Posts Tagged ‘facebook’

I pulled into the driveway Saturday night to find a bear munching on crab apples in my front yard. I believe this clip from The Simpsons accuratley reflects my cool, composed reaction:

The bears have been everywhere this fall, having been forced by a dry spring and summer to leave the highcountry and venture into human populations in search of the berries necessary to fatten them up for a winter’s rest. This, naturally, has led to numerous bear-human interactions, some of which have ended badly. A few of us concerned citizens implored City Hall to do something about the situation, but our catchy slogans were to no avail:

On to the tax stuff:

An interesting read on the tax obligation of those Facebook  employees who received restricted stock units pursuant to the recent IPO.

The WSJ has the first of what is likely to be many discussions on this topic: what should investors do with stock holdings given the uncertainty surrounding 2013 capital gains tax rates?

Also from the WSJ: Here’s more information that you’d ever care to know about the evolution of the personal income tax rates from 1945 to today. Most interesting tidbit: the average tax rate for the top 0.1% of taxpayers has plummeted from 55% in 1945 to approximately 26% today.

Albert Hunt at Bloomberg questions the political feasibility of Mitt Romney’s proposed base broadening.

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[Ed note: this post is nothing more than me asking questions based on what I know about tax…and what I DON’T know about SEC law. If I’m charging down an incorrect path — or if you happen to be an SEC attorney — please let me know.]

As Facebook grew during its formative years, to avoid reaching a shareholder limit that would have forced them to report their financial statements as if they were a public company, the tech giant switched from issuing stock options to Restricted Stock Units (RSUs) to compensate its employees. As of December 2011, Facebook had 378,772,184 shares of RSUs outstanding.

The granting of restricted stock units — as opposed to the granting of restricted stock — does NOT involve the issuance of actual shares of stock at the time of grant. Rather, after the recipient employee reaches certain pre-determined vesting bogeys, either shares of company stock or cash can be used to “settle” the employee’s right to receive the value of the RSUs. For the remainder of this post, let’s assume all Facebook RSUs will indeed be settled with Facebook stock.

This much I’m certain of: under I.R.C. § 83, when the employee vests in the underlying RSUs and actual shares are issued, the employee recognizes ordinary income equal to the value of the shares less any amounts paid by the employee for the RSUs. In order for an employee to vest in the RSU, the Facebook S-1 provides:

Pre-2011 RSUs granted under our 2005 Stock Plan vest upon the satisfaction of both a service condition and a liquidity condition. The service condition for the majority of these awards is satisfied over four years. The liquidity condition is satisfied upon the occurrence of a qualifying event, defined as a change of control transaction or six months following the completion of our initial public offering.

Assuming most employees have met the service condition (and the S-1 seems to indicate they have), all employees who received pre-2011 RSUs will vest and receive their Facebook stock six months after the IPO date of Friday, May 18th.  Each employee will recognize compensation income at that time equal to the FMV of the shares less any amount paid for the stock.

Here’s where my SEC knowledge may be leading me astray.

Under  Rule 144, once Facebook has been subject to public company reporting requirements for at least 90 days, any person who is not deemed to have been an “affiliate” for purposes of SEC law at any time during the 90 days preceding a sale and who has beneficially owned the shares proposed to be sold for at least six months, is free to sell those shares. The Facebook S-1 further provides:  

The shares of common stock that were not offered and sold in our initial public offering as well as shares underlying outstanding RSUs will be upon issuance, “restricted securities,” as that term is defined in Rule 144 under the Securities Act. These restricted securities are eligible for public sale only if they are registered under the Securities Act or if they qualify for an exemption from registration under Rule 144 or Rule 701 under the Securities Act, which are summarized below.

Putting this all together, does this mean that the RSUs issued to employees upon vesting six months after the IPO date cannot be sold for another six months?

