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  • © The Regents of the University of California, 2010-2017. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

The “Zuckerberg Tax” and the Buffett Rule: More Fiscal Facebook Fallout

Updated May 15, 2012: Eduardo Saverin, the Brazilian-born co-founder of Facebook with a 4 percent stake in the company (worth about $4 billion) reportedly renounced his U.S. citizenship last year to avoid or at least minimize the tax bill from future sales of stock in the company, and other investments. Unlike most countries, the United States imposes income tax on citizens as well as residents, and the capital gains tax on existing investments cannot be avoided entirely just by dropping citizenship, but it can sometimes be reduced. By renouncing his citizenship, Saverin will be taxed on the much smaller estimated gains that likely would have occurred if he had sold his stock last year, well before the initial public offering. For a detailed discussion of the so-called expatriation regime (exit tax), go to CEB’s California Estate Planning §§16.85–16.90A.

Facebook has announced that Mark Zuckerberg will exercise 120 million options to purchase the company’s stock in connection with its planned initial public offering, potentially resulting in a $2 billion tax bill.

Because the options are nonqualified stock options (NQSOs), Zuckerberg will be taxed immediately on the difference between the exercise price ($0.06 per share) and the value of the stock on the exercise date (estimated at $50 per share) as ordinary income.

If these numbers are correct, Zuckerberg will realize $6 billion of income and will owe approximately $2 billion in federal income tax. He will also owe some $600 million in state income tax, assuming he is a California resident for income tax purposes.

This transaction has sparked renewed interest in unrealized appreciation as a source of revenue. Zuckerberg reportedly owns 28 percent of Facebook, which will have an estimated market capitalization of $100 billion. This means that he currently has $28 billion in unrealized appreciation, most of which may never be taxed if he follows the lead of Warren Buffett and donates his entire fortune to charity.

The so-called “Buffett Rule” proposed by President Obama would impose a minimum tax of 30 percent on incomes over $1 million. The provision is based on Buffett’s observation that he pays tax (including payroll tax) on his income at a lower rate than his secretary.

But critics have noted that Buffett’s taxable income is miniscule (including his $100,000 salary) compared to his personal wealth, most of which has never been taxed at the individual level.

Under a proposal floated by tax lawyer David Miller in the New York Times, individuals and married couples with $1.6 million of income or $5 million of publicly traded property would be taxed each year on “mark-to-market” gains at the current 15 percent long-term capital gains rate. The individual thresholds roughly correspond to the top 0.1 percent of taxpayers. All other taxpayers would continue to be taxed under the realization system.

This proposal would result in the taxpayer’s publicly traded property being valued annually and taxed on the increase in value. The government would make or guarantee loans to permit taxpayers to pay their taxes on illiquid or restricted property, with the loans bearing interest at market rates and being secured by the property. Losses would be fully deductible. Under the proposal, Zuckerberg would owe an additional $4.2 billion in tax this year.

Despite the simplification benefits and theoretical advantages of such a system, don’t expect to see the proposal turned into legislation any time soon.

For more on stock options and executive compensation, see California Estate Planning, chapter 22. Also check out Organizing Corporations in California, chapter 4, on offering, selling, and issuing securities.

© The Regents of the University of California, 2012. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

One Response

  1. Here’s an interesting L.A. Times article on how the Facebook IPO is expected to benefit California’s budget situation: http://www.latimes.com/news/local/la-me-state-budget-20120116,0,811683.story
    Another great resource for California attorneys tasked with documenting employee stock incentive plans is Chapter 8 of CEB’s title, Drafting Employment Documents for California Employers, which was prepared by Rob Thomas, of Doty Barlow Britt & Thomas LLP, Palo Alto. The chapter includes helpful checklists and forms for drafting stock options and other stock incentive plans.

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