The practice of paying dividends (or dividend equivalents, in the case of units) on unvested awards has been declining since we first started tracking it in 2007. No one likes the practice, other than companies and the employees who benefit from it. Investors certainly aren’t a fan, FASB imposes some onerous accounting requirements on it, and even the IRS has taken issue with the practice. Now, ISS’s 2017 Equity Plan Scorecard deducts points for this.
What’s the Big Deal?
The main criticism of paying dividends on unvested awards is philosophical: if dividends are paid out before an award vests, employees have arguably received compensation they aren’t entitled to. And, if the awards are subsequently forfeited, no one makes the employees pay back the dividends; they are allowed to keep the dividends on shares that they ultimately didn’t earn. Here are a few of the consequences of this practice:
Implicates the dreaded two-class method of reporting earnings-per-share, something few people, if any, even understand (I’ll admit it—I am not one of the few) (see “Applying the Two-Class EPS Method to Share-Based Payments,” by KPMG)
When the awards are forfeited, any dividends paid prior to vesting that aren’t also forfeited are treated as compensation expense (normally, dividends do not increase the expense associated with an award)
If paid on performance awards, the dividends cannot be considered performance-based compensation for purposes of Section 162(m) unless they are subject to vesting contingent on performance goals (see “IRS Clarifies Treatment of Dividends Under Section 162(m)“)
ISS Gets into the Game
One of ISS’s changes to its 2017 Corporate Governance Policy is to add paying dividends on unvested awards to the Plan Features pillar of its Equity Plan Scorecard. Plans will receive full points for this test only if they prohibit paying dividends prior to vesting for all awards offered under the plan. If the plan is silent or includes the prohibition for some awards but not others, the plan receives no points for this test.
It is permissible for dividends to accrue on awards prior to vesting, so long as the dividends are still subject to forfeiture in the event that the underlying award is forfeited.
The Data
This handy interactive infographic shows how payment of dividends on unvested awards has declined since 2007 (click on the years to see the data change):
Perhaps one day, paying dividends on unvested awards will go the way of reloads and pyramid exercises: mythic transactions rarely, if ever, seen in the wild.
– Barbara
* Data referenced in this blog, including the infographic, are from the Domestic Stock Plan Design Survey (years 2007, 2010, 2103, and 2016), co-sponsored by the NASPP and Deloitte Consulting LLP.
Here’s what’s happening at your local NASPP chapter this week:
Atlanta, KS/MO, Philadelphia, Nashville: The chapters host a joint webcast featuring Kerri McKenna and Robert Purser from PwC along with Thomas Swindle from UBS presenting “FASB Simplification of Stock Compensation Accounting and Early Adopters Insights.” (Wednesday, November 30, 3:00 PM Eastern)
Twin Cities: The chapter hosts a double-session featuring Jason Jones and Chris Ansley from EY presenting “Changes to Statutory Withholding under ASU 2016-09 – Practical Considerations” and ” Issues to Consider with Equity Plans during Corporate Transactions.” (Thursday, December 1, 7:30 AM)
It will come as no surprise to any of you that accounting for modifications under ASC 718 is complicated. In the aftermath of the issuance of ASU 2016-09, the FASB has received a number of questions about whether amending a stock plan or award to allow shares to be withheld for more than the minimum statutorily required tax payment would trigger modification accounting under ASC 718. It probably seems crazy to you that we even have to consider this question and I guess it also seemed that way to the FASB, because they’ve issued an exposure draft to amend ASC 718 to clarify that this sort of change isn’t a modification.
ASC 718 currently says that any change whatsoever to an award is considered an modification and goes on to define four types of modifications: probable-to-probable, probable-to-improbable, improbable-to-probable, and improbable-to-improbable. The accounting treatment varies based on which type of modification you are dealing with and for some types of modifications, a new valuation of the award is required even if the value of the award isn’t changed as a result of the modification. Hence, the concern about the amendments relating to share withholding, even though these amendments arguably don’t materially increase the value of an award to the award holder.
So the FASB has proposed an amendment to ASC 718 that would clarify that not every change to the terms and conditions of an award requires modification treatment. Instead, a change to the terms and conditions of an award would require modification treatment only if at least one of the following conditions is met:
The fair value of the award is changed as a result of the amendment. For purposes of determining if there is a change in fair value, the fair value of the award immediately following the amendment would be compared to the fair value immediately beforehand (rather than to the grant date fair value). Generally, there would be no change in fair value if the amendment does not impact any of the inputs necessary to determine the award fair value.