This is an important question, because based on my understanding of the relevant case law and underlying congressional reports, the Rule 144 restriction is not considered a restriction on transferability worthy of postponing the recognition of income under Section 83. As a result, the employees would be required to recognize compensation income upon receipt of the stock on November 18, 2012, even though they cannot sell it pursuant to Rule 144 for an additional six months. This would lead to two problems:

 1. The employees would not be able to sell the stock in order to pay the tax on the compensation income recognized upon vesting. It appears this concern is being mitigated by Facebook’s decision to net-settle the RSUs, selling enough stock to cover the employee’s tax burden and only issuing the “net” shares to the employee.

2. There is a risk that the value of the stock on the vesting date will exceed the value six months later, when the shares can be freely traded. If that is the case, the employees will have recognized ordinary income to the extent of the higher value, with an offsetting capital loss which may provide no immediate tax benefit — or only a 15% benefit by offsetting long-term capital gains.

Understand, I don’t think this is what’s going to happen, but I can’t be certain. It appears based on discussions on the Internet — and when have anonymous web comments ever led us astray?  — that the vested RSUs will be free to be sold immediately upon vesting in November, so the issues I identified may be completely moot. It’s completely dependent on the application of Rule 144, which is where my comfort level dissipates.

So please, if you can add some clarity to the topic, do so in the comments.

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Building on our previous post regarding the decision by Facebook co-founder and current 4% shareholders Eduardo Saverin to renounce his U.S. citizenship in advance of the Facebook IPO comes this news from Bloomberg:

Facebook Inc. (FB) co-founder Eduardo Saverin will save at least $67 million in federal income taxes by dropping U.S. citizenship, according to a Bloomberg analysis of the company’s stock price. Those savings will keep growing if Facebook’s shares increase.

Saverin’s stake may be worth as much as $2.89 billion, based on the company’s 1.898 billion total shares outstanding. His stake was worth about $2.44 billion in September. Bloomberg calculated the $67 million figure by applying the 15 percent U.S. capital gains rate to the approximate $448 million spread between the two values.

The savings results from the fact that by renouncing his citizenship, though Saverin must pay an “exit tax” as if he sold his Facebook shares, the hypothetical gain is determined based on the value of the Facebook shares in September  — when Saverin formally renounced his citizenship —  rather than at the inflated post-IPO value. As an additonal benefit, by leaving the U.S. in 2012 rather than 2013, Saverin will pay the exit tax on the hypothetical gains at the current 15% preferential long-term capital gains rates, rather than the 20% rate slated to return on January 1. Better still, Saverin can choose to defer the exit tax until he subsequently sells the Facebook shares, and the gain will still be determined based on the value on the date he left the U.S.; all Saverin will have to pay currently is annual interest of 3.28% on the deferred tax.

 Saverin’s spokesman, Tom Goodman, refused to acknowledge that tax savings played a role in Saverin’s decision:

“The calculations and assumptions are not only erroneous, they also further perpetuate the false impression that tax was the reason behind Eduardo’s decision,” Goodman said, declining to cite specific errors. “His motive had nothing to do with tax and everything to do with his desire to live and work in Singapore.”

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A few things you may have missed this weekend while watching Manchester City score twice in stoppage time to stun QPR and claim the Premiership.

In the biggest news of the weekend, it was revealed that Eduardo Saverin — co-founder and current 4% shareholder of Facebook and one of the countless insufferable characters depicted in the Social Network — renounced his U.S. citizenship in advance of the tech giant’s IPO. The reason is obvious: while Saverin will still have to pay an “exit tax” as if he sold his stock prior to departing the U.S., the gain will be determined at a pre-IPO valuation, and Saverin will reduce his future tax burden by relocating to Singapore.

There are various levels of evil in the world. There’s “taking too many items into the express lane” evil,  “dog fighting ringmaster” evil, and of course, there’s  the “Mr. Burns, impossibly devious super-villain” evil. But just when you think you’ve seen it all, people set a whole new standard by trolling public lists of dead children, stealing the identities of their parents, and filing a false tax return claiming the children as a dependent. There’s a special place in hell for those guys.

