Before the pandemic, few people had used the Zoom video conferencing platform. Fast forward to 2021 and it’s a household name for anyone who has tried to work, study, or host a virtual event. The company’s net income rose from around $ 25 million to $ 672 million last year. However, one thing remains unchanged in the company’s most recent financial report: The current federal tax expense has remained constant at $ 0.
Cue the angry tweets from politicians like Sen. Bernie SandersBernie SandersGOP believes the Democrats will present them with the Senators’ victory of the 2022 campaign in the dark over the MP’s decision. The world has 3 million more deaths from coronavirus (I-Vt.) And complains that this is another indication of “manipulated tax legislation” that “benefits the rich and powerful”. While Sanders is correct that many aspects of the US tax system favor the rich, it is not. Companies like Zoom and Amazon are wrong about for one very simple reason that politicians ignore: It is a good thing to pay employees with stock options.
Many startups (like Zoom and Amazon earlier) are financially troubled and cannot afford to pay their employees what they are worth. Hence, they make all the difference with stock options. These options go not only to the company’s “wealthy and powerful” executives, but also to the engineers, sales team, and human resources department – even Amazon’s warehouse workers have received this benefit once. This is nothing new. When I started a barista job at Starbucks in the early 2000s, the company was delighted to share stories of baristas who now drove fancy cars thanks to the company’s employee share plan.
How do companies use share-based compensation to “play” the system and “avoid” federal income tax? You follow the rules. The dirty truth is that companies like Zoom and Amazon have almost no control over how stock compensation affects their tax burden. The reason for the dramatic tax savings has to do with the point in time at which companies are allowed to deduct these costs for the purposes of financial statements (US GAAP) and taxes (Internal Revenue Code) and how these two rules differ.
For financial reporting purposes, companies use a complex valuation process to estimate the fair value of stock options, and this amount is recorded as an expense in the company’s books when they are first issued.
However, tax law hates estimates for good reason, which is why the Internal Revenue Code tells a company that a deduction will not be allowed until a future year when the employee exercises the options and the fair market value is determined.
For companies like Amazon and Zoom, the intervening years between issue and exercise can make a huge difference in the value of those stock options. The estimated value of Zoom’s stock options when initially issued to its employees (and as an expense on the company’s books) was certainly far lower than when employees exercised those options after the share price soared above $ 500 per share in 2020 had risen. The initial stock price when Zoom first went public in April 2019 was $ 36.) However, the value of Zoom stock was beyond the control of the company. Zoom did not use a “manipulated system” or exploited a “loophole” – it just followed the rules.
Meanwhile, the angry tweets about tax bills from Zoom and Amazon ignore the very real benefit that thousands of average workers get when their stock options go up in value. These workers, whether they are high net worth executives or low-wage warehouse workers, are required to report the value of those shares as income on their respective individual income tax returns when exercising the options. Additionally, these individuals are likely to pay Uncle Sam more tax dollars through income tax on this share-based compensation than the company saved through deduction, as individual tax rates for middle and high income taxpayers are above the current 21 percent corporate rate.
So why look for companies whose success ultimately benefits their employees? If politicians really see this as a problem, what is the solution? There is no real political proposal in the angry tweets. Senator Sanders has not yet suggested how he would change tax laws to tax these options differently. The problem with these attacks is that this is an area of tax law where the rules in place are actually quite fair, despite the occasional randomness for companies whose stocks grow significantly in value in a short period of time.
The US tax code allows a company to make a deduction for the compensation paid to its employees, whether in cash or in shares. If Zoom had decided, instead of stock options, to pay all long-term employees a cash bonus of $ 100,000 each for their years of loyal service, the left would still be furious that this successful company had reduced its taxable income by paying average workers exceptional wages ? If anything, Zoom would be recognized as an exemplary corporate citizen.
There are many tax code issues and ways to fix them that can make a meaningful difference to progressive goals. This is not one of them. Zoom and Amazon may be convenient targets because of their high profile, but they are the wrong targets if our goal is to actually fix the areas of our tax system that need to be fixed.
Christina Rice is the director of the Graduate Tax Program at Boston University School of Law and an expert in tax law and tax policy. Follow her on Twitter @BULawTaxMom