The amendment modifies the vesting conditions of the award.
The amendment causes the classification of the award to change (from equity to liability or vice versa).
Amending a plan or award to allow additional shares to be withhold for taxes would not meet any of the about conditions (provided the share withholding is still limited to the maximum individual tax rate in the applicable jurisdiction) and, thus, under the proposed amendment, there would be no question that this is a modification. Even without the proposed amendment to ASC 718, I believe that many practitioners would not treat this as a modification.
Comments may be submitted on the exposure draft until January 6, 2017. The update would be applied prospectively only, thus the accounting treatment for any prior modifications of awards would not change. The exposure draft does not specify an effective date.
Last week, just a few days after election day, I blogged (“Post Election: Things to Watch Part 1,” November 11, 2016) about a couple of things to watch in the coming months post-election, namely possible changes to tax rates and the likely reintroduction of some variation of the Financial Choice Act. Since then, the blog-sphere has been electrified with commentary and comments on these topics, as well as a few new ones. Keep reading to find out how the conversation has evolved over the last week.
It turns out I am not alone in trying to figure out how a Trump presidency and Republican-dominated Congress will impact stock compensation. I’ve expanded our list of things to watch in 2017.
SEC. 631. CONGRESSIONAL REVIEW. If the agency classified a rule as “major,” according to specified criteria, the rule would require a joint resolution of Congress to go into effect, unless the President finds that an emergency requires that it be effective (for 90 days). Congress would also have the right to disapprove certain non-major rules.
Romanek says “Read that provision again. A joint Congressional resolution to adopt a “major” rule – and even some non-major ones! It’s goal appears to be neutering the so-called “independent” federal agencies that govern our financial institutions & markets. Talk about putting partisan politics into “independent” agencies. And here I was worried that having Congress involved in the SEC’s budget process was too much meddling with a federal agency!”
2. Tax changes could mean an increase in the value of equity compensation. A myStockOptions.com blog (“What a Trump Presidency and Tax Changes Could Mean for Stock Compensation” – November 14, 2016) explores the various tax rates that could change under Trump’s proposed tax plan. Tax rates to watch include the Federal rate on ordinary income, the additional Medicare tax introduced under Obamacare, the future of Alternative Minimum Tax, and how supplemental withholding rates play into the picture. What does not appear to be (currently) on the table are changes that would affect the capital gain rates. myStockOptions.com points out that:
“Given the enormous federal budget deficit, the likely need for 60 votes in the Senate to defeat a filibuster and pass a major tax overhaul, and Trump’s inexperience in the art of political compromise, there are no guarantees that these proposals will become law.”
Additionally, since it’s not highly likely that these tax proposals will come to fruition in time to take effect for the 2017 tax year, myStockOptions.com suggests that plan participants need not take a rushed approach to pulling in stock compensation transactions to 2016 (whew! hopefully that reduces the likelihood of a bunch of stock plan transactions over the holidays close to year-end).
“In the short term, with little risk of tax increases in 2017, there is no pressing tax-law reason to accelerate income into 2016. Even if you do predict that your tax rates are likely to drop or rise in the future, taxes should never be the only planning consideration for stock options and company stock at year-end. Instead, you may want to let investment objectives and personal financial needs, not tax considerations, drive your year-end planning.”
3. President-elect Trump is no stranger to stock compensation. Are you at all curious about whether or not Trump understands stock compensation? The staff at myStockOptions.com did an analysis of public filings to determine his past affiliations with stock plans. It turns out at least some of his companies have adopted stock plans, and he has personally been a recipient of stock options under at least one of those plans. For the complete analysis and commentary, check out “What a Trump Presidency and Tax Changes Could Mean for Stock Compensation” – myStockOptions.com, November 14, 2016).
If anything, 2017 promises to be a year of changes. When changes occurs, we often communicate about it by blog early on. To be notified about new information on topics such as these, be sure to subscribe to The NASPP Blog.
Lately, there’s been a lot of speculation about what a Trump presidency and a Republican Congress means for tax rates in 2017. I got nothin’ on that. But what I do have for you today are some tax changes for 2017 that are already finalized.