Some advice for recent graduates on managing money and student loan debt. Lesson #1: While putting a $2,000 surround sound system in your $500-a-month studio apartment may seem cool, it’s probably not a wise investment.

It’s only been done 15 times in major league baseball history, but that didn’t stop this 6-year old from pulling off an unassisted triple play.

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Double Taxation hits 50,000 page views!!! Author celebrates by making 60,000th Simpsons reference.

Mark Zuckerberg cuts his 2012 tax bill in half; should qualify for the earned income credit in 2013 after salary drops to $1.

Man loses wife and kid, beats IRS in Tax Court.

Stephen King writes letter begging to be taxed. It’s not quite as long as “The Stand”, but it’s a much better read.

Be warned: Even if Romney wins the White House, the promised tax breaks may not materialize.

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Back in February, Facebook filed S-1 documents announcing its plans to go public and raise a cool $5 billion in cash. Today, the social media giant released a revised regulatory filing, clarifying that the offering will consist of 337,000,000 shares at a value from $28 to $35 per share, meaning the company’s haul could reach upwards of $12 billion. While many of the tax aspects of the IPO noted in our previous post hold true, there are a couple of changes worth noting:

  • In the first filing, it was announced that CEO Mark Zuckerberg would be exercising 120,000,000 options to acquire Facebook with an exercise price of $.06 per share. Because Zuckerberg would be taxed upon exercise under Section 83 to the extent the FMV of the stock (assumed to be approximately $40 per share at the time) exceeded the exercise price, initial estimates put Zuckerberg’s compensation income resulting from the exercise at $4.8 billion, leaving him with a tidy federal and state tax bill of approximately $2.0 billion, which according to one CPA, was the largest single year tax bill they’d ever seen.

Today’s S-1 clarifies that the CEO will be exercising only 60,000,000 of his 120,000,000 options. Assuming each share is indeed worth $35 upon exercise, Zuckerberg will recognize compensation income of “only” $2.1 billion in 2012.

To pay the resulting $1.0 billion tax bill, Zuckerberg plans to immediately sell 30,200,000 of the shares. Since the shares will have a basis equal to the sales price courtesy of the step-up afforded to Zuckerberg after he recognizes compensation income on the bargain element at exercise, he will recognize no further gain on the sale. He will, however, generate $1.1 billion in cash from the sale, $1.0 billion of which he can use to settle the tax liability resulting from the exercise, and the rest he can just piss away on hats.

  •  With the stock price a becoming more clear, today’s filing quantified the anticipated corporate level deduction related to employee option exercises and vested restricted stock units. Facebook expects to settle 280,000,000 restricted stock units in 2012 — meaning they will vest, and the company will be entitled to a deduction equal to the FMV of the stock[i] . An additional 185,000,000 shares of stock are expected to be issued upon the exercise of nonqualifed stock options, upon which the company will be entitled to a compensation deduction equal to the excess of the FMV of the stock on the exercise date over the exercise price. 

Based on the foregoing, Facebook anticipates deducting a staggering $14 billion in stock based compensation on its 2012 tax return,[ii]an amount that would, believe it or not, put a company with estimated revenue of $4 billion in 2012 in a net operating loss position. Facebook plans to carry back the NOL to recover $500 million in previously paid taxes, an act that is sure to command a lot of attention and really, really anger this guy.


[i] Assuming no Section 83(b) elections were made at issuance.

