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Twitter to Stay in San Francisco: Future Tax Breaks for Tech Companies?

Insight June 03, 2011

Recently, the San Francisco Board of Supervisors voted to give Twitter a 6 year break from the city’s 1.5% payroll tax – which also extends to stock options – to prevent them from leaving, losing their tax revenues, and to promote job creation in the city. 

Recently, the San Francisco Board of Supervisors voted to give Twitter a 6 year break from the city’s 1.5% payroll tax – which also extends to stock options – to prevent them from leaving, losing their tax revenues, and to promote job creation in the city.  The one condition for Twitter was that they have to move into the Central Market area of San Francisco, an area bordering the infamous Tenderloin, in an effort at gentrification and revitalization.  Twitter is currently in SOMA.   

The payroll tax is something that no other city in California imposes.  It kicks in when a business has a payroll over $ 250,000/year, and ends up affecting around 6,000 San Francisco businesses a year.  It has been derided as discouraging business growth, as employers can be reluctant to hire past that threshold.       

While a payroll tax by itself is not enough to galvanize action from Twitter, the implications of the stock option extension, especially for pre-IPO Twitter, are massive.  For a company thinking about putting its headquarters in San Francisco, such a tax basically does one of two things: it either completely deters them from locating in San Francisco because they project themselves to IPO in the future, or it encourages companies to stay private to avoid the payroll tax, which usually deters business growth.  Twitter would have lost over $ 30 million to the payroll tax, which is small relative to their $ 8-10 billion valuation, but massive in light of Twitter’s 2010 revenue of just $ 45 million – and that’s just in direct losses.  Indirectly, investors are likely to be deterred from working with the company because they are already losing part of their returns to the payroll tax. 

The fairness of such a huge tax break to one single company is debatable, but the public opinion expressed through the Board of Supervisors culminated in an 8-3 vote to approve the tax break.  So the fairness of using the city’s funds this way notwithstanding, San Francisco obviously decided that the benefits of such a move outweigh the potential controversy and backlash.  In fact, Twitter may have been obligated by its fiduciary duty to shareholders to leave San Francisco otherwise.  Palo Alto and Mountain View would have been very attractive alternatives which also boast a startup culture (Google, Facebook, Mint, LinkedIn, Playmesh, Udemy, Meebo, Y Combinator), numerous meetups and networking events, with San Francisco just a short Caltrain ride away.

Social game giant Zynga figures to be the next recipient of a possible San Francisco tax break; the other option being that San Francisco decides to abolish the payroll tax in light to prevent future issues with high-growth social web companies, and outright avoidance of San Francisco for new startups.  After all, Zynga already has offices in Sunnyvale and Los Gatos – who’s to say it wouldn’t convert one of those locations into their headquarters and move out of San Francisco altogether?  Zynga hired 800 new employees in 2010, and projects to hire 1500 in 2011; that’s a big incentive for San Francisco to look hard at its taxation structure.