It’s game on with one hand out and another in a fist as Zynga follows Twitter’s lead and threatens to move its highly paid employees to Silicon Valley unless San Francisco grants the company a payroll tax waiver on employee stock option gains.
In a meeting last week that included San Francisco Mayor Edwin Lee, Board of Supervisors President David Chiu, Zynga CEO Mark Pincus and CFO David Wehner, company executives indicated that without their own exemption Zynga may convert its 270,00 square-foot office into a call center and relocate its headquarters – including its programmers and highly paid staff – to Silicon Valley, according to people present at the meeting. In the week since, the company has contacted a number of supervisors to argue a similar case, said at least two supervisors who have met with the company.
Zynga, creator of popular online games like Farmville, is expected to go public within the next few years. The company is particularly concerned about a payroll tax provision unique to San Francisco that allows the city to tax gains on employee stock options.
According to the Bay Citizen, City Hall was “stunned by Zynga’s threat,” which, to be honest, is the only part of this story that actually stunned us.
Comments from Plugged-In Readers
What a shock.
Either apply the tax to everyone or apply it to no one but to give twitter an exemption on the tax due for ten years of employee compensation for moving into mid market for five years is bad policy.
I think the right thing to do here is to either kill the tax altogether or tell twitter to take a hike. I think it makes sense to allow them to avoid taxes for options and payroll GOING FORWARD if they make the move, I see no reason why they should be able to avoid taxes on compensation that accrued while they were NOT in mid market.
And to all the realtors salivating over twitter stock option money, do you really think they are all going to buy houses in Brisbane? Really?
Tell Zynga they can get one if they move to mid-Market too.
This is going to be an on-going problem as long as SF’s payroll tax is around. Time to get rid of it.
Zynga can keep a call center in townsend and move their HQ to mid-market if they want a tax break.
They are behaving badly and asking the public to be on their side. Very childish…
I fully support the idea of tax breaks for companies willing to move mid market, but I think the city royally screwed this up by making it all about twitter rather than the area.
Good point by tipster with respect to stock option gains accrued before a move.
I don’t want anyone’s hard-earned money to go down the SF tax rat hole. Zynga brings prosperity, they can “stun” the tax eaters if they want to.
Ever buy something and have it go on sale the next day? I return my item and buy it back at sale price. I’m 100% with Zynga on this. I second Ivan’s motion to get rid of this counterproductive tax.
Agree with tipster here. The tax break should be very limited in scope — i.e. solely with respect to employees who have worked, let’s say, 75% of their time at mid-market during the tax year and only for compensation issued during the applicable period. Giving Twitter 10 years instead of 5 was a big mistake. It also shouldn’t be retroactive.
As to the stock option issue, I’m not familiar enough with the payroll tax provision to know what’s going on here. However, if the employees had made proper 82(b) elections, there should be no issue of ordinary income when they cash in those options. Does the city put a payroll tax on capital gains coming from employee stock options, in addition to ordinary income?
the tax should be eliminated completely. So while I don’t like the strong arm tactics, in this case the means justify the end. Hopefully the SF leadership will get the point that this tax will kill business growth in SF and eliminate the tax completely.
3 words, Not Gonna Happen… they already invested heavily into their new digs at 699 Eighth Street… though I don’t blame them for trying. =)
No tax break for you since SOMA has long been gentrified.
Kill business growth might be a little extreme, it should probably say force growing startups to move out of SF.
I actually bought two same shirts yesterday, one from Macy’s and one from bloomingdales. I returned the one from bloomingdales because it was more expensive.
Does realestate have such a similar return policy as other products? If yes, Zynga can cancel their current lease and move to mid market. If not, they can wait until lease is up and move to mid market.
What is so hard to understand here?
The purpose of the city is to revitalize mid market. As much as I support elimation of payroll tax, I also totally support mid market policy.
hah, nice try. this one is going nowhere, it’s almost charming that they’d even try, really shows a very significant ignorance of the ins and outs of sf municipal politics. indeed, pressing this sort of claim actually tees up just the sort of smackdown electeds love to give, and will do a lot to promote moves to mid-market.
