The widely-respected billionaire investor has famously said that he pays a lower rate on his taxable income than his secretary.Why High Net Worth Investors Should Buy Shares in Pre-IPO Companies
Most Facebook employees who joined the company after will see almost half of their stakes in the company disappear through taxes following the IPO.
When he sells, he will pay taxes at something closer to the long-term capital gains rate likely in the 20 to 25 percent range when you add in state and other miscellaneous taxes for Social Security and Medicare.
Those restricted stock units will convert into shares six months after the IPO. At that time, the value of these shares will be taxed at the ordinary income rate — not the much lower long-term capital gains rate. This is the Silicon Valley version of the Warren Buffett problem — a debate about tax fairness that is embroiling the presidential race.
Facebook’s 99%: Later employees may pay almost double the tax rate that early employees will – Adweek
Duncan, who was a corporate attorney for Google after serving as general counsel for Slide. He has structured restricted stock agreements for two companies and is working on a third.
Duncan adds that Facebook actually gets more of a tax deduction the more its employees earn under ordinary income.
But the company gets no such deduction for what its employees take home under capital gains taxes. The filing says the company has reserved The other thing to take into account is that there are big equity drop-offs between employees who join the company at different times — a standard practice to reward the earliest employees who take the most risk.
So the number of restricted stock units Facebook offers has also declined over the past two years as secondary markets have priced in the value of the shares. Restricted stock units also behave differently in one other important way: So only early employees and investors who hold real shares have been able to participate in the secondary markets that have cropped up over the last few years.
Facebook also instituted an insider trading policy in that banned current employees from selling shares. There are thousands of employees who hold restricted stock units in companies like Groupon and Zynga.
Restricted stock units became popular over the last few years as more Silicon Valley technology companies chose to delay their initial public offerings.
The act that established the SEC said that companies with more than shareholders needed to start divulging details about their financial performance. So to keep the official shareholder count low while still allowing employees to enjoy upside, companies like Facebook began issuing restricted stock units. One of the main reasons the company is even going for an IPO is to fulfill a pledge to employees, Zuckerberg said in his letter to shareholders. Zuckerberg just wanted a way build a business for the long-term without the distraction of public ownership.
The tax issue is a side effect. In fact, if Facebook had relied more on options instead of restricted stock units, a similarly regressive tax scenario might have emerged anyway. The downside of options is that employees have to spend money to exercise them.
Options have also fallen slightly out of favor over the last 10 years as accounting law tightened around how to value shares in privately-held companies. For companies with strong valuations, the strike price on options can end up being quite high, diminishing their upside to employees. It would be hard to change it too, given the complicated tangle of laws around incentivized options, non-qualified stock options, stock grants and restricted stock units.
Nobody would ever propose taxing founders more, either. They provide so much of the value that makes Silicon Valley tick. Facebook employees are lucky to have joined the one big winner of the last several years out of thousands of failed startups. We anticipate that we will expend substantial funds in connection with the tax liabilities that arise upon the initial settlement of RSUs following our initial public offering and the manner in which we fund that expenditure may have an adverse effect.
We anticipate that we will expend substantial funds to satisfy tax withholding and remittance obligations on a date approximately six months following our initial public offering, when we will settle a portion of our RSUs granted prior to January 1, Pre RSUs.
On the settlement date, we plan to withhold and remit income taxes at applicable minimum statutory rates based on the then-current value of the underlying shares. The amount of this obligation could be higher or lower, depending on the price of our shares on the RSU settlement date.
In connection with this net settlement we will withhold and remit the tax liabilities on behalf of the RSU holders in cash to the applicable tax authorities.
To fund the withholding and remittance obligation, we expect to sell equity securities near the settlement date in an amount that is substantially equivalent to the number of shares of common stock that we withhold in connection with the initial settlement of the Pre RSUs, such that the newly issued shares should not be dilutive.
However, in the event that we issue equity securities, we cannot assure you that we will be able to successfully match the proceeds to the amount of this tax liability. In addition, any such equity financing could result in a decline in our stock price.
If we elect not to fully fund our withholding and remittance obligations through the issuance of equity or we are unable to complete such an offering due to market conditions or otherwise, we may choose to borrow funds from our credit facility, use a substantial portion of our existing cash, or rely upon a combination of these alternatives. In the event that we elect to satisfy our withholding and remittance obligations in whole or in part by drawing on our credit facility, our interest expense and principal repayment requirements could increase significantly, which could have an adverse effect on our financial results.
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