I’ve been getting a lot of questions about what tax withholding rate can be used for federal income tax purposes, now that the FASB’s update to ASC 718 is final and companies are free to adopt it. So I thought I’d take a blog entry to clarify what’s changed and what hasn’t.
Who’s the Decider on Tax Withholding Procedures
One thing that a lot of folks seem to have forgotten is that the FASB doesn’t determine tax withholding procedures; they just determine how you account for situations in which tax is withheld. The ultimate authority on how much tax you should (and can) withhold in the United States is the IRS, not the FASB.
Tax Withholding for Supplemental Payments
I’ve blogged about the rules for withholding on supplemental payments, which include stock plan transactions, quite a bit (search on the term “Excess Withholding” in the NASPP Blog). There are two choices when it comes to withholding taxes on stock plan transactions for employees who have received less than $1 million in supplemental payments for the year:
Withhold at the flat rate (currently 25%). No other rate is permissible.
Withhold at the employee’s W-4 rate. Here again, no other rate is permissible.
If employees want you to withhold additional FIT, they have to submit a new W-4 requesting the withholding (as a flat dollar amount, not a percentage) and you have to agree to withhold at the W-4 rate. This is stated in IRS Publication 15 and even more emphatically in IRS Information Letter 2012-0063. Whether you are using method 1 or 2, you can’t arbitrarily select a withholding rate.
Where Does the FASB Come Into This?
The FASB has no authority over these requirements and they didn’t amend ASC 718 to make is easier for you to ignore the IRS requirements. They amended ASC 718 to make it easier for companies that grant awards to non-US employees to allow those employees to use share withholding. Other countries don’t have a flat rate, making it challenging for the US stock plan administration group to figure out the correct withholding rate for non-US employees. This would allow companies to withhold at the maximum rate in other countries and refund the excess to employees through local payroll (who is more easily able to figure out the correct withholding rate).
The only change for US tax withholding procedures is that if you want to use the W-4 rate to withhold excess FIT, withholding shares for the excess payment will no longer trigger liability treatment once you adopt the update to ASC 718. But if you want to withhold excess FIT, you still have to follow the IRS procedures to do so. Previously, even if you had followed the IRS W-4 procedures, withholding shares for an excess tax payment would have triggered liability treatment.
Why Not Use the W-4 Rate?
No one wants to use the W-4 rate because it is impossible to figure out. You have to aggregate the income from the stock plan transaction with the employee’s other income for the payroll period, which the stock plan administration group doesn’t have any visibility to. The rate varies depending on the number of exemptions the employee claims on Form W-4. And the rate is complicated to figure out. I count at least seven official methods of figuring out this rate and companies can make up their own method (but if they make up a method, they have to apply it consistently, the stock plan administration group can’t make up a method that is different than the method the payroll group uses).
The upshot is that you literally can’t figure it out. You would have to run the income through your payroll system to figure out what the tax withholding should be. And that’s a problem because your stock plan administration system is designed to figure out the withholding and tell payroll what it is, not the other way around.
What’s the Penalty?
Members often ask me what the penalty is for withholding extra FIT without following the IRS procedures. Generally there isn’t a penalty to the company for overwithholding, provided there’s no intent to defraud the IRS (if you don’t understand how overwithholding could involve tax fraud, see “Excess Withholding, Part 2“) and the withholding is at the request of the employee. Doing this on a one-off basis, at the occasional request of an employee, probably won’t result in substantial penalties to the company, especially if the employee has appropriately completed Form W-4 for his/her tax situation. (Note, however, that I’m not a tax advisor. You should consult your own advisors to assess the risk of penalty to your company.)
But I’ve encountered a number of companies that want to create a system to automate electing a higher withholding rate without following the W-4 procedures (in some cases, for all of their award holders). I think that it could be problematic to create an automated system that circumvents the W-4 process, especially in light of Information Letter 2012-0063. That system is likely to be noticed if the company is audited, and I think it could have negative ramifications.
Many estimates point to figures around 65% of the US population being “visual” learners. Perhaps that’s what inspired the old adage “a picture is worth a thousand words.” Certainly when it comes to participant communications, that seems to ring true. In today’s blog I’ll explore how one of my favorite new tools, infographics, can creatively transform our word-heavy stock plans into a visual story. It may very well be that an infographic is also worth a thousand words.
