The NASPP Blog

Withholding on Equity Compensation

For equity compensation transactions that are subject to U.S. federal income tax withholdings, companies can choose to withhold at either the employee’s W-4 amount or the supplemental wage flat rate of 25% for the first $1,000,000 of supplemental wages paid to the employee within a calendar year. As Barbara mentioned in her entry on Excess Tax Withholding, most companies choose to withhold at the flat rate for supplemental wages simply because it is easier than tracking employees’ W-4 rate and applying it. A definition of supplemental wages, the withholding requirements, and examples can all be found in IRC Regulation §31.3402(g)-1.

The Difference $1 Million Makes

In the context of U.S. income tax withholding on equity compensation, $1 million within a calendar year is a threshold for how employers should withhold on supplemental income. Below that amount, a company can choose to withhold at the 25% flat rate or the employee’s W-4 rate. After that amount, a company must withhold at the 35% flat rate.

This means that cumulatively, all supplemental wage payments made in the same calendar year are combined to determine the total supplemental wage payments made to each employee. After an individual reaches $1 million, the flat rate changes from 25% to 35% and the choice to withhold at the employee’s W-4 rate is no longer available. Because equity compensation is considered supplemental wages, stock plan management teams need to be prepared to withhold at the higher level once an employee crosses this threshold.

Supplemental Wages

So, exactly what are supplemental wages? While there are a number of examples specific listed in the Code, many are not. The definition of supplemental wages is “all wages paid by an employer that are not regular wages.” I know, not a lot of help, right? Fortunately, the most common types of supplemental wages are given as examples including cash bonuses, noncash fringe benefits, equity compensation, and commissions. It’s a good idea for stock plan managers to meet with their payroll contacts to confirm that the cumulative year-to-date supplemental wage amount for each employee is being correctly calculated and communicated to the stock plan management team.

Remind Me Again When I Need to Do This?

It sounds pretty simple, right? If a company has paid $500,000 in supplemental wages to an employee, and that employee realizes income from an option exercise in the same calendar year for another $500,000, then the stock plan management team must be prepared to withhold at the 35% flat rate for any additional equity compensation income in that year.

But, what happens if that option exercise is $700,000 instead of $500,000? The IRS has offered companies two methods to handle that situation. If one particular payment (e.g.; one specific option exercise) straddles the $1 million threshold, companies may either withhold at the 35% flat rate for the entire payment or withhold at 35% for only the portion of the payment that exceeds $1 million. So, in my (very simplified) example, the company could withhold on the entire $700,000 RSU vest at 35% or apply the 35% withholding rate to only the $200,000 that exceeds the first $1 million.

As a stock plan manager, make sure you know how your company wants to withhold on single transactions that straddle the $1 million supplemental wage threshold. Also, get a solid understanding of how your stock plan administration software handles this situation.

For more information on tax withholding on equity compensation, visit our Tax Withholding and Reporting portal on the NASPP site.

Discount on Conference Registration

Don’t forget to register for the 18th Annual NASPP Conference.

If you missed the early-bird rates, it’s not too late to get a discount. We are now offering a $200 discount on registration through May 14th. You can even get an additional 10% discount by participating in the 2010 Domestic Stock Plan Design Survey before our final extended deadline tomorrow, April 23rd.

-Rachel