When Facebook goes public later this year, Mark Zuckerberg is planning to sell $5 billion of the $28 billion in stock that his ownership stake is worth.
The $5 billion he will receive upon exercising his stock options will be treated as salary, and Zuckerberg will have a tax bill of more than $2 billion, quite possibly making him the largest taxpayer in history. He is expected to sell enough stock to pay his tax.
But how much income tax will Mark Zuckerberg pay on the rest of his stock that he won’t immediately sell? He need not sell any. Instead, he can simply use his stock as collateral to borrow against his tremendous wealth and avoid all tax. That’s what Lawrence J. Ellison, the chief executive of Oracle, did. He reportedly borrowed more than $1 billion dollars against his Oracle shares and bought one of the most expensive yachts in the world.
If Zuckerberg never sells his shares, he can avoid all income tax and can pass on his shares to his heirs. Then, when they sell them, they will only be taxed on any appreciation in value since his death.
That’s what Steven P. Jobs did.
After rejoining Apple in 1997, Jobs never sold a single Apple share for the rest of his life, and therefore never paid a penny of tax on the over $2 billion of Apple stock he held at his death. Now his widow can sell those shares without paying any income tax on the appreciation before his death. She would only have to pay taxes on the increase in value from the time of his death to the time of the sale.
Compare Zuckerberg with Lady Gaga. Last year she told Ellen DeGeneres that she had to get “completely wasted” to sign her tax returns because she owed so much. Lady Gaga reportedly earned $90 million in 2010. Because she earns fees and royalties, she’s subject to the highest income tax rate. So, assuming she’s just as successful this year, she will certainly pay more than $30 million in taxes and probably more than $45 million, which is infinitely more tax than Zuckerberg will pay on the $28 billion of Facebook stock he now holds.
Why is this?
America’s tax system is based on the concept of “realisation”. Individuals are not taxed until they actually sell property and realise their gains.
But this system makes less sense for the publicly traded stocks of the superwealthy. A drastic change is necessary to fix this fundamental flaw in our tax system and finally require people like Warren E. Buffett, Ellison and others to pay at least a little income tax on their unsold shares. The fix is called mark-to-market taxation.
For individuals and married couples who earn, say, more than $2.1 million in income, or own $5 million or more in publicly traded securities (representing the top 0.1 per cent families), the appreciation in their publicly traded stock and securities would be “marked to market” and taxed annually as if they had sold their position at year’s end, regardless of whether the securities were actually sold. The tax could be imposed at long-term capital gains rates so tax rates would stay as they are. We could call this tax the “Zuckerberg tax”.
Under the Zuckerberg tax, Zuckerberg would owe an additional $3.45 billion when Facebook goes public (that’s 12 per cent times the value of the roughly $28 billion of stock he owns, after he sells the $5 billion he has already announced he plans to sell). He could sell some shares to pay the tax (and would be left with over $20 billion of Facebook stock after tax), or borrow to pay the tax.
If his Facebook shares decline in value next year, he’d get a refund.
US President Barack Obama has proposed a “Buffett rule” that would require millionaires to pay tax at a 30 per cent effective minimum rate. My Zuckerberg tax is far better.
Under the Obama rule, Buffett’s taxes might have doubled to $12 million in 2010, but this would represent only a trivial amount of additional tax for him. If the Buffett rule applied in 2010, his effective tax rate would only be about 2/100 of one per cent on the $8 billion in appreciation of his holdings.
But under a Zuckerberg tax, Buffett would have paid $1.2 billion in tax in 2010.
A mark-to-market system of taxation on the top one-tenth of one per cent would raise hundreds of billions of dollars of new revenue over the next 10 years. The new revenue could be used to lower payroll taxes, extend the Bush tax cuts, repeal the alternative minimum tax, reduce the budget deficit, prevent military cuts or a combination of all of these.
This tax would not affect the middle class, or even most wealthy Americans. It would affect only individuals who are undeniably, extraordinarily rich. Nor would it affect small business owners. Only publicly traded stock would be marked to market. Some would argue that it is inherently unfair to tax “paper gains” before they are realised. Zuckerberg won’t receive $28 billion in cash; he holds only paper.
Moreover, markets are inherently volatile; one year’s paper gains is another’s real losses. However, these arguments are far less credible when paper losses give rise to real tax refunds. Moreover, in a downturn, the mark-to-market tax would act as its own stimulus — the cash refunds would offset a declining stock market.
Mark-to-market taxation follows the Reagan model by broadening the “base” of tax without increasing rates. In fact, President Ronald Reagan was responsible for the last major reform of our antiquated realisation system of taxation when he signed the law requiring all taxpayers to pay a tax on interest that accrues on bonds but is not paid.
The most profound effect of a mark-to-market tax would be to level the playing field between wage earners, on one hand, and entrepreneurs and investors on the other. Superwealthy holders of publicly traded securities could no longer escape tax on their vast wealth.
The writer is a tax lawyer