Editor's Notes

What happens when Twitter goes public -- and its employees get very, very rich?

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tredmond@sfbg.com

The numbers in the Twitter tax-break deal just keep getting bigger. And the politics keep getting stranger.

City Editor Steven T. Jones went through hundreds of pages of city records on the Twitter negotiations; the results of his investigation are in this issue.

But two elements jumped out at me right away. One is that San Francisco officials seem be really bad at negotiating with private companies. It's now clear that billionaire Oracle CEO Larry Ellison took the city to the cleaners on the America's Cup deal, demanding (and getting) millions of dollars in extra concessions that the Board of Supervisors never approved. And talks with Twitter aren't a whole lot better.

Then there's the size of the tax break.

When this was first presented, proponents argued that the city's 1.5 percent payroll tax would discourage Twitter from staying in town and expanding its workforce. I've always said that's ridiculous; the tax amounts to such a modest business expense that no honest corporate executive would ever say it was a factor in a hiring or relocation decision.

Ah, but that's not what's really going on here. The documents show that Twitter isn't just worried about the annual payroll tax. It's all about what happens when the company goes public — and many of its employees become very, very rich.

See, the city's payroll tax also applies to stock options. If, as city economist Ted Egan estimates, Twitter winds up after its initial public offering with a market capitalization of $12 billion (entirely possible), and 25 percent of that money goes to employees as stock options (entirely possible), then the Twitterites (350 or so now and maybe another 300 in a few years) will walk away (after costs) with $2.7 billion.

That's about $7.7 million for each current employee — although the folks at the top will get a whole lot more than that.

So several hundred instant multimillionaires and possibly a couple of instant billionaires. People who will vault into the income and wealth bracket that has been radically undertaxed in this country for many years.

For the $12 billion company, it also means a payroll tax liability of $40 million. And that's got Twitter all a-twitter.

Let's be honest here: A number like that is not chump change, and might convince a CEO to leave town. But it's also politically tricky. Who wants to go out there and argue that a company that rich, with all those rich employees, can't pay taxes on its windfall?

The payroll tax exemption is supposed to create jobs. This is another league altogether — and it has nothing to do with job creation.

So let's have that discussion, shall we? Forget the puny tax on weekly payroll and this rapidly-growing tax-free zone in the Tenderloin. Cut to the chase: should San Francisco exempt Twitter from the IPO stock options tax? That, at least, is worth fighting about.

Comments

Tim, an absolutely brilliant and stellar synopsis on what time it is on Twitter and
San Francisco's political economy and what all these ambitious interests are cheering, chattering and coalescing about. Of course, in this modern day neo-Dickensian tale of two cities, the other San Francisco: poor and working-class families, and the beautiful and forgotten youth in the City's future aren't even traded away, but rather entirely written off.

Posted by Guest on Mar. 15, 2011 @ 9:44 pm

"It was the best of times, it was the worst of times, ..."

Long live the Plutocracy!

Posted by Guest David on Mar. 15, 2011 @ 11:25 pm

You on fire this morning, boy,

Some of your best work, Tim. New material presented coherently and mindful of longer range ramifications. I particularly like your consideration of the change in mindset of the nouveau riche. It works on all levels. I watched the Taxi Commission for years and it was amazing to watch serf/drivers complain about the tyranny of the medallion holders ... until they got a medallion.

Then, there's the classic field study of the gorillas and the banana supply.

And, don't get me started on the sense of entitlement of the New York Yankees.

Did you copy off the paper of the kid in front of you?

Go Giants!

h.

Posted by Guest h. brown on Mar. 16, 2011 @ 4:06 am

H.,

I think you nailed it ... the young man with the business plan is the magnet for mid-Market's troubles.

Posted by Jamie Whitaker on Mar. 16, 2011 @ 2:51 pm

San Fran is the only city in the world with such taxes. Coupled with state income tax, we decided to avoid the city for a startup ourselves. Twitter is an extreme example of success, but other ventures could and have been seriously damaged by the over-the-top taxes.

This is a new economic reality... either San Fran plays ball and continue job growth or lose those jobs and tax revenue.

Posted by Marko on Mar. 16, 2011 @ 5:42 am

Consider this. If Twitter does an IPO - and they will - both the executives and the employees with stock options are going to be very happy campers. Voila! - instant new campaign contributor pool for any politicians who have done favors for the company.

Posted by Mark Barnes on Mar. 16, 2011 @ 6:01 am

I think you have pointed out a very good reason to locate your start-up outside of SF. SF should recosider the Pay roll tax, for a commercial Rent tax, not sure a reciepts tax is a good idea. May be this will motivate our smarter local politicians to move on this.

Posted by Chris Pratt on Mar. 16, 2011 @ 6:57 am

I'm not saying which way I sit on the Twitter tax holiday, but I have to say that it is much too easy for politicians to give away money that is not there's but may help them climb closer up the power ladder to meet their ultimate political ambitions. See pension problem.

