TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, February 6, 2012

Tax Aspects of Facebook's IPO

FacebookGregg D. Polsky (North Carolina), Zuckerberg and Taxes:

Today's Times includes an article that describes how Facebook will recognize a huge tax benefit when Mark Zuckerberg exercises some options later this year in advance of the company's IPO. When the options are exercised, the company gets a deduction equal to the spread between the fair market value of the stock received by Zuckerberg and the low exercise price he pays. The value of this deduction in the form of tax reduction is roughly equal to 35% (the corporate tax rate) of this spread. There has been some recent uproar over this result because the company gets the huge deduction without laying out any cash. But what this uproar seems to neglect is that Zuckerberg pays ordinary income tax on the same spread at the same time, plus employment taxes, resulting in a 37.9% tax liability. So, the option exercise is a net winner for the government. ...

On the other hand, when Zuckerberg sells his founders' stock (the stock he received very early on), he will recognize capital gains (taxable at 15%) and the company will get no deductions at all. This prospect has also created some uproar, as much of the gains can be attributed to Zuckerberg's labor. But, on a net basis, Zuckerberg's receiving founders' stock instead of more options will have made the government lots of money because Zuckerberg will pay a bunch of tax and the company will not get any tax benefit.  ...

Brant Hellwig and I have a piece coming out in the Iowa Law Review that compares the tax consequences of issuing founders' options versus founders' stock. In some cases (like Facebook), options are better; in other cases where the company's loss utilization is much slower, founders' stock is better. In either case, the story is a lot more complicated than it appears if you look only at one side of the transaction.

Anthony J. Nitti (WithumSmith & Brown, Aspen, CO), Tax Aspects of the Facebook IPO:

Despite recognizing $1.7 billion in pre-tax book income in 2011, Facebook anticipates that it will generate a net operating loss (NOL) in 2012. How is that possible? Through its employees’ exercise of nonqualified stock options, that’s how. ...

Because the income recognized by employees upon the exercise of NQ options is taxed as compensation, Facebook is anticipating using a good portion of the $5 billion in proceeds raised from the IPO to pay its required tax withholding obligations. ...

In addition to its public offering, the prospectus indicates that CEO and Founder Mark Zuckerberg will also sell a significant amount of his common stock to the public. Why would he do it? To pay a tax bill. In the most startling information contained in the S-1 comes the news that Zuckerberg will be exercising options to purchase 120 million shares of Facebook stock after the IPO. These shares have an exercise price of 6 cents per share, so if the stock price reaches $40 per share as anticipated, Zuckerberg stands to make $4.8 billion in compensation upon exercise. That’s right…billion. The tax bill on that $4.8 billion — between federal and California — could reach nearly $2.0 billion, so Zuckerberg will have to sell additional shares to generate some cash. Needless to say, collecting state income tax of this magnitude from Zuckerberg and other Facebook employees could provide a temporary reprieve to the long-struggling California economy.

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Tracked on Feb 6, 2012 5:36:08 AM