Yay Zynga! I predicted that exactly this would happen. Up next, Gap! You hear that San Francisco pols? That’s the sound of your idiotic payroll tax going down the tubes!
My next question, which of the retarded SF social programs will get the ax after the payroll tax is abandoned? Oh this is just getting good.
I am not generally anti-tax but the SF payroll tax has got to go. Absolutely stupid for us to be the only city in California with a payroll tax. Way to give incentives to move jobs to anywhere else in California.
@wonder lol! It was never about mid-market (aka TL north). It was about trying to figure out a way around the payroll tax and packaging it in a way so that pols and “the public” would buy into it. Everyone immediately saw it as a giveaway to the well-connected. LOL mid market revitalization my ass. This is just a well orchestrated tax dodge. Twitter moving in won’t do anything for the area except maybe add a new blue bottle. Do you think they’ll actually go out to lunch near there? Do you think they’ll buy property near there? Are you kidding me?! They’ll bunker up, eat catered food, work, then quickly hop on their new Muni routes, private buses, or UberCabs on their way home. Sticking a bunch of over-privileged office workers in a rundown building won’t suddenly make the area “revitalized.”
@sfrenegade, I’m no accountant so take the following with a grain of salt.
I suspect you are thinking of 83(b) elections which apply to things like founders stock that you purchase, not to stock options.
It appears SF has a payroll tax on the gain from stock options (which is different than the tax that employees pay to the state and feds on their gains), which apparently not too many knew about and hasn’t been enforced in the past.
Just tax the stupid people!
one of my favorite scenes in all of television.
the whole thing is awesome, but especially starting at 1:22.
i bet salesforce is wishing they thought of this
“Do you think they’ll actually go out to lunch near there?”
Of course they will.
Yes, sorry, that was a typo — 83(b).
83(b) does apply to all restricted stock, not just founder’s stock. 83(b) can apply to stock options that allow early exercise, but you’re right that it shouldn’t apply to general stock options. My mistake there.
For the record, here’s 902.1. The provision applicable to stock options, which apparently hasn’t been enforced yet, is (b). Note also that (c) affects realtors — the brokers must pay the fee, not the actual salespeople:
SEC. 902.1. – PAYROLL EXPENSE.
(a) The term “Payroll Expense” means the compensation paid to, on behalf of, or for the benefit of an individual, including shareholders of a professional corporation or a Limited Liability Company (“LLC”), including salaries, wages, bonuses, commissions, property issued or transferred in exchange for the performance of services (including but not limited to stock options), compensation for services to owners of pass-through entities, and any other form of compensation, who during any tax year, perform work or render services, in whole or in part in the City; and if more than one individual or shareholders of a professional corporation or members of an LLC, during any tax year performs work or renders services in whole or in part in the City, the term “Payroll Expense” means the total compensation paid including salaries, wages, bonuses, commissions, property issued or transferred in exchange for the performance of services (including but not limited to stock options), in addition to any compensation for services to owners of pass-through entities, and any other form of compensation for services, to all such individuals and shareholders of a professional corporation or members of an LLC.
(b) Any person that grants a service provider a right to acquire an ownership interest in such person in exchange for the performance of services shall include in its payroll expense for the tax year in which such right is exercised an amount equal to the excess of (i) the fair market value of such ownership interest on the date such right is exercised over (ii) the price paid for such interest.
(c) Any individual compensated in his or her capacity as a real estate salesperson or mortgage processor shall be deemed an employee of the real estate broker or mortgage broker for or under whom such individual performs services, and any compensation received by such individual, including compensation by way of commissions, shall be included in the payroll expense of such broker. For purposes of this Section, “real estate broker” and “mortgage broker” refer to any individual licensed as such under the laws of the State of California who engages the services of salespersons or a salesperson, or of mortgage processors or a mortgage processor, to perform services in the business which such broker conducts under the authority of his or her license; a “salesperson” is an individual who is engaged by a real estate broker to perform services, which may be continuous in nature, as a real estate salesperson under an agreement with a real estate broker, regardless of whether the individual is licensed as a real estate broker under the law of the State of California, a “mortgage processor” is an individual who is engaged by a real estate broker or mortgage broker to perform services which may be continuous in nature, as a mortgage processor under an agreement with such real estate broker or mortgage broker, regardless of whether the mortgage processor is also licensed as a mortgage broker under the laws of the State of California.
