Monday, February 18, 2013

I am sure the tax code has its logic, but

… how is it that Facebook had $1.1 billion in pre-tax profits from US operations in 2012, resulting in a federal tax liability of $559 million, but will instead receive a tax refund of $429 million?

Because of the deductibility of executive and employee stock options. This is all explained quite clearly in footnote 68 of Facebook's 10-K, according to Business Insider, for those who know how to read such footnotes.

That's right -- while the rest of us are working on our 1040s, and while Congress dithers as the automatic budget cuts loom, Facebook is paying a negative corporate tax rate.

As it did for 2011. And for 2010. And as it will probably pay for years in the future, because after all that, it still has $5.8 billion of tax loss carry forwards to use in future years.

So you tax grumblers, stop complaining about government inefficiency, fraud, and waste. Just remember how happy you are making some people with your tax payments. Facebook shareholders are smiling; a slice of your check is going to their company, with Uncle Sam just acting as a conduit.

I am sure someone can explain this tax policy to me. I am sure it stimulates innovation and the growth of new businesses. But aren't those businesses supposed to start paying taxes at some point?

I suppose the good news in the coming budget crisis will be that if health care and medical research are cut, that will begin to get at the root of the problem, which is that people are living longer than they used to. It's a pretty indirect strategy, but in the long run it might work: cut government spending on health and the nation's population will start to move back toward the age distribution which the existing tax structure was adequate to support.


  1. Harry,

    It's not too difficult to understand. The footnotes, and the article, state very clearly, that taxes were in effect "prepaid." Second, and most importantly, the loss carryforwards will take care of taxable income until the carryforwards are used up or expire. This is common sense, and it applies to individuals as well as corporations. If you, as an individual, take realized capital losses in a particular year, you can "carryforward" those losses to offset against gains taken in subsequent years. Same thing with corporations. Now of course this doesn't apply to you because you never have losses on your tech stock investments, but for the rest of us who, periodically, do have losses, it is very important.

    Of course, all this would be eliminated if the extraordinarily convoluted tax code were changed to a flat tax, That, however, is unfortunately never going to happen. In fact, there will never be an even more simplified tax code because lobbyists run this country and their clients have "vested interests" in keeping the code as it is.

    Sam Spektor

    1. Thanks, Sam. The part I don't get is not why a negative and a positive number sometimes add up to a negative number. The question is why employee and executive stock options are booked as deductions. The code was set up that way to encourage what?

  2. It is booked as deductions because it is a cost of doing business. Perhaps it shouldn't be that way, but "way back" the corporate lobbyists got it cemented in the code.

    There are so many things in the code that don't make sense. For umpteen years, I have had two pet peeves about the code.

    The first is the difference in rates on investments between long term capital gains and short term capital gains. Why should there be a difference? The second is the difference in rates between gains on investments and gains on ordinary income. Why should rates be more favorable on investments? But... it's never going to change.

  3. So the more inflated the stock price becomes the less taxes the company pays? Sounds like a perverse incentive to pump up the stock price. Not that anyone at Facebook would ever do that, or that the regulatory apparatus would ever let it happen.

  4. Mr. Lewis thinks other institutions are not paying enough taxes. Has he thought about his own? Harvard has a roughly $30 billion endowment, invested tax-free and generated in part by tax-deductible contributions. These tax breaks are worth hundreds of millions of dollars a year. Even though it has a huge endowment, it has continually raised its list price faster than inflation. Harvard professors, including Mr. Lewis, continually advocate higher taxes on the rich. Can we start by making Harvard's endowment pay the taxes on dividends, interest, and capital gains that private citizens do? If not, what limits does he think there should be on Harvard's tax-free accumulation of wealth?

    1. "A college 'score card,' unveiled last week by the US Department of Education to help families compare the affordability and value of colleges, contains a bit of sticker shock: An average net price of $18,277 a year to attend Harvard University, compared with $32,493 for Northeastern University." --

  5. This report from Citizens for Tax Justice is a good example how poorly corporate finance is understood by the masses. Anyone with knowledge of the issues can read the source material and see how misguided this report is. Yet I had to click through several pages of search results on Google to find an article with a decent explanation about Facebook ( In fact, Facebook had an 89% effective tax rate in 2012, as can be seen in their 10-K ( Rarely are effective tax rates so high--if you skim through the 10-K, you'll see they had some substantial tax hits this year. So it boggles the mind that Facebook is being subject to criticism that it didn't pay enough tax in 2012.

    Of course, both the 89% figure and the $429mm refund figure are simplifications of a much more complicated collection of payments, deductions, anticipated costs, etc. Although I'm not a fan of arguments from authority, if you're going to look at just one number, the 89% figure is audited and obeys US Generally Accepted Accounting Principles, whereas the $429mm figure is an advocacy group's number based on public information only and nonstandard methodology.

    The extent to which people latch on to a particular interpretation that suits their prejudices, without researching the underlying issues, is a sad fact of human nature. And worst of all, it can really undermine legitimate causes: tax reform is badly needed, but reports like this one from Citizens for Tax Justice, with egregious ignorance in corporate finance, immediately undermine their credibility with people knowledgeable in the issues.

    (And I feel it needs saying, Harvard is very savvy about taking advantage of its tax positioning--if CFTJ covered non-profits, we'd be at the top of their list. Glass house and all that...)

    1. OK, I give up. My last blog about taxation! I'll stick to stuff I vaguely am supposed to know something about.