Wednesday, May 4, 2011

Controller's Office Economic Impact Report: Excluding Stock Options from the Payroll Tax

BOMA San Francisco Members:

The Controller's Office has released the report Excluding Stock Options from the Payroll Tax: Economic Impact Report.

Main Conclusions

San Francisco is unique among California cities in levying a tax on the payroll expense of businesses. This tax (the "payroll tax"), levied at a rate of 1.5%, applies to most companies doing business in the city whose payroll exceeds the payroll exemption for small businesses. This tax covers all forms of compensation paid to employees, including wages and salaries, bonuses, and any form of stock compensation. The tax on stock options has recently raised concerns that it could encourage successful companies to leave San Francisco.

On March 29th Board President David Chiu requested the Offices of Controller. Treasurer & Tax Collector, City Attorney, and Economic and Workforce Development research a solution that reduces the risk of growing technology companies leaving San Francisco, while minimizing the cost to the City's General Fund. Also on March 29, Supervisor Mirkarimi introduced an ordinance that would establish a two-year exclusion for the stock compensation of a privately-held company after its initial public offering.

This report contains both the results of the Controller's research into President Chiu's inquiry, and the economic impact analysis of Supervisor Mirkarimi's legislation.

The City requires businesses that are subject to the payroll expense tax to report their total compensation to employees and pay tax on that. The City does not require companies to detail how much employee compensation comes from wages and salaries, stock compensation, or any other source. Thus, the City has no way to estimate precisely what any exclusion of stock compensation from the payroll expense tax will cost, or what, if any, job creation will result from it.

The impact of San Francisco's business tax is particularly disproportionate for a highly-valued company immediately after its initial public offering.

An exclusion of stock options granted before an initial public offering—as opposed to some other form of payroll tax cut—would be effective in reducing the high tax burden facing such a company.

At the same time, of the 8,000 payroll expense tax-paying businesses in San Francisco, only perhaps 2-3 per year on average undertake an IPO, and would benefit from an exclusion for pre-IPO stock options. An efficiently-designed stock options exclusion can, therefore, have the policy advantage of providing a tangible benefit to a few successful companies, reducing their incentive to leave San Francisco, while leaving the majority of taxpayers—and the City's payroll tax revenue—unaffected.

The OEA's best estimates of the cost of such an exclusion are based on annual estimated payments of payroll tax associated with stock options, created for the 14 companies that have gone public in the city since 1997.

The annual payments attributable to stock options ranged from $39,000 a year to $685,000, with an average of $140,000. Given that rate, an exclusion of stock options or other stock compensation that are granted before an IPO may cost the City between $500,000 and $750,000 a year in tax revenue annually.

An exclusion could be made even more efficient by capping the stock option tax instead of eliminating it completely. The evidence suggests that technology companies in San Francisco have paid tax on stock options up to $500k-$1M per year. Capping the tax on stock options at some ceiling within the $500k - $1M range would allow the City to retain the payroll expense tax associated with stock options from the less-valued IPOs, while protecting against a prohibitively-high payment for the most highly-valued companies, whose higher tax burden creates the greatest risk they will move out of the city.

In addition, the report recommends that the economic impact of Sup. Mirkarimi's legislation can be maximized by extending the exclusion to six years from the current three, as six years should cover every technology start-up now in existence, and give sufficient time to study the effect of the exclusion.

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