A change in federal reporting requirements has San Francisco-based companies worried that the city will begin enforcing a 2004 municipal tax provision that levies a 1.5% payroll tax on gains in employee stock options, a provision that has thus far gone unenforced.
San Francisco has long levied a 1.5% payroll tax on local businesses. The provision dictates that “payroll” includes what is commonly referred to as “the spread,” which is the value employees receive in stock options.
There are two kinds of stock options, non-qualified options and incentive stock options often referred to as ISOs. While ISOs are the more common option, the federal government ruled in 2004 that it would only enforce a payroll tax against the spread of non-qualified options.
San Francisco, on the other hand, has made no such ruling. Even so, the tax has not been enforced because, in the past, companies were not required to report to the IRS the spread in employees’ ISOs, meaning the city had no access to the information needed to determine taxable income.
As of January, however, that has changed. Companies are now required to report such information to the IRS, giving the city of San Francisco access, for the first time, to the information required to enforce the 2004 provision against gains in ISOs.
This has many in the business community worried. Furthermore, enforcement of the provision may encourage startups to avoid the city or relocate out of it. It remains to be seen whether the city will take advantage of the new IRS reporting requirements; what is clear, however, is that many observers are nervous about the potential implications enforcement may have on job creation and retention in the city.