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Should Zuckerberg Get Capital Gains Treatment for His Facebook Stock?

Mark Zuckerberg
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Mark Zuckerberg

Are the founders of tech companies under-taxed?

If you think that private equity fund managers are under-taxed because carried interest is considered a capital gain rather than income, you should probably also advocate higher taxes for the founders of companies.

Let's begin with the most common argument for changing the way “carried interest” is taxed:

Most hedge-fund and private-equity managers, including venture capitalists, are paid with a combination of a management fee (1 percent to 3 percent of assets under management) and a performance-based fee (generally 20 percent to 50 percent of the "gains" on their funds). The managers are generally paid these fees regardless of whether the gains are due to their own performance or simply the market going up. (Most hedge funds are a horrible deal for hedge-fund investors, but since investors are still dumb enough to line up around the block to put their money in, that's their problem).

In both cases, however, the fees the managers receive are compensation for service, not "capital gains."

…But the management and performance-based fees paid to hedge-fund and private equity managers are NOT capital gains. They're ordinary income. Just because they don't arrive in a monthly paycheck and are based on performance doesn't change that.

That’s former equity research analyst Henry Blodget. But you can read the same sort of thing from almost every advocate of raising taxes on carried interest.

My question is this: How can carried interest be distinguished from the 414 million shares of Facebook stock Mark Zuckerberg owns?

Zuckerberg did not acquire those shares in exchange for a capital contribution to the company. It’s “Founders Stock.” He acquired almost all of it in exchange for doing stuff like inventing Facebook. In other words, Zuckerberg’s stock is compensation for service.

Under current law, Zuckerberg will only be taxed at the capital gains rate if he sells shares.

Is there something I’m missing? As far as I can tell, Blodget’s argument about compensation should apply equally to Zuckerberg’s “Founder Stock.”

I’m not alone on this. Vic Fleischer, the law professor who first brought public attention to the carried interest issue, agrees. In his paper “Taxing Founders Stock” he argues that “it would be normatively desirable to tax gains from founders’ stock at the same rate as labor income.”

Ask not for whom the taxman’s bell tolls. It tolls for thee, tech startup folks.

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