Investors will soon be able to own a portion of California-based Facebook when the company goes public. While the imminent initial public offering is a source of excitement for some, it may be cause for concern among some Facebook employees. Because of an interesting provision in the Tax Code, Facebook estimates that its workers will owe the Internal Revenue Service and the state of California a total of $4 billion in taxes when the company's shares hit the open market.
The reason for the high tax bill is the way in which Facebook has chosen to compensate its employees. In addition to a normal salary, some workers have received restricted stock units, or RSUs. They are not like more traditional employee stock options. Instead, they are paper placeholders that do not--and cannot--become real shares until there is a specified "liquidity event."
When RSUs become stock, the Tax Code does not treat them like stock, however. Because RSUs are part of an employee's compensation package, the IRS deems them ordinary income in the year of their vesting. The amount of that income depends on the value of the company's stock at the time the RSUs vest in an employee.
The trouble is that all this income is a paper gain. After a liquidity event, such as an IPO, an employee may owe millions of dollars in taxes, but have insufficient funds to pay the bill because the income is tied up in shares of stock. Employees may have to sell off some of their shares to meet their tax obligations, and Facebook is helping them do that.
But RSUs are an increasingly popular form of employee compensation, especially in the technology industry. Employees who receive RSUs should plan for the potential tax consequences so that they do not get taken off guard and potentially become the subject of an IRS audit.
Source: CNN Money, "Facebook employees face $4 billion tax bite," Stacy Cowley, May 9, 2012.