Senators target Facebook with bill that would close stock-option loophole

Correction: An earlier version of this story attributed a statement to both Sens. Levin and Conrad when it was only from Sen. Levin. The sentence has been corrected.

February 29, 2012

Facebook executives with lucrative stock options aren’t the only ones set to benefit from the company’s highly anticipated debut on the stock market this spring. The social media juggernaut stands to save billions of dollars on its tax bill, as well.

Sens. Carl Levin (D-Mich.) and Kent Conrad (D-N.D.) introduced a bill Wednesday that would close what they called a significant loophole in the country’s tax code, which allows companies to take a hefty deduction when employees cash in their stock options.

Facebook anticipates its deduction will be so large that it will wipe out the company’s tax obligations for all of 2011, according to the firm’s regulatory filing for its initial public offering. The company also expects to get as much as $500 million in refunds applied to the taxes it paid over the last two years.

All of this is legal. Under current law, companies can take a deduction when employees cash in stock options. The thinking is that compensating employees with stock options is an expense for companies that the government wants to offset.

Levin and Conrad argue that companies are being allowed to save more than is fair. When they report this expense to Uncle Sam, firms claim a deduction equal to the market value of the shares. But when they report the cost of these options to their shareholders, they use the amount employees paid for the shares — typically far less.

“The books show a highly profitable company — profitable, in part, because of the relatively small expense the company shows on its books for the stock options it grants to its employees,” said Sen. Levin in a floor speech. “But when it comes time to pay taxes, to pay Uncle Sam, the loophole in the tax code allows the company to take a tax deduction for a far larger expense than they show on their books.”

For instance, Facebook founder Mark Zuckerberg paid six cents for each of his 120 million shares. When he exercises those options, they are expected to be worth $40.

Using the higher share price in its tax bill calculations will yield the company big savings, as much as $3 billion, some analysts estimate.

Facebook declined to comment.

Levin and Conrad want to change the law so that companies cannot claim tax deductions valued at more than what they report to shareholders. There would also be a $1 million cap on deductions related to stock options, the same limit that applies to other kinds of executive compensation.

The proposed change would bring more than $20 billion in revenues, according to the Joint Committee on Taxation.

There is some dispute over whether companies should be allowed to claim deductions for stock options at all. Robert McIntyre, director of Citizens for Tax Justice, says the options should not be counted as an expense because they don’t cost the companies any cash. McIntyre argues that Facebook should not be allowed to tell the Internal Revenue Service that it faced an expense in the stock offering and then receive a large tax refund.

The company says in its filings that all 187 million of the company’s vested options will be exercised. With some analysts estimating that the share price will be roughly $40, the company could claim $7.5 billion in deductions. Based on state and federal tax rates, that would translate into $3 billion in savings.

The proposal on the Hill comes as the White House and Republican presidential candidates present dueling ideas for how to reform the corporate tax code, which is widely considered to contain too many loopholes.

President Obama has said he wants to lower the corporate rate from 35 to 28 percent and eliminate many tax breaks for industries. Mitt Romney, the GOP’s leading presidential candidate, has proposed a rate of 25 percent.

Jia Lynn Yang is a staff writer at The Washington Post who covers policy and business. Before joining the Post, she worked at Fortune magazine.
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