(d) All compensation, including all pass-through compensation for services paid to, on behalf of, or for the benefit of owners of a pass through entity, shall be included in the calculation of such entity’s payroll expense tax base for purposes of determining such entity’s tax liability under this Article. For purposes of this section, the “pass-through compensation for services” of a pass-through entity shall be the aggregate compensation paid by such entity for personal services rendered by all such owners, and shall not include any return on capital investment. The taxpayer may calculate the amount of compensation to owners of the entity subject to the Payroll Expense Tax, or the taxpayer may presume that, in addition to amounts reported on a W-2 form, the amount subject to the payroll expense tax is, for each owner, an amount that is two hundred percent (200%) of the average annual compensation paid to, on behalf of, or for the benefit of the employees of the pass-through entity whose compensation is in the top quartile (i.e., 25%) of the entity’s employees who are based in the City; provided, the total number of employees of the entity based in the City is not less than four.
Move to midmarket and you’ll get your damn tax break.
“Do you think they’ll actually go out to lunch near there?”
‘Of course they will.’
Wrong. Catered lunch. Every day. You’re a bit out of touch with spoiled tech workers.
Only problem is the adhoc way the city did the mid-market. This is long precedence to define redevelopment areas and then offer benefits to those developers or businesses that start up within the boundary.
Hey but what the heck maybe this will be a kinda Tunisia revolution…only difference is that the businesses only count as a few votes, provided the business owners live in the City or better yet the district. Votes still do count.
Well, I guess we know what you think of tech workers now, scurvy, with all the discussion of them being overprivileged and spoiled. A lot of the hipsters who work at these types of companies do crowd around food trucks and other eclectic things, don’t they? Something like Sushirrito (not a truck) or Japacurry (a truck) would probably do well with the demographic. Of course, that only covers a couple days a week at best. The rest of the food options aren’t so great.
Note that with a 83(b) election the exercise price of the option must actually be paid, either by the employee or via a bona fide loan from the company to the employee.
For very early stage companies with small valuations this amount can be trivial, but with the large valuations of Twitter and Zynga, an 83(b) could require significant out of pocket expenses or borrowing.
I guess Twitter actually does get catered breakfast and lunch daily. I didn’t know that. So scurvy’s probably correct for the most part on the lunchtime thing. There will of course be people here and there who go out for lunch but why spend money when you don’t have to?
@sfrenegade I don’t think that way about all tech workers. Just overprivileged ones.
So what makes Twitter and Zynga tech workers “overprivileged” as compared to other tech workers?
I had never heard that Twitter gets catered breakfast and lunch before either. I knew Google and Facebook had certain food policies. What’s funny is that while many of the people who work at those places see the free food as a perk, it’s actually meant to make them more productive workers.
Right. The idea being that if you don’t have to leave the building, or even your desk, to eat, you wind up getting more work done. Apple, Sun (RIP), and others in The Valley have done this since the eighties.
Zynga is an awful company who doesn’t deserve any breaks at all. They are social polluters with as much public benefit as a case of tootsie-rolls. Plus: pets.com.
In 2-3 years when Twitter takes the path of MySpace or gets acquired, Zynga will be in a prime position to take over that mid-market space on the cheap.
Although the 83(b) situation is somewhat unclear, it appears to me that 83(b) does not apply to ISO options, except for purposes of AMT. 83(b) does not apply for regular tax for ISO options.
More importantly, 83(b) is a Federal Income Tax section, and the SF tax is a local payroll tax and doesn’t make any mention of adhering to Federal rules, as far as what was listed above, so it doesn’t seem like a Federal 83(b) election would help anyone with this SF payroll tax.
If I was The City I’d call Zynga’s bluff and tell them go pound sand. Does anyone think they’d pay those kind of lease rates for a call center? I don’t blame them for trying to get tax break, but there’s a huge difference between their headquarters on Townsend and Twitter’s location at 8th and Market.
The tax is ridiculous. But if you’re going to have a tax it should apply to everyone. But corrupt progressive government loves such taxes b/c then they can take bribes and hand out tax breaks.
