Saturday, February 19, 2011
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:
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.
- 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.