IP: RE: Absurd multi-billion dollar deductions eradicate Cisco, Micro soft federal tax liabilit Good Morning Silicon Valley Tue Oct 10 12:00:13 EDT 2000

[Dave Farber <farber@cis.upenn.edu>]

>From: John Shoch <shoch@alloyventures.com>
>To: "'farber@cis.upenn.edu'" <farber@cis.upenn.edu>
>Cc: John Shoch <shoch@alloyventures.com>
>
>
>Dave,
>
>As usual, these issues may be a bit more complicated than they seem.  I am
>only an amateur financial engineer, but here are some of the standard
>observations, not well reported in the article in the Chronicle:
>
>--The gain on the stock is viewed as a form of compensation, received by
>employees who sell.
>Thus, the gain on that stock IS being taxed, but it's being taxed on the tax
>returns of the employees.
>--Alternatively, if the companies chose to pay an equivalent amount in
>bonuses, they could still deduct those as business expenses, and the
>employees would still pay the tax on their gains.
>--Thus, this structure tries to make it "tax neutral" if the company wants
>to compensate people with cash or stock.  If the employee got taxed but the
>company got no deduction, they would never give out stock options.
>--By incenting employees with stock the company does avoid the cash expense
>of the equivalent compensation, but the company does pay a price for this on
>the balance sheet:  when exercised the options become shares in the company,
>increasing the share count.  This dilution will reduce the effective
>earnings per share, potentially reducing the value of the stock.
>--The real benefit, though, is that the options are a form of
>performance-based incentive:  a) the employee gets the gain, and b) the
>Treasury gets their tax payments, and c) the company gets hit with the
>dilutive effect of the options --  ONLY if the stock is doing well.
>
>Of course, both sides of this are a lot more complicated....
>
>John Shoch
>Alloy Ventures.
>
>-----Original Message-----
>From: Dave Farber [mailto:farber@cis.upenn.edu]
>Sent: Tuesday, October 10, 2000 4:47 PM
>To: ip-sub-1@majordomo.pobox.com
>Subject: IP: Absurd multi-billion dollar deductions eradicate Cisco,
>Microsoft federal tax liabilit Good Morning Silicon Valley Tue Oct 10
>12:00:13 EDT 2000
>
>
>
> >Absurd multi-billion dollar deductions eradicate Cisco, Microsoft federal
> >tax liability: Although the annual reports of both companies made it
> >appear that they had paid billions of dollars in federal income taxes,
> ><http://www.sfgate.com/cgi-bin/article.cgi?file=/chronicle/archive/2000/10/
>09/MN3707.DTL>Cisco
> >Systems and Microsoft reportedly paid no federal income tax last year. By
> >leveraging a sorely outdated corporate tax break that allows a company to
> >offset tax liability by deducting gains employees realize from stock
> >options during the company's most recent fiscal year, Cisco was able to
> >eradicate $1.8 billion in federal taxes. Microsoft was reportedly able to
> >avoid a tax liability of about $4.74 billion. As one might imagine, the
> >practice has drawn no small amount of criticism. As Jon Coupal, president
> >of the Howard Jarvis Taxpayers Association said, "for a company that makes
> >that kind of money not to pay taxes raises serious tax-equity questions."