On the other hand, anyone who locates a business in San Francisco should have their head checked. Zynga, Facebook, Twitter, GroupOn, etc. are going to be forgotten 10 years from now – just another Bubble 2.0. But SalesForce, hehehehe, that’s Pets.com on steroids.
“and the SF tax is a local payroll tax and doesn’t make any mention of adhering to Federal rules”
I agree. The City and County of San Francisco made absolutely no attempt to harmonize its tax rules with federal rules with respect to Section 902.1. It was silly of me to assume that the People’s Republic would actually harmonize its tax rules, in retrospect.
“Right. The idea being that if you don’t have to leave the building, or even your desk, to eat, you wind up getting more work done. Apple, Sun (RIP), and others in The Valley have done this since the eighties.”
Thus proving my point that it won’t help the surrounding area one iota. Thank you defender of the tax break. You proved my point better than I ever could have.
Some history, in case it hasn’t been covered already:
The amendment that added stock options to the payroll tax was approved by Mayor Gavin Newsom on February 19, 2004.
At least some people noticed at the time, for example:
See the section labeled “New Stealth Increases”.
“It was silly of me to assume that the People’s Republic would actually harmonize its tax rules, in retrospect.”
The state has never harmonized its rules with the Fed’s in regards to HSA’s, a lot of states de-harmonized their estate taxes with the Fed’s system, the trend has been toward less harmonizing between federal tax rules and local/state tax rules over the last decade.
Am I the “defender of the tax break”? I’m not convinced the tax itself is good policy, but if San Francisco wants to offer a limited tax break for locating in Mid-Market, it should at least be more intelligent about it than the proposed tax break for Twitter.
Love the comment by EH: Zynga as a social polluter.
You ever see how insanely STUPID and time wasting that game Farmville is? And the number of adults on it?
Part of the real dumbing down of America.
“The state has never harmonized its rules with the Fed’s in regards to HSA’s, a lot of states de-harmonized their estate taxes with the Fed’s system, the trend has been toward less harmonizing between federal tax rules and local/state tax rules over the last decade.”
Yes, you’re correct on HSAs and on estate taxes. However, for the most part on state income taxes, most states at least aim to harmonize with federal income tax. There are exceptions, and sometimes they are strange (e.g. California with the AMT, which I believe may have once been harmonized with the federal AMT, but no longer is).
This particular provision doesn’t aim to harmonize itself with anything in particular. The intention of the 2004 amendment was just to make it all inclusive and to tax everything they could get their hands on.
“so it doesn’t seem like a Federal 83(b) election would help anyone with this SF payroll tax.”
While this is not tax advice, I believe an 83(b) election for options allows you to exercise (i.e. pay for) your options early. The difference between the exercise price and the FMV is taxable income for federal tax purposes. Reading the above SF code it appears that SF uses the same definition.
The point of this is to perform the 83(b) immediately after receiving the grant so that the exercise price is equal to the FMV so no taxable income is incurred. The downside as I mentioned above is the need for cash or a loan to fund the exercise.
shall include in its payroll expense for the tax year in which such right is exercised an amount equal to the excess of (i) the fair market value of such ownership interest on the date such right is exercised over (ii) the price paid for such interest.”
Zynga can have their tax break when they move into the defenestrated building at 6th and Howard.
the city screwed the pooch
mark off the mid market redevelopment zone, put in a time-limited tax exemption (payroll in this case) to land businesses and jobs
that’s how real cities with functional governments do it
if the goal is just to get Twitter, then the city is being idiotic – Twitter’s future success is far from a ‘known’
changing mid market, however, is a worthy goal
bottom line – let zynga do whatever they want. or just get rid of the tax. or make it apply to mid market only.
my guess is SF does none of the above. zynga will get some other free $ another way, just not on the payroll tax so the supes can save face.
we need a tax break too, or we’re leaving.
This tarnish Zynga’s reputation in my eyes. Hard to believe these companies will haggle over a 1% tax when the marginal income tax is more like 40% for many employees.
Let me ask the question in a different way. If you are looking for a job, a San Francisco company offers you $x. An Oakland or Brisbane company offer you the same job but pay you 1% more. Which company will you work for? The San Francisco company is a no-brainer for me.
