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Facebook IPO highlights tax break for options

by Ira Teinowitz | Published March 1, 2012 at 4:56 PM

A top Senate Democrat is hoping a whopping tax break that Facebook Inc. would be entitled to as a result of its pending initial public offering will shame Congress into closing a loophole that has benefited companies that offer options to their executives before going public.

Michigan Sen. Carl Levin has been trying to end a practice that allows companies to expense options provided to employees at a relatively low cost against earnings while at the same time valuing the options at a far greater price when seeking a tax break. He has introduced the legislation previously but gained little support from his colleagues.

Though the bill's chances are still slim, Facebook's planned IPO creates eye-popping numbers that Levin hopes will finally draw some attention to his bill. He said that under current law, options Facebook has provided to founder and CEO Mark Zuckerberg may be booked against earnings at 6 cents a share while at the same time valued at their expected $40 offering price for tax purposes.

The disparity between valuations is a particular issue for startup companies going public because company founders often own huge proportions of the companies' stock and the offering price is often many multiples higher than the IPO price.

Levin said in a speech on the Senate floor that the vast size of a tax break Facebook is entitled to is "extraordinarily lucrative" and suggested it would be enough to pay the Pentagon's housing of military families for two years or to take a major bite out of the federal deficit. Levin said the loophole "illustrates dramatically our tax code's distortions" and urged the Senate move forward on his legislation to rein in the break.

Levin cited the 120 million options Facebook says Zuckerberg intends to exercise at the time of the IPO. Those options, on the company books for 6 cents a share, will be reflected as a $7 million cost against earnings when they are exercised. But under current tax law, the company also can seek a tax credit for the market price of the shares that can be applied against the company taxes. A refund could be received for taxes paid in the previous two years and any unused portion of the credit could be used to offset taxes for the next 20 years.

Valuing Facebook's shares at $40 for tax purposes could result in a tax break worth $3 billion, Levin said.

"The books show a highly profitable company -- profitable, in part, because of the relatively small expense the company shows on its books for the stock options it grants to its employees. But when it comes time to pay taxes, to pay Uncle Sam, the loophole in the tax code allows the company to take a tax deduction for a far larger expense," he said.

Levin called Facebook's situation "the most pointed illustration yet" of the impact of the deduction. He said it could allow Facebook to report a "loss" for up to two years in the past and carry forward its "loss" up to 20 years in the future.

"Instead of paying taxes to the Treasury, this profitable company will claim a hefty refund on taxes already paid," Levin said. "The end result is that a profitable U.S. corporation -- a success story -- could end up paying no taxes at all for years, even decades."

He suggested the $3 billion tax break is unreasonable.

"It is difficult to get our minds around a $3 billion tax break for a single corporation. Just how big is it? In 2009, taxpayers from 11 states in our union sent less than $3 billion in individual income tax revenue to the Treasury.

"How does this make any sense? American taxpayers will have to make up for what Facebook's tax deduction costs the Treasury. That $3 billion will either come out of the pockets of American families now, or it will add to the deficit which they will have to pay for later."

Levin, along with Sen. Kent Conrad, D-N.D., proposed legislation earlier this year that would bar companies from reporting option expenses on their taxes, larger than those they tell shareholders or potential shareholders the options cost. It also would subject stock options to the same $1 million cap on deductions for executive compensation that now applies to other forms of compensation. The bill only impacts company tax treatment of options, not the treatment of the options by company executives.

A Facebook spokesman declined comment.

Steve DelBianco, executive director of NetChoice, a coalition of trade associations and major online companies, questioned Levin's move.

"Facebook employees are set to deliver billions in tax revenue to state and federal coffers this year while spawning a flurry of spinoff companies. But Sen. Levin's first thought is to slam these employee-owners for complying with the present tax laws," he said. "On one hand the senator calls for more taxes on the IPO engine that brings new companies to market, while on the other hand he calls for tax breaks that specifically benefit his home state auto industry."

DelBianco added that if companies have to recognize far greater employee expenses, cutting their book earnings, it could have other repercussions, and reduce equity valuations, which will shrink the stock gains on which employees and investors will pay their taxes.

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Facebook IPO highlights tax break for options

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