What’s an Infographic?
If I lost you at the word “infographic,” fear not! A quick Google search turned up this definition: “a visual image such as a chart or diagram used to represent information or data.”
Essentially, the most important details are portrayed in a graphic full of pictures and minimal words. Here’s a simple ESPP infographic I found on Salesforce.com’s website:
Key details are prominently portrayed in a format that allows the reader to visually absorb the information. Another company, GuideSpark, also used infographics in a video to summarize their ESPP:
I’ve seen quite a few infographics depicting ESPP plan terms, but not so many focused on other award types. Think of the possibilities! Infographics can be a great tool to summarize processes, key plan terms, calculations, and more. A quick list of areas where I think they could be further utilized for stock plans:
Award vest/release process (tax elections, withholding, release of shares)
Stock option exercise
Tax withholding/reporting
Explaining performance conditions attached to awards
Explaining dividends/dividend equivalents
Insider trading guidelines
Blackout periods/trading windows
ESPP plan
Many more!
Do you have a stock plan infographic you’d be willing to share? I’d love to see what other creative stock plan infographics are out there. This can be a very engaging, effective (fun!) way to communicate information without overload.
Here’s what’s happening at your local NASPP chapter this week:
Los Angeles: Ken Stoler of PricewaterhouseCoopers LLP, presents “Advanced EPS for Stock Compensation.” (Wednesday, June 8, 11:30 AM)
San Diego: Nathan O’Connor of Equity Methods and David Reichel of QUALCOMM present “The Cutting Edge of Compensation Practices – What we Expect to See in 2017.” (Wednesday, June 8, 11:30 AM)
Atlanta: Scott Wallace of E*TRADE Financial and Kerri McKenna of PricewaterhouseCoopers discuss the recent changes to ASC 718 and how these changes will impact equity compensation. (Thursday, June 9, 11:30 AM)
Michigan: Art Meyers of Choate, Hall & Stewart presents “Protecting Your Company’s Stock Plans in Today’s Environment.” (Thursday, June 9, 11:30 AM)
NY/NJ: Daniel Moynihan and Sydney Hilzenrath of Korn Ferry Hay Group discuss the firm’s annual study of CEO compensation. (Friday, June 10, 8:30 AM)
Yesterday I attended the Orange County NASPP chapter’s summer social. The event was held at a restaurant in Irvine and was a great opportunity for members to network and chat in a less formal setting than a traditional chapter meeting. The food was great, the conversation was even better, and I think everyone had a great time. Here are a few pics from the event.
A recent Baker & McKenzie blog (“What To Do When Your Board Goes Global,” available in the NASPP’s Global Stock Plans portal), focuses on an accelerating trend – that of company boards of directors becoming more and more globally diversified. “We are seeing an accelerating trend among U.S. companies to add non-U.S. residents to their Board of Directors. This makes sense: as more and more companies “go global” and expand in ever more countries, their Boards should reflect the global nature of the company.” While it may be a positive that companies are comprising their boards of more globally diverse members, there are things to know.
Areas of Key Consideration
Taxation can get complex. To ensure proper withholding occurs, companies need to verify the director’s tax status relative to the US. Are they a US citizen or permanent resident? Did they reside in the US for 183 or more days per year? These questions are essential in determining US tax withholding requirements. Additionally, companies will also need to assess and determine whether an exemption from US tax withholding exists based on a treaty with the director’s home country.
Even if there is no complex US withholding required beyond a flat rate of 30%, the director may be subject to withholding taxes in his/her home country. Canada is one such country where this is a distinct possibility.
Companies need to determine whether any income/tax reporting needs to occur at the US state level where the non-US director performed services.
Careful attention should be given to analyzing regulatory exemptions in the home country that may be available. While some exemptions may apply to employees, those same exemptions may or may not be available to non-employees, including non-employee directors. It’s important not to outright assume that if employees qualify for an exemption that non-US directors will qualify too.
The Baker & McKenzie blog suggests thoroughly vetting tax and regulatory requirements that apply to non-US directors in each jurisdiction, similar to the practices many companies undertake in vetting requirements that are applicable to employees. Additionally, such analysis should be ideally conducted on an annual basis to capture changes to tax and regulatory requirements, as well as board demographics.