The election has to do with timing of income tax. No election means no tax due at grant, but taxes due at each vesting at FMV at that time x number of shares vested.
Election means taxes due at granting of options at the FMV at time of grant (usually the strike price) x number of shares granted, no taxes due at vesting.
In both cases, you pay taxes on the diff between the last value on which you paid tax and the price at which you sell. It’s just that w/o election, you can get a huge tax bill when a) you don’t have any cash b/c there was no sale and b) the value might go down to zero before you sell.
I’m not the authority:no one should rely on this for investment advice – check with a tax attorney.
For those who are dreaming of stock option rich, contrary to the report from certain journalist from TechCrunch, they taxed by both federal and state at income tax rate of likely to be around 40%. It is more profitable for you to move to Nevada to avoid the 9% state tax rather than haggle with San Francisco.
Tarnishing Zynga’s image?
Give me a break. It’s either “Love It” (smart people with a winner business model) or “Hate It” (extortion of lunch money from addicted kids and adults).
Either way, that won’t change the idea people have bout Zynga.
@tipster — I believe the point is to both delay paying taxes and in some cases to convert w2 income into long term capital gains.
Exercising an option when the exercise price equals the FMV does not yield taxable income. After holding onto the stock for some period of time any gains would be taxed at the long term CG rate.
@Wai Yip — Probably not much of a factor for the average employee, but for the main principals when the company could be worth billions the tax amount even at 1% could be substantial.
The commenters dissing Zynga should really sit back, have a cup of coffee and think about whether or not Twitter actually serves a socially useful purpose. Once you’ve granted that producing and delivering entertainment over the Internet is worth subsidizing via a tax break, I’m not seeing how drawing a distinction between these two companies holds up to much analytical scrutiny. Isn’t distributing the unhinged emanations from Charlie Sheen’s id ‘social pollution’ and ‘dumbing down’ America?
That said, I predicted this kind of thing would happen even though I thought for the sake of redevelopment that Twitter should get the tax break. I agree with polip that the way out of this dilemma would be to generalize the tax break to any sizable company moving into that specific area; I thought that’s what it actually amounted to.
@tc_sf — the VC are probably expecting 10x gain from their investment. Pincus should focus on what he do best, build value for the company so that it can return 1000% gain for his investors. Haggling for 1% tax won’t get them there. They in in SF in the first place despite knowing it all along there is a payroll tax. That’s because they know San Francisco and their talent is part of the ingredient to archive the gain. Don’t blackmail the city that nurture them.
You guys are all about tax breaks but whine at potholes and wildly dangling utility lines.
Plus, when comes 65 you’ll be wondering how you’ll survive your retirement because you’ll have slaughtered that sacred cow too.
Sure we can help companies that need a push. But money printing machines? They’re just greedy.
902.1(b) uses the term “service provider”, but does not define that term. It does say “terms not defined in this Article that are defined in Article 6 shall have the same meaning as given to them in Article 6”. However, as far as I can see the term “service provider” is not defined in Article 6, either, although it does say ‘The term “employee” means any individual in the service of an employer’.
Does the term “service provider” have a commonly-accepted legal meaning that includes employees?
“Does the term “service provider” have a commonly-accepted legal meaning that includes employees?”
It doesn’t look like the term “service provider” is used anywhere else from a quick search of the SF codes (which are numerous). I can’t tell from the legislation if “service provider” is meant to be unusually broad — e.g. include venture capitalists or anyone else who takes equity or options to buy equity for services (e.g. a lawyer who takes equity for services).
From what I can tell (b) was added in 2004 through an ordinance, although I can’t find the language of the ordinance through a quick search. Prop Q was the provision that added all the language about pass-through entities, LLCs, and professional corporations and came afterwards in 2008, intended to close loopholes.
It’s unclear if use of “service providers” in (b) was lazy/bad drafting or intended to be ambiguous/broad. Presumably if they meant to cover the same parties as (a), they would have written the language in the same way as (a) (i.e. the badly drafted “individuals, who …, perform work or render services” and then subsequently updated the language under Prop Q). They didn’t for some reason.
