The NASPP Blog

Corporate Tax Deduction

I’m going to start this discussion from the end and start with the company’s tax deduction. Certain employee stock compensation transactions that result in taxable income (e.g., non-qualified stock option exercises and restricted stock vests) are eligible for a corresponding company tax deduction. For example, if an employee realizes $1,000 income on an NQSO exercise and the company’s applicable tax rate is 40%, the company is eligible for a tax deduction of $400.

However, under FAS123(R), a company can’t just wait for the transaction to take place and then book the entire tax deduction. Instead, it must try and anticipate what that tax benefit will be and book it over the same schedule as the expense accrual for the award. Because the company can’t know for sure what income will result from eligible transactions, FAS123(R) details how to go about anticipating that unknown with as a deferred tax asset (DTA).

Calculating DTA

DTA, unlike the actual tax deduction, is calculated based on the FAS123(R) valuation of the grant using the company’s current tax rate and is generally booked over the vesting schedule. For example, if the company is expensing $5,000 for an NQSO each year over a four-year vesting schedule and the company’s tax rate is 40%, the company books a DTA of $2,000 each year of the same schedule (adjusted for expected forfeitures until the actual vest date).

Back to the End

When a transaction does take place the company can calculate the actual tax deduction, which will most likely be either more or less than the DTA amount. The company reverses the DTA that was previously booked and takes the actual tax deduction. However, the difference between these two numbers must also be reconciled. If the DTA is less than the actual tax deduction (i.e., the company realized more than the anticipated tax benefit), the company adds the excess tax benefit to the paid in capital account–often referred to as the APIC pool. However, if the actual tax deduction turns out to be less than the booked DTA (i.e., the company anticipated more tax benefit than it realized), then the company reduces the existing APIC pool by the unrealized tax benefit amount–or takes a tax expense if the APIC pool isn’t sufficient.

Get More

This is, of course, just the beginning of tax accounting for equity compensation under FAS123(R)–or even just a full conversation on deferred tax assets. We have a wealth of information on the NASPP’s Stock Plan Expensing portal. We also have an in-depth webcast in the NASPP webcast archive, “Practical Guide to Tax Accounting Under FAS 123(R).” However, if you are looking for the total information package on financial reporting, including accounting for tax effects, I highly recommend the NASPP’s course, Financial Reporting for Equity Compensation. The first class is today at 12:00 PM PT, but if you miss it, don’t worry. Not only are there four more fact-filled sessions, you can catch up on the recording of today’s class and take advantage of all the bonus materials. Register now!

-Rachel