results in a compensation expense which is reported in both the financial statements filed with the SEC and the tax returns filed with the IRS. There is logic from an accounting principles perspective that a charge against income for the expense of the options would flow through to the P&L and the tax return.  

         

        "let's talk about that"

        by VClib on Tue Feb 26, 2013 at 01:00:42 PM PST

        [ Parent ]

    •  Diary Fails on Option Taxes and Total Tax impact (2+ / 0-)
      Recommended by:
      VClib, johnny wurster

      See my more detailed comment below.

      The most important way to protect the environment is not to have more than one child.

      by nextstep on Tue Feb 26, 2013 at 12:30:51 PM PST

      [ Parent ]

  •  Sarge, your source is wrong on Option Taxes (4+ / 0-)
    Recommended by:
    cfm, VClib, Lujane, johnny wurster

    When options are exercises, the taxable gain to employees, overwhelmingly are taxed at the ordinary income rate - which was 35% in 2012 and is 43.4% in 2013.

    So the effect of the tax deduction for Facebook is no net reduction in federal taxes.  Even more, when similar transactions take place in 2013 when this happens the Federal Government collects over 20% more in taxes net on what the company plus employee pays.

    The most important way to protect the environment is not to have more than one child.

    by nextstep on Tue Feb 26, 2013 at 12:29:01 PM PST

  •  The capital gains rate utilized by the rich is a (2+ / 0-)
    Recommended by:
    Lujane, cynndara

    poor tax, because the tax revenue inequality this generates is made up by those of us with earned income and from taxes on corporate profits. Thus our income tax and corporate tax rates cover what the rich don't pay in capital gains tax.

    This is a supreme inequity, and isn't really capitalistic. It's a benefit lobbied by and for those with lots of passive income gains from investments. Capital gains are not earned income, which the rest of us are taxed on. It is therefore not market, but greed-driven, and so isn't is truly capitalistic.

    You can't go back and rewrite your past, but you can use your past to create your future. ~ Ray Lewis

    by 4Freedom on Tue Feb 26, 2013 at 12:33:26 PM PST

  •  Your numbers are wrong. (5+ / 0-)

    "Non qualified stock options" which we appear to be talking about, are taxed as regular income at the time of exercise. So a married FB employee working in the boiler room at $40K, who exercises options with $40K of gain will pay ~25% marginal rate on the exercised options.

    Zuckerberg will pay 35% (2012) or 39.5% (2013) on the gain.

    Long term Capital gains rates only apply to stock (or other capital asset) which is held over 12 months. So if after holding FB stock (which was received by option exercise and the gain taxed as regular income) for 367 days an exec sells it for an additional gain, they pay 15% of that (20% in 2013) as tax.

    What FB is getting a deduction for is the expense of giving stock to employees below market value. The employee then is stuck with paying the taxes on the gain, its close to a wash.

    The company could have issued "incentive stock options" that work like you describe, but then the company doesn't get to deduct the "expense" of the options.

    •  Add 3.8% to the above tax rates for 2013 for (1+ / 0-)
      Recommended by:
      VClib

      those with higher incomes.

      The top Federal Marginal Tax rate is not 39.6& but 43.4% because of the 3.8% Medicare tax applied to investment income.

      The most important way to protect the environment is not to have more than one child.

      by nextstep on Tue Feb 26, 2013 at 12:57:19 PM PST

      [ Parent ]

      •  Are Option exercises "investment" ? I'm not sure. (1+ / 0-)
        Recommended by:
        nextstep

        I hadn't thought about it, but if option exercise counts, then yes add the 3.8%. I don't think that option exercise would count as "net investment income" the 3 categories don't mention option exercise, but do mention capital gains, passive activities, and interest, rents and royalties.

        In the past, exercises (where I worked) were withheld as normal payroll actions, so the "additional" 3.8% wouldn't apply, just the "normal" Medicare tax, which is also above the income tax rates, so even in 2012 35% was really 36.45%. And the income was reported on your W2 so looked like regular old income (but withheld at the supplemental rate)... those were the good old days where you could complain about how much money you made ...

    •  How is it an "expense" (0+ / 0-)

      to issue stock at below market value? It's not like the company is writing a check for the difference. It is simply a windfall to the recipient.

