Why is Facebook’s tax rate so much higher than those of its competitors?

Look out IBM, he’s lurking right behind you.
Look out IBM, he’s lurking right behind you.
Image: Reuters/Robert Galbraith
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Facebook reported an effective tax rate of 41% in the third quarter, higher than most of its peers and higher than the US corporate tax rate of 35%. But have no fear, investors: It’s just an accounting artifact, and Facebook will be getting its money back.

The high rate comes from two reasons: The first is that the company doesn’t actually keep a ton of its money overseas, unlike cash-heavy rivals Google and Apple, which hold billions in cash abroad to avoid paying taxes on it. In 2012, Facebook only kept $348 million of its $3.9 billion in cash overseas, and paid taxes on it.

The second reason is much more important: Facebook pays its staff with stock options, and thanks to a quirk of tax law, Facebook end up with large costs that can be deducted later. The company issues options to executives and records their a rough estimate of their value in its earnings report. When the options are exercised and the executives purchase the stock, it has often increased in value beyond that estimate—and the company can deduct that new, higher value, even though it didn’t cost it any real cash.

That’s one reason Mark Zuckerberg has a salary of $1, but can exercise 60 million stock options in 2015 for the price of $0.60 a share. Today, FB shares are trading at $50. If it is still that high in two years, Zuckerberg would earn $2.96 billion if he exercised them all at once, and the company would be able to deduct a significant share of that money from its taxes.

For an actual example, consider that in 2012, when Facebook went public, Zuckerberg and other executives exercised their stock options. In its first annual report, released in January, the company reported that it expected to pay $441 million in income taxes on earnings of $494 million, for an effective tax rate of 89%. Sounds high! But, by June, it reported an income tax refund of $419 million thanks to stock option losses recorded in 2010 and 2011. That means its effective tax rate in 2012 was closer to 16%.

In the third quarter of 2013, the company reported $726 million in before-tax income, and expected to pay $301 million in taxes, resulting in that 41% figure. But it can still cash in $1.03 billion in paper losses from 2012, and in future years it estimates it will have $2.17 billion in further stock-option related losses that it can use to erase its tax bill. While we won’t know the full extent of its tax rate until the Facebook’s 2013 annual report is released next year, it’s safe to say it won’t be as high the company says it is today.