With Mark Zuckerberg following Bill Gates’ lead by donating mountains of cash to humanitarian efforts, we’re entering a new era of The Gospel of Wealth, though with slightly less condescension than found in Andrew Carnegie’s famous essay.
Good for them. If you want to use your money to help your fellow beings, more power to you.
This is a tax blog, though, so what caught my eye was not another billionaire bragging about his great plans to make the world a better place, but this line from Mark Zuckerberg’s recent Facebook post:
By using an LLC instead of a traditional foundation, we receive no tax benefit from transferring our shares to the Chan Zuckerberg Initiative, but we gain flexibility to execute our mission more effectively. In fact, if we transferred our shares to a traditional foundation, then we would have received an immediate tax benefit, but by using an LLC we do not. And just like everyone else, we will pay capital gains taxes when our shares are sold by the LLC. (emphasis mine)
No tax benefit? Could that possibly be true?
Let’s take one step back before we answer that question and ask a much more important one. Is Zuckerberg’s gray T-Shirt supposed to be his signature look? Because he’s definitely not pulling it off like Steve Jobs and the black turtleneck.
On a more relevant topic, does it really matter if the Chan Zuckerberg Initiative were to get around paying a boatload of taxes? At the current estimated value of $45 billion, assuming Mark Zuckerberg has little to no basis in the stock, that would net the government around $10 billion if he were to sell it all today. While that’s not an insignificant amount, a quick Google search pegs that lifetime’s worth of taxes of one of the wealthiest men in America as enough to fund the government for about one day.
If we’re really super worried that Zuckerberg’s trying to use his money to help humanity rather than blowing it all on one day of government operation (note that he’d probably sell it off over the next 60+ years if he were to hold onto it, so who can guess when that money would end up in the Feds’ greedy little hands), then maybe it’s time to reevaluate our priorities.
That’s all as irrelevant as bullets through a zombie’s heart, though. Because he’s receiving no tax benefit. And we know it’s true because he said so.
Since Zuckerberg decided to use an LLC for his Chan Zuckerberg Initiative, he could be setting it up in one of a few different ways. However, to simplify things, I’m going to assume he set it up to be taxed as a partnership. This is a little complicated, so I’ll do my best to not explain it like some tax specialist douchebag who assumes everyone lives in the same dreary world as I do.
Since Mark Zuckerberg started Facebook from scratch, his Facebook stock has a basis, or initial value, of close to zero. When he sells the stock, he recognizes the full amount between the sales price and the basis, or, in this case, he’d be paying taxes on the full $45 billion (at preferential capital gains rates).
If you look at his announcement, though, it says he’s contributing the stock, not selling it. He’s giving his stock to his new LLC, and in exchange he’s receiving ownership in the new LLC. The basis carries over, which ends up looking something like this:
Mark Zuckerberg and Priscilla Chan combined own 100% of the Chan Zuckerberg Initiative with a partnership basis of zero (since the Facebook stock had a basis of zero).
The Chan Zuckerberg Initiative has Facebook stock with a basis of zero.
Okay, zeros all around. Got it so far? Good.
Next, the Chan Zuckerberg Initiative will sell the Facebook stock for $45 billion, (both the contributions to the Initiative and the sale of stock will over time per Mark Zuckerberg’s initial announcement). Once the stock is all sold, the Chan Zuckerberg Initiative will have recognized $45 billion in Capital Gains.
Since the LLC is taxed as a partnership, all that income flows back to Mark Zuckerberg, and he has to pay taxes on his personal taxes for the gain.
It’s the same amount as if he were to sell it himself, right? No tax benefit, Mark Zuckerberg was telling the truth, case closed.
But wait, there’s more!
The entire purpose of the Chan Zuckerberg Initiative is to do. . .well, something. Whatever that something is will include expenses. Expenses in a business offset the capital gains in a business. And that’s HUGE.
Let me demonstrate it with an example. In Year 1, the Zuckerbergs plan to give up $1 billion in Facebook stock. It’s an expensive year to get things up and running, so they predict they’ll have as much as $500m in expenses that year.
Option #1: Mark Zuckerberg sells stock and contributes the proceeds to the Chan Zuckerberg Initiative. He recognizes $1 billion in long term capital gains, which is taxed at 23.8 percent, or $238,000,000 in taxes. That leaves him $762,000,000 to give to the Initiative.
The Initiative takes the $762m, and has $500m in expenses, giving them $262,000,000 leftover. Since this was a contribution and not income, that $262 million isn’t taxed again.
Net Tax: $238 million
Option #2: Mark Zuckerberg contributes his stock to the Initiative. He receives Partnership Interest in exchange. This is all a tax-free transaction.
The Chan Zuckerberg Initiative sells $500m in stock to cover the $500m in expenses. The two net out, leaving them with net income of zero. They have zero dollars in the bank, but still have $500m in Facebook stock to sell at a future point to as additional expenses arise.
Net Tax: Zero
There’s risk in Option #2. If Facebook goes the way of Friendster, the stock could be worth next to nothing when the Chan Zuckerberg Initiative goes to sell it. It’s a risk I’m sure they’re willing to take, though, since they will be better off holding on to the stock as long as it doesn’t decline more than 23.8%. Plus if the stock value goes up, even better for them.
So where does this leave us?
I don’t really want to call Mark Zuckerberg a liar. For all I know, he plans on paying crazy amounts of taxes against the advice of all of his legion of tax planners and lawyers. I’m not holding my breath. Show me the returns and I’ll believe it. Since LLCs are not legally required to share their tax returns, I doubt we’ll ever know for certain.
One thing is for sure, though. Being the CEO of a major corporation has taught Mark Zuckerberg to tell the truth just like a real politician.