Silicon Valley’s favorite compensation strategy — paying top employees in stock rather than cash — just got more expensive.
A recent federal court ruling means companies won’t be able to deduct the full cost of the stock payments they make to employees when calculating their corporate tax bills, which they’ve done for years.
Instead, they’ll have to allocate some of the expense to their foreign subsidiaries, usually in tax havens such as the Cayman Islands, where the deduction is nearly worthless because they don’t have much of a tax liability there.
For Facebook, the change means the struggling social media giant could face a tax rate as high as 30 percent in the third quarter, compared to the new corporate rate of 21 percent. That’s because the company has to make up for previous quarters and pay additional taxes for when it deducted more of the stock-based compensation than the court decision allows, according to a regulatory filing. In the third quarter of 2017, it paid a rate of just 10 percent.
Facebook hasn’t yet disclosed what it will actually owe in the third quarter as a result of the court ruling.
“It’s going to be a huge number,” Robert Willens, an independent tax consultant in New York. “This also means the loss of certainly several hundred millions of deductions each quarter going forward. It could even be $1 billion.”
A spokeswoman for Facebook declined to comment.
Technology firms rely on stock-based compensation because it gives employees and executives an opportunity to share in the growth of the company without burning through the cash the company has on hand. Investors also like it because it can encourage employees to think about market value in addition to product development.
“This is a big Silicon Valley issue and there is a lot of money at stake,” said David Fischer, a tax litigator at Crowell & Moring.
The tax benefits tied to stock-based compensation can figure prominently in a company’s tax bill. Facebook’s deduction decreased its tax liability by $1.25 billion and the company’s effective tax rate by 6 percentage points, according to an annual regulatory filing last year.
Alphabet paid $7.7 billion in stock-based compensation, yielding a $1.7 billion deduction in 2017, according to a regulatory filing. Apple Inc. valued the tax benefit at $1.6 billion last year, and said in a filing Thursday it would allocate some of that deduction to its foreign entities as a result of the Altera ruling.
Tech firms could get a reprieve if the case is elevated to the Supreme Court, where a conservative bench of judges could be interested in overturning a Ninth Circuit decision, according to Patrick J. Smith, a partner at law firm Ivins, Phillips & Barker.