New Filing Deadlines
Where nonemployee compensation is reported in box 7 of Form 1099-MISC, the deadline to file the form with the IRS has been accelerated to January 31 (previously the deadline was February 28, for paper filers, and March 31, for electronic filers). This will apply to Forms 1099-MISC issued to report compensation paid to outside directors, consultants, independent contractors, and other nonemployees.
Form 1099-MISC is also used to report income recognized on (i) stock plan transactions after an employee’s death, and (ii) transactions by an employee’s ex-spouse for stock awards transferred pursuant to divorce. In each of these cases, however, the income is reported in box 3, rather than box 7. Consequently, a Form 1099-MISC for these transactions doesn’t need to be filed until the regular February 28/March 31 deadline. (Assuming, of course, no other income is reported in box 7 of the form. For instance, if an employee’s ex-spouse provided services to the company as a consultant in 2016 in addition to exercising a stock option transferred to him in their divorce settlement, and the income for the consulting fees is reported in box 7 along with the option gain in box 3, the Form 1099-MISC would have to be filed with the IRS by January 31. And if the employee died in 2016 and hadn’t updated her beneficiary designation so her RSUs were paid out to the ex-spouse in addition to the consulting fees and the option gain…well, you get the idea.)
The deadline to file Form W-2 with the Social Security Administration has also been accelerated to January 31. These changes were part of the Protecting Americans from Tax Hikes Act and are intended to help prevent tax fraud. In the past, individual taxpayers received their copy of these forms before the IRS and could have even filed their tax return before the IRS received their Form W-2 or 1099-MISC. This could result in errors (inadvertent or intentional) that the IRS wasn’t able to catch until possibly as late as April, when the company filed these forms with the SSA/IRS. By then, a refund might have been issued to the taxpayer and the IRS was in the difficult position of trying to recover it. With the accelerated filing deadlines, the IRS will theoretically be able to catch these errors before refunds are issued.
The deadline for filing Forms 3921 and 3922 with the IRS is still February 28/March 31. Also, the deadline to distribute the employee copy of all of these forms is still January 31.
COLAs
The cost-of-living adjustments for 2017 have also been announced. Here are the highlights that related to stock compensation:
The wage base for Social Security is increasing to $127,200 (up from $118,500 in 2016). The Social Security tax rate isn’t changing (that requires Congressional action), so if I’ve done the math right (something you should never take for granted—math just isn’t my gig), the maximum withholding for Social Security will be $7,886.40 in 2017.
No changes to the Medicare rates or the threshold at which the higher rate kicks in, at least for now. Changing either of these things also requires Congressional action; while it’s certainly possible that a repeal or amendment of Obamacare might result in changes to Medicare tax rates or thresholds in 2017, it’s unlikely that either will change before the new administration begins.
The level of annual compensation at which employees can be considered highly compensated for purposes of excluding them from participating in a Section 423 ESPP will remain $120,000.
Here’s what’s happening at your local NASPP chapter this week:
Connecticut: Lenka Haase of E*TRADE Financial presents “Year End Procedures—How Your Equity Vendor Can Help You!” (Tuesday, November 15, 10:00 AM)
Ohio: Daniel Dunn and Lenka Haase of E*TRADE Financial present “Year End Procedures—How Your Equity Vendor Can Help You!” (Wednesday, November 16, 9:00 AM)
Carolinas: Paul Bailey from Red Hat presents “ASC 718 in Motion: The FASB’s Amendments.” (Thursday, November 17, 11:30 AM)
NY/NJ: Stephen Giove of Shearman & Sterling and Christine Cognetti McCasland of Morgan Stanley present “Hot Topics for Public Companies.” (Thursday, November 17, 8:30 AM)
Election season is over and with the a Republican president and majority in Congress, new questions are emerging about what changes may occur in the coming year. Are you wondering how a new administration may impact stock compensation? Read more in today’s blog to find out.
Repeal of Dodd-Frank?
The day after the election, Cydney Posner of Cooley posted a blog (“Undo Dodd-Frank?” – November 9, 2016) that explored the possibility that certain aspects of Dodd-Frank could be on the table for repeal when the new government is in session/post inauguration. Keep an eye out for a variation of the Financial Choice Act to find its way back to Congress. Posner describes the Act as:
“The bill, sponsored by Jeb Hensarling, Chair of the House Financial Services Committee, was framed as a Republican proposal to reform the financial regulatory system necessary to undo the burdens of Dodd-Frank, which were characterized as a distraction from the SEC’s basic statutory responsibilities. In addition to taking aim at much of Dodd-Frank, among other things, the bill places a heavier burden on proxy advisory firms, regulators and regulations generally and eases some other regulations. Although the bill was never expected to make much progress this year, the NYT suggested that the bill may “help shape the Republican agenda in the next term.” The bill’s chances of becoming law have, well,… to say that they have substantially improved doesn’t quite do the situation justice.”
