Senator Carl Levin, D-Mich., has proposed closing a tax loophole that would give Facebook an estimated $3 billion tax break on stock options for CEO Mark Zuckerberg.

Carl Levin

Levin has been pushing to close a number of tax loopholes and deductions, particularly for multinational corporations (see Senator Introduces Bill to Cut Tax Loopholes). Under current law, he noted, Facebook can tell investors, regulators and the public that the stock options Zuckerberg received cost the company a mere 6 cents a share. But the company can also file a tax return claiming that those same options cost the company something close to what the shares actually sell for later on, perhaps $40 a share.

Levin pointed to President Obama’s recent tax reform proposals and the need for changes, particularly for corporations.

“One recent and very public announcement illustrates dramatically our Tax Code’s distortions and the need for reform,” Levin said in a speech Wednesday. “At the center of this story is Facebook and its founder and CEO, Mark Zuckerberg. Mr. Zuckerberg and his company have become a remarkable American business success story. As part of that success, Facebook is in the process of making its initial public offering of stock. The public documents Facebook is required to file as part of that offering tell another compelling story, about one of our Tax Code’s unjustified corporate loopholes. According to its filings, when Facebook goes public, Mr. Zuckerberg plans to exercise options to purchase 120 million shares of stock for 6 cents a share. Mr. Zuckerberg’s shares, obviously, are going to be worth a great deal more than 6 cents, a total of about $7 million; they will apparently be worth more than 600 times as much, something in the neighborhood of $5 billion.”

Levin noted that while under current law, Facebook can tell investors and regulators that the stock options Zuckerberg received cost the company only 6 cents a share, and the company would record the expense that way on its books, the company can also legally later file a tax return claiming that those same options cost the company something close to what the shares actually sell for later on, perhaps $40 a share. The company can also take a tax deduction for that far larger amount.

“So the books show a highly profitable company—profitable, in part, because of the relatively small expense the company shows on its books for the stock options it grants to its employees,” said Levin. “But when it comes time to pay taxes, to pay Uncle Sam, the loophole in the Tax Code allows the company to take a tax deduction for a far larger expense than they show on their books.”

In addition, Levin noted, Facebook is allowed by law to carry back the so-called “loss” arising from this deduction for two years into the past, which means the company can claim a tax refund for the income tax that it has paid over the past two years, a refund that the company estimates at half a billion dollars. “So instead of paying taxes to the Treasury, this profitable company will claim a hefty refund on taxes already paid,” said Levin.

He noted that Facebook also says it will, as allowed by law, carry forward the “losses” arising from this tax deduction up to 20 years into the future, thereby reducing any tax it owes in the years ahead, giving Facebook a tax break of up to $3 billion.

“Now, the end result is that a profitable U.S. corporation—a success story—could end up paying no taxes at all for years, even decades,” said Levin. “I emphasize that Facebook’s actions are within the law. As with so much of our tax code, it’s not the law-breaking that shocks the conscience, it’s the stuff that’s perfectly legal.”

Levin noted that the Senate Permanent Subcommittee on Investigations that he chairs has identified the stock option tax loophole for years and tried to explain its cost, unfairness, and why it should be closed. “The stock-option loophole allows corporations to compensate their executives with stock options, report a specific stock option expense to their shareholders, and then later take a tax deduction for typically a much higher amount,” he said. “Stock options grants are the only kind of compensation where the Tax Code allows companies to claim a higher expense for tax purposes than is shown on their books. Our subcommittee found that the difference between what U.S. corporations tell the public and what they told the IRS was as much $61 billion in one year. Facebook’s use of this loophole is the most pointed illustration yet of the cost of this loophole.”