I bet this is collusion between Twitter and Zynga (a major Facebook business partner) like was done in Noe Valley with the “close Noe St.” gambit that got permission for the parking lot on 24th to be turned into that parkletish thing some time in the future. It forces people to choose between allowing the break for Twitter or consistency with the payroll tax, which is anathema to people who see themselves as bosses. Don’t subsidize Twitter.
Companies like Twitter and Zynga CANNOT stay in the City if the tax is not amended. The way it is structured, it is an unlimited liability that could bankrupt a company.
“The way it is structured, it is an unlimited liability that could bankrupt a company.”
Thanks for the hyperbole, but that is not true and doesn’t help anyone. What is true is that it’s a cost that would likely reduce proceeds from an IPO.
SFRenegade, it is absolutely true. IPOs as well as private VC funding is designed so that the money raised goes back into the business, to build the business. Depending on valuation and % of company sold, it would be very easy to see 30, 40 or even 50% of the proceeds from fund raising to be captured by the government. Also, keep in mind that this would be counted as an operating cost — which as a big one time hit would surly erase any and all profit and injure growth and hiring opportunities.
These highly successful and fast growth companies simply shouldn’t be in San Francisco — for the sake of the industry they should leave, or SF should change the law.
On a side note — there is a great piece in techcrunch on this issue — they surfaced it a few weeks ago — check it out.
Where I take issue with your statement, Mark, is that even if a large percentage went to SF, it would not “bankrupt” the company. In addition, it’s a predictable cost, so it has little effect on profit, growth, and hiring if those things are properly calculated. I’ve read the TechCrunch article, thank you very much, and it only assumes a $100M raise by Twitter for some reason. If the size of the issue was a problem, Twitter could raise the size of the offering (if it’s as promising a company as people seem to think).
Look, I think SF is overstepping its bounds here and these companies should just leave if that’s SF’s stance on this, just like you, but hyperbole helps no one.
“The way it is structured, it is an unlimited liability that could bankrupt a company.”
This is a weird and untested provision of the city code so this is somewhat conjecture, but my first thought would be that while it could be technically true that this could bankrupt a company it seems unlikely to be a practical issue.
If employees were to exercise $1B of options one year then the company would owe SF $15M. It would seem technically possible that this additional $15M would bankrupt the company, but firstly it seems unlikely that a company with a $1B> valuation couldn’t access $15M. Secondly an option exercise of this magnitude would most likely be dominated by high level management or other principals who would be unlikely to accidentally push the company into bankruptcy.
“IPOs as well as private VC funding is designed so that the money raised goes back into the business, to build the business. Depending on valuation and % of company sold, it would be very easy to see 30, 40 or even 50% of the proceeds from fund raising to be captured by the government.”
My understanding was that this was a payroll tax and would not apply to the capital investment process.
“pass-through compensation for services” of a pass-through entity shall be the aggregate compensation paid by such entity for personal services rendered by all such owners, and shall not include any return on capital investment. ”
“In addition, it’s a predictable cost, so it has little effect on profit, growth, and hiring if those things are properly calculated.”
I believe that the unpredictability arises from the fact that employees can choose the timing of their option exercises also the market value, and thus proceeds to the employee, are not under the companies control. The employees get the proceeds yet the company pays the tax.
My point above was that while this unpredictability exists for the rank and file they are unlikely to control enough equity such that the resulting tax would be significant.
It would also seem possible for the company to add a clause in their equity award agreement to compel the employee to reimburse the company for any taxes paid as a result of the employees exercise.
“Look, I think SF is overstepping its bounds here and these companies should just leave if that’s SF’s stance on this, just like you,”
This is also my general belief.
“I believe that the unpredictability arises from the fact that employees can choose the timing of their option exercises also the market value, and thus proceeds to the employee, are not under the companies control. The employees get the proceeds yet the company pays the tax.
My point above was that while this unpredictability exists for the rank and file they are unlikely to control enough equity such that the resulting tax would be significant.”
tc_sf — one thing you’re missing though. You are correct that the amount of taxation is dependent on the stock price at the time of exercise, but the stock price at the time of exercise is also dependent on the amount of taxation.
The tax would be a liability on Twitter’s balance sheet and would affect its stock price commensurately.
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