[ii] Assuming a $31.50 per share price

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If you’ve ever wondered how the Internal Revenue Code grew to 70,000 pages, allow me to borrow a parable from TV’s favorite family:

On an otherwise lazy day in Springfield, a lone brown bear emerged from the woods and stumbled into town, terrifying the townspeople:   

Despite the fact that this was the first bear spotted on Springfield’s streets in decades, the town viewed this isolated occurrence as evidence that constant bear attacks would soon threaten their way of life, eating the town’s children and scaring away its salmon. An angry mob immediately confronted Mayor Quimby, demanding that something be done to protect them. The Mayor satiated their concerns with a swift and decisive overreaction, instituting a daily Bear Patrol complete with ground troops and helicopter surveillance.

Silly as it sounds, the exact same thing happens in the tax world. A code or regulation section can exist for decades without creating a kerfuffle, but as soon as one high-profile fact pattern gives rise to an anomalous result, the outcry for change begins, often resulting in a completely unnecessary amendment that further complicates the statute.

To wit: as we discussed a month ago, the Facebook IPO contained a rather interesting bit of information:

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.

After the IPO, hundreds of millions of shares of NQ options previously granted to employees are expected to be exercised. As a reminder, these forms of compensation are generally not taxable under I.R.C. § 83 until exercise …[but] upon exercise the employee must recognize income equal to the excess of the FMV of the stock over the exercise price, with the employer getting a corresponding deduction.

Here’s the thing: Section 83 has existed in the Code since 1969, and I.R.C. § 83(h) —  which allows for the corporate level deduction highlighted in the underlined text — was incorporated into the statute to achieve a rather logical result: if an employee is required to recognize compensation income upon exercising stock options or receiving property from a corporation in exchange for services provided, then the corporation should receive an offsetting deduction, since they are the ones providing the compensation.

It’s an equitable provision, and one that has existed free from controversy for over 50 years. In light of the enormous one-time compensation deduction Facebook is set to receive upon the exercise of its options, however, Senator Carl Levin, a Democrat from Michigan, has made it his own personal crusade to wipe I.R.C. § 83(h) from the code, decrying it as a “loophole.”

As proof of the “loophole,” Levin repeatedly points out the lost tax revenue resulting from Facebook’s stock-based compensation deduction, while failing to mention that those who exercised the nonqualified options are recognizing compensation income in the exact same amount, and thus will be paying tax at the same 35% that the corporation would have paid had the options not been exercised.

Of course, the facts should never get in the way of a good filibuster, so Levin is moving forward with his plans. He’s proposing to limit the corporation’s deduction to the amount it deducts on the financial statements (which is typically significantly less), or alternatively, to cap the deduction at the $1 million per employee limitation currently applied to regular executive compensation under I.R.C. § 162(m). So to clarify, he wants the employees to recognize income to the full extent, but for the corporation to lose or limit the corresponding deduction.

Others are taking an even more extreme approach. In this op-ed published in the New York Times titled “The Zuckerberg Tax,” a tax attorney recommended taxing the super-rich each year on the growth in value of their publicly-traded stock, even if it is not sold:

For individuals and married couples who earn, say, more than $2.2 million in income, or own $5.7 million or more in publicly-traded securities (representing the top 0.1 percent of families), the appreciation in their publicly-traded stock and securities would be “marked to market” and taxed annually as if they had sold their positions at year’s end, regardless of whether the securities were actually sold. The tax could be imposed at long-term capital gains rates so tax rates would stay as they were.

As an example, if Bill Gates saw his publicly-traded portfolio grow by $1 billion in 2012, he would be on the hook for $150 million in tax, even if he didn’t sell a single share.

Ignoring the countless real-world economic hazards of instituting such a proposal, consider the many changes to the Code that would be necessary for its implementation. A mark-to-market system would drastically alter the landscape of the statute, just as the overwhelming majority of the nation has been united in its agreement that the Code needs to be simplified.

Of course, these types of needless proposals do sometimes become law, which is precisely how we’ve come to be saddled with the convoluted, overly complicated statute that exists today.  It is exactly this type of reactionary response to an isolated, extreme example that left Springfield with a pricy Bear Patrol, and the U.S. with a 70,000-page Internal Revenue Code.

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