Aspects of the bill that may impact stock compensation include repeal of the CEO pay ratio disclosure rules, which are not even implemented yet. It’s unclear where this bill will go or how it may be re-introduced, but it certainly is something to keep on the radar.
Tax Rates
President-elect Trump made tax reform a cornerstone of his campaign platform, and his tax plan identified several changes, one of which was a reduction of the top Federal tax rate from 39.6% to 33%. Republican members of Congress also have drafted similar proposals. Most information that I’ve come across in the days post election suggests that tax reforms is not an “if” what rather a “when” and “what” scenario, with good potential for the changes to be significant. What that means in terms of the details is to be determined, but change is likely.
Congress doesn’t reconvene until early January 2017, and Inauguration Day is January 20, 2017, so nothing will happen before then. But I expect it won’t be long after that before we start seeing some of the details around these scenarios to begin to take shape.
It’s not often that the worlds of professional sports and equity compensation intersect. True, I have a Google alert set up for “stock options” that sometimes returns articles about how the stock of football players impacts their career options (as in “Joe Schmo played really well in the last game; his stock is really rising”), but that’s not what I’m referring to. I’m talking about domestic mobility. While we are struggling with how compensation is taxed when employees travel from one state to another, this is an issue that professional sports has been dealing with for a long time now.
Here are a few concepts discussed in the articles that are applicable to equity compensation:
1. If the employee is a resident in a state that has income tax, 100% of the employee’s compensation, including any gains on stock options or awards, is generally taxable in that state. This is true even if the compensation is also taxable in another state.
2. Generally, compensation earned for work performed in another state (that has income tax) is also taxed in that state. For example, when your favorite non-Californian athletes play in California, they have to pay California state income tax on the portion of their compensation attributable to those games. In the context of stock compensation, this could apply to employees on assignment in another state, employees in remote locations that regularly travel to headquarters, employees in any location that travel to other states for work, employees that live in one state and commute to another for work, and a host of other situations.
3. The amount of income attributable to the employee’s non-resident state is generally determined by dividing the days worked in that state, referred to as “duty days,” by the total days over which the compensation is earned. In the context of stock compensation, the period over which the compensation is earned is most likely the vesting schedule.
4. Employees may be able to claim a credit in their state of residence for taxes paid in other states. Unlike a tax deduction, which reduces the income subject to tax, a credit is applied to the employee’s ultimate tax liability.
I’ve used the words “generally,” “typically,” and “most likely” a lot in this blog entry. It’s not that I have a fear of commitment, it’s that there are fifty states and they all write their own tax laws. As with anything that is legislated at the state level, the laws can, and do, differ by state.
Here’s what’s happening at your local NASPP chapter this week:
Chicago: Emily Cervino of Fidelity Stock Plan Services and PJ Gabel of Aon Hewitt present “Hot Topics in Equity Compensation.” (Tuesday, November 8, 7:30 a.m.)
Wisconsin: Emily Cervino of Fidelity Stock Plan Services presents “Turning Up the Heat with Hot Topics in Equity Compensation.” (Tuesday, November 8, 11:45 a.m.)
Nashville: Nathan O’Connor and Josh Schaeffer of Equity Methods present “2016 State of the Union—A World Tour of Equity Compensation.” (Wednesday, November 9, 7:30 a.m.)
Twin Cities: Emily Cervino of Fidelity Stock Plan Services continues her tour of the Midwest NASPP chapters with “Hot Topics in Equity Compensation.” (Wednesday, November 9, 7:30 a.m.)
Los Angeles: Luncheon meeting sponsored by E*TRADE and hosted by Activision! Join Gustavo Dalanhese and Lenka Haase of E*TRADE Financial Corporate Services as they present “Managing Fixed Processes in a Changing Environment.” (Thursday, November 10, 11:30 a.m.)
Michigan: CJ Van Ostenbridge and Dan Kapinos of Radford present “Pay Versus Performance: SEC Proposed Disclosure Rules.” (Thursday, November 10, 8:30 a.m.)