TaxProf Blog

Editor: Paul L. Caron
Pepperdine University School of Law

A Member of the Law Professor Blogs Network

Saturday, February 19, 2011

San Francisco to Impose 1.5% Tax on Stock Options

Tech Crunch, San Francisco Wants to Tax Your Stock Options – All of Them:

Few people are aware the San Francisco has had a tax provision in its municipal code since 2004 that requires companies to pay a payroll tax on gains from employee stock options. No one pays it, and San Francisco hasn’t enforced it to date, but companies are becoming increasingly agitated that the city may change that policy at any time. The number of high profile and high value startups based in San Francisco – like Twitter and Zynga – may be too big of a temptation for the city to ignore.

Recently, I heard San Francisco Mayor Ed Lee on our local NPR station talking about how important it was to keep Twitter’s headquarters in San Francisco. To those worried that the recent talks between Twitter and the City were stalling, his words must have been reassuring. But if Lee really wants to keep Twitter – and thousands more tech jobs– in San Francisco he needs to defuse this much bigger ticking tax time-bomb now. This isn’t just about keeping Twitter in San Francisco – this has ramifications for San Francisco’s entire startup ecosystem.

To be clear, this is not a trend. Even the federal government considers taxing these options off the table, and we haven’t been able to find a single city in the United States with such a far-reaching tax policy. This would create potentially huge costs for startups that they can sidestep simply by moving a few miles to the North, East or South. If enforced, expect an exodus of San Francisco jobs to surrounding areas. ...

The tax rate? 1.5%. And remember that neither the federal government, nor California, tax gains on most employee stock options at all. ... Here’s the run down:

  • San Francisco has long had a 1.5% payroll tax on any local businesses. ...
  • San Francisco’s payroll tax says that “payroll” includes the value employees get for options, also known as the “spread,” says [Google's John] Duncan.  “If I work for Slide, and I make $50,000 from my stock compensation, San Francisco says that is just as if Slide wrote me that check,” he says.
  • There are two kinds of options. Non-qualified options and ISOs. Typically, ISOs are the ones most employees get. In 2004, the Federal government examined this issue, and that it would not charge payroll tax on the ISO spread, although taxing the spread on non-quals was fine.
  • San Francisco has not clarified that ISOs are exempt from payroll tax. But so far they haven’t been taxed for one simple reason: Companies didn’t have to report the spread on employee’s ISOs to the IRS, so San Francisco never knew what that possibly taxable income was. That has just changed in January of this year, Duncan says. Now, companies have to file with the Feds to tell them how many people exercise ISOs, allowing the city of San Francisco the right and the information it needs to start charging payroll tax on this spread if it wants to.
Here’s how this would play out. Say a company like Twitter, valued at $3.4 billion in its last funding round, goes public at a $10 billion valuation and raises $100 million. There’s a good chance that most founder and employee equity would be tied up in ISOs, meaning as much as $3 billion – $6 billion of the $10 billion valuation could be tied up in stock that was originally an ISO. If it were half – $5 billion – then Twitter would get a tax bill from San Francisco for $75 million. 75% of the $100 million they just raised would be paid to San Francisco.

http://taxprof.typepad.com/taxprof_blog/2011/02/san-francisco.html

Tax | Permalink

TrackBack URL for this entry:

http://www.typepad.com/services/trackback/6a00d8341c4eab53ef014e862b12b4970d

Listed below are links to weblogs that reference San Francisco to Impose 1.5% Tax on Stock Options:

Comments

A great exam question, when do you tax them and how do you value them, I thought of it first . . .

Posted by: mike livingston | Feb 19, 2011 6:34:28 AM

I doubt that San Francisco will be able to resist the urge to collect this money. The most likely scenario I see is that 2 or 3 years from now they will assess the tax retroactively to 2011, while simultaneously repealing the tax prospectively. That way they can collect a pile of money without driving all the jobs out of town. Or so they will hope, because business owners may still choose to move rather than risk another such stab in the back.

Posted by: AMTbuff | Feb 19, 2011 9:09:29 AM

Wow 1.5%! No more options, ever! The sky is definitely falling! How can capitalism survive? All of those poor people forced into bankruptcy when their options get whacked at 1.5%. The horror. Where anyone got the idea that stock options should be non taxable compensation is interesting.

Posted by: George W | Feb 19, 2011 9:22:44 AM

Amtbuff, you are missing the point. This tax is not paid by the employee, it is paid by the company, and it is paid every time a company is revauled. So if Twitter raises 100mm to invest in growth, sf would likely hit Twitter with a tax bill of 75million, meaning it makes no sense for companies that grant options to be in SF.

Posted by: Mark | Feb 19, 2011 10:41:03 AM

I am not sure why any business would operate in SF if it could operate anywhere else. SF has to be the worst place for a business. Remember, it had a compulsory health care law long before the feds did. It has a higher minimum wage. And that doesn't even get to the sky high prices of rent and real estate. SF is a fun place to visit, but not a fun place to start or grow a business.

Posted by: Shante | Feb 19, 2011 1:31:53 PM

This article is false. The bargain element on the exercise of stock options is generally included in income under Section 83 of the Tax Code. The San Francisco ordinance imposes the tax when an option is exercised, not when its unexercised, potential value changes. The writer just doesn't know what she's talking about.

Posted by: Gwailo | Feb 20, 2011 5:06:37 PM