      "It is easier to fool people, than to convince them they've been fooled" - Mark Twain

      by Sarge in Seattle on Tue Feb 26, 2013 at 01:28:13 PM PST

      [ Parent ]

      •  Well... (1+ / 0-)
        Recommended by:
        johnny wurster

        At its most basic, they are selling something below cost. If GM sells you a $30,000 car for $25,000, they take a loss, and can write that loss off as an expense.

        Current accounting rules allow for any asset of the company, for example its stock, to be accounted for in this way. If you sell it for less than its value, then you can deduct the loss. One can argue whether the market price of a stock represents value, but you can't argue that the company could have sold the same stock on the open market at a different (usually much higher) price than the price they agreed to when they issued the option. That "loss" is what they are deducting.

        •  Not exactly (1+ / 0-)
          Recommended by:
          samddobermann

          Whether GM sells a car for $25,000 or $30,000 effects only revenues, and has nothing at all to do with "expense" (but the tax implication might be the same). The "expense" side of the ledger is not affected by sales price.

          "It is easier to fool people, than to convince them they've been fooled" - Mark Twain

          by Sarge in Seattle on Tue Feb 26, 2013 at 02:00:51 PM PST

          [ Parent ]

      •  Stock options are rarely issued below market value (3+ / 0-)

        if they are the difference is W2 income to the recipient. It would have been highly unlikely that Facebook ever issued below market stock options. In the early years, before Facebook went public, I am sure they followed the practice of pricing the common stock options at 1/5-1/10 the price investors paid for preferred stock, but that treatment has long been viewed as an appropriate value by the IRS for companies prior to becoming profitable.

        The accounting for stock options from both a GAAP and tax perspective is one of the most complex parts of corporate accounting. Much of how stock options are treated make no sense whatsoever, but we live with the current accounting rules and IRS code. You are right, a company actually receives cash when the option holder exercises the option, and never pays out any cash. However, public policy created the desire to place a value on the options for compensation disclosure purposes and to charge the expense to the P&L.  

        "let's talk about that"

        by VClib on Tue Feb 26, 2013 at 01:48:50 PM PST

        [ Parent ]

  •  15% rate needs to be capped at $250k (1+ / 0-)
    Recommended by:
    Sarge in Seattle

    After your first $250,000 in earnings, you should pay the full 35% or thereabouts.  The 15% rate is supposed to be for senior retirement savings, etc..  Instead it's CEO's and bankers cheating the taxpayers and those who do real work.

  •  Do you understand how an option (1+ / 0-)
    Recommended by:
    johnny wurster

    works?  I don't mean to be snarky, but it's hardly an accounting trick.  It creates an obligation on behalf of the company to buy (or sell) the asset at a later date at some fixed price.  It's a liability for the company - it's going to owe money (or stock) in the future.  

    •  It is entirely an accounting convention (0+ / 0-)

      So far as deductibility is concered. First of all, liabilities and assets are completely different than income and expenses.

      Tax is paid on net income, after expenses. Certain things may or may not be deductible as expenses because of certain things called lobbyists and accountants and politicians. At one point I used to get to deduct 100% of meals and entertainment charges, then it went to 50%. Don't know what it is now. At one point I used to be able to deduct 100% of an equipment purchase in the first year, because politicians decided that was okay, for a while, then they decided that wasn't okay any more and I could only expense a small portion of it as depreciation.

      The exercise of a stock option does not cause a company to incur an expense, unless some lobbyist convinces enough politicians that it does.

      Deducting the value of stock options is a tax loophole engineered by accountants and politicians. That is a convention. There is no metaphysical reason for it. They could just as easily decide that the value of a stock option is determined at the time it is issued, not exercised, which would produce a radically different result.

      "It is easier to fool people, than to convince them they've been fooled" - Mark Twain

      by Sarge in Seattle on Tue Feb 26, 2013 at 03:35:08 PM PST

      [ Parent ]

    •  Let me put it this way (0+ / 0-)

      At the end of the accounting period, Facebook had $1.1 billion more than it did at the beginning, because it made $1.1 billion! (I realize in actual cash that could be quite different, but lets just pretend net income equalled cash flow for the purpose of this illustration).

      Then the government decided because Facebook executives exercised stock options, the company actually lost $1.5 billion dollars, and deserves a .4 billion rebate from taxpayers, even thoug it has an extra $1.1 billion from operations in its bank account.

      Are you really going to argue that isn't an accounting trick?

      "It is easier to fool people, than to convince them they've been fooled" - Mark Twain

      by Sarge in Seattle on Tue Feb 26, 2013 at 03:57:13 PM PST

      [ Parent ]

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