Facebook reduced its federal and state taxes by a record-breaking $1.87 billion in 2014 by granting lavish stock options to its executives.
The company has used this tax break in the past to zero out its federal and state income-tax bills. But this year it set a record, claiming hundreds of millions more than any other Fortune 500 company has previously disclosed receiving from this tax break.
In 2014, Facebook enjoyed U.S. pretax profits of $4.9 billion and paid federal income taxes of just $260 million, for a federal income tax rate of just 5.3 percent. The stock option tax break explains basically all of the difference between the company’s single-digit tax rate and the 35 percent statutory tax rate.
As we have previously documented, Facebook is hardly alone in using this tax giveaway. Between 2010 and 2012, 280 companies in the Fortune 500 disclosed reducing their tax rates using this dubious loophole. More than 20 companies, including Facebook, managed to cut their taxes by a quarter billion dollars or more during this period.
But none of these corporations enjoyed tax breaks even approaching what Facebook’s newest report discloses. Even Apple, the previous king of the stock option tax break, has never received more than $1.1 billion a year in stock option tax cuts.
Stock options are rights to buy stock at a set price. Corporations sometimes compensate employees (particularly top executives) with these options. The employee can wait to exercise the option until the value of the stock has increased beyond that price, thus enjoying a substantial benefit.
The problem is that poorly designed tax rules allow corporations to deduct the difference between the market value of the stock and the amount paid when the stock option is exercised. For example if a company gives an employee the option to purchase stock at $10 a share but it’s actually worth $18 a share when the employee buys the shares, the corporation can deduct the $8 difference.
In practice, corporations are often able to deduct more for tax purposes for stock options than they report to shareholders as their cost.
Lawmakers on both sides of the aisle have opposed this loophole. 2013 Legislation sponsored by Democratic Sen. Sheldon Whitehouse would have pared back the stock option tax break. The Cut Loopholes Act would address situations in which corporations take tax deductions for stock options that exceed the cost they report to their shareholders. It would also remove the loophole that exempts compensation paid in stock options from the existing rule capping companies’ deductions for compensation at $1 million per executive. And retired Republican Sen. Tom Coburn called for closing this loophole.
The defenders of this tax break sometimes argue that when companies pay their employees, it shouldn’t matter whether the pay takes the form of salaries and wages or stock options. But this argument glosses over the fact that while paying salaries imposes a dollar-for-dollar cost on employers, issuing stock options simply does not. As we have argued elsewhere, a sensible analogy is airlines giving employees the opportunity to fly free on flights that aren’t full, which costs the airlines nothing. It would be ludicrous to argue that airlines should be able to deduct the retail value of these tickets.
Allowing high-profile tech companies to zero out or substantially lower their taxes to single-digit rates their taxes using phantom costs erodes the public’s faith in the tax system; any meaningful attempt to reform our corporate tax should remedy this situation.