Posted by Jamie Whitaker on Mar. 16, 2011 @ 2:49 pm

I watched the hearing on TV and was waiting for someone to mention the stock options in public comments but no one did.

It would be interesting to include an amendment that would ban stock options from the tax exclusion, just to see Titter/JP Morgan's reaction.

But another thing, if the payroll tax exemption only applies to new employees, and the employees likely to exercise the most options are CURRENT EMPLOYEES, then don't they still have to pay the payroll tax on their options?

How were the CURRENT employee option holders able to avoid paying taxes when the exclusion only applies to NEW employees?

Posted by Guest on Mar. 16, 2011 @ 3:09 pm

than an opportunity to buy company stock at a pre-determined price. The actual value and profit from that comes when you sell at, hopefully, a higher price than you paid for them.

Such a profit is a capital gain and therefore should not be subject to any type of income or payroll tax.

Posted by TonyW on Mar. 16, 2011 @ 3:13 pm

SO true thank you TonyW!

I guess what I'm saying is, since, according to the Office of the Controller's Economic Impact Report, SF taxes stock options as part of the city payroll tax, and the payroll tax exclusion only applies to NEW employees, then Twitter is still liable for the stock options payroll tax on the OLD employees. Right?

So even if the payroll tax exclusion passes and becomes law, it only applies to new hires.

Twitter is still responsible for the payroll tax on options for the current employees, who I would assume hold the lions share of the options.

Is there an exception for options to Jane Kim's amendment that made the tax exclusion only applicable to new hires?

Or, actually, has anyone actually read the proposed legislation yet????

Or something....I'm dumb/////

Posted by Guest on Mar. 16, 2011 @ 4:38 pm

Here is an article about it.

http://techcrunch.com/2011/02/18/san-francisco-wants-to-tax-your-stock-o...

"Few people are aware the San Francisco has had a tax provision in its municipal code since 2004 that requires companies to pay a payroll tax on gains from employee stock options. No one pays it, and San Francisco hasn’t enforced it to date, but companies are becoming increasingly agitated that the city may change that policy at any time....

The provision: Section 902.1 of the San Francisco Business and Tax Code. It was amended in 2004 to include stock options...."

Posted by Guest on Mar. 16, 2011 @ 4:48 pm

enforced is because the City has grave concerns about the constitutionality and legaility of that provision.

Any which way you look at it, an option has no inherent or guaranteed value at the point it is granted or vested. So there's no value to tax.

Moreover, since you still actually have to buy the underlying stock upon exercize, there is still not a constructive receipt of value at the time of exercize.

While any realization of value when the acquired stock is sold is subject to the rules about capital gains. And since the City can't tax gains, and even the State only taxes such gains at ordinary income tax rates, I can't see the validity of the argument at all.

Posted by TonyW on Mar. 16, 2011 @ 5:07 pm

I guess ask the City Economist?

"Twitter is growing rapidly and reportedly needs a new location. It is said to be choosing between the San Francisco Mart building, at Market and 10th Street, or locations in San Mateo County. Analysis of rent, commuting, labor, and tax costs suggests that San Francisco's higher business tax could create a significant incentive for Twitter to leave the city. San Francisco's payroll tax covers all
compensation to employees, including stock options. Twitter is currently valued in secondary markets in excess of $7 billion, after being valued at only $250 million in February 2009. The compensation associated with its stock options could be sizable in the future, and the accompanying payroll tax could reach into the tens of millions of dollars. If that is the case, it would appear to make a San Francisco location more expensive for the company than an alternative in San Mateo County."

http://bomasanfrancisco.blogspot.com/2011/03/controllers-office-economic...

Posted by Guest on Mar. 16, 2011 @ 5:31 pm

"I've always said that's ridiculous; the tax amounts to such a modest business expense that no honest corporate executive would ever say it was a factor in a hiring or relocation decision."

Really Tim? I'm a CFO of a startup, and the SF Payroll Tax is definitely a factor in our planning moves. The SF Payroll tax is a pure, incremental tax - it's not like it's an income tax, where you only pay it if you have earnings. We watch every penny, as we are not profitable yet; cutting these checks to the SF Treasurer every six months is an ugly reminder of the City's attitude towards business. If the SF Treasurer is damned and determine to tax stock options, then that will only incline us further to move out of SF.

Posted by Guest on Mar. 24, 2011 @ 11:19 am

"I've always said that's ridiculous; the tax amounts to such a modest business expense that no honest corporate executive would ever say it was a factor in a hiring or relocation decision."

Really Tim? I'm a CFO of a startup, and the SF Payroll Tax is definitely a factor in our planning moves. The SF Payroll tax is a pure, incremental tax - it's not like it's an income tax, where you only pay it if you have earnings. We watch every penny, as we are not profitable yet; cutting these checks to the SF Treasurer every six months is an ugly reminder of the City's attitude towards business. If the SF Treasurer is damned and determine to tax stock options, then that will only incline us further to move out of SF.

Posted by Guest on Mar. 24, 2011 @ 11:38 am