The NASPP Blog

December 1, 2008

Excess Tax Withholding

With the 2nd Annual NASPP Webcast on Tax Reporting coming up next week, I thought I’d blog about a question that comes up quite frequently here at the NASPP: for stock plan transactions, can companies withhold federal income taxes at a rate that is more than 25%?

Generally, for all stock plan transactions that are subject to withholding in the United States and where the employee has received less than $1 million in supplemental payments for the calendar year, the company has two choices for withholding federal income tax:

  1. The flat rate applicable to supplemental payments (currently 25%), or
  2. The W-4 rate (this is the rate that is applied to the employee’s regular salary).

Where an employee has received more than $1 million in supplemental payments, the company must withhold federal income taxes at the maximum individual tax rate, which is currently 35%.

Where the 35% rate isn’t mandated, virtually all companies apply the flat rate to stock plan transactions. This is because figuring out the W-4 rate is prohibitively difficult; you have to aggregate the income from the stock plan transaction with the employee’s other income for the period and then there’s some ridiculously complicated formula for determining the tax rate.

The withholding collected at the time of the transaction is just an estimate of the employee’s tax liability for the stock plan transaction.  For some employees, 25% withholding is too high; these employees receive a refund when they file their tax returns at the end of the year.  For other employees, however, 25% isn’t enough withholding.  These employees will end up owing extra taxes to the IRS when they file their tax return. This is a problem for several reasons:

  1. No one likes to write a big check to the IRS when they file their tax return.
  2. Some employees won’t realize that the taxes withheld are insufficient, are in for an unpleasant surprise when they complete their tax return, and, worse, may not have the funds to cover the additional tax payment necessary.
  3. Sometimes additional tax penalties can apply if an employee’s withholding for the year is too low.  If employees’ withholding is less than 90% of their tax liability AND if it is less than their tax liability on the previous year’s tax return, then they may be subject to underwithholding penalties.

To mitigate these concerns, companies sometimes want to withhold additional federal income taxes on stock plan transactions.

From an accounting standpoint, the first thing to bear in mind is that allowing employees to tender shares back to the company (i.e., share withholding) for tax payments in excess of the minimum statutorily required withholding triggers liability accounting under FAS 123(R).  I don’t know of any companies that are willing to take on liability accounting to save their employees from a tax hit when they file their tax returns, so this pretty much settles the matter at least as far as share withholding goes.  But liability accounting only applies for share withholding; it won’t apply if the excess tax payment is made in cash by the employee or if the employee sells shares on the open market to cover the excess payment.

Which, brings us to the bigger question–is the excess payment allowed under the tax code? I think the simple answer to this question is no, but it’s a little more complicated than just a simple answer.  I’m already stretching the boundaries of what is a reasonable blog length, so next week I will finish this topic up with a discussion of what the IRS says about this and what the penalties might be for non-compliance.

See the NASPP’s fabulous Tax Withholding and Reporting Portal for more information on tax withholding requirements for stock compensation.

Reason #4 to Renew Your NASPP Membership:  Our January 29 Webcast on The Dark Side of Option Exchanges 

I know many of our members’ companies have experienced a decline in their stock price and are facing large numbers of underwater options.  The good news is that under 123(R) repricing is not nearly as costly as it was under APB 25; the bad news is that repricing is still an extremely complicated undertaking.  For most of you, you’ll only have one shot to get it right; repricing the same options twice probably isn’t a viable strategy for most companies.  The risks here are considerable; I recently spoke with a stock plan administrator at a company that implemented a repricing–with all the requisite employee communication, SEC filings, tedious and painful accounting, and other significant administrative overhead–only to see their stock price continue to decline by another 50% (and still dropping).  All that work and nothing to show for it.  So if your company is contemplating a repricing, make sure you head into it with your eyes open.  Just announced, our webcast on January 29, The Dark Side of Option Exchanges, will cover everything you need to know about repricings and other option exchange programs.  You do not want to undertake any action to address underwater options without this information. But if your NASPP membership is expired, you won’t be able to listen to the webcast–renew today to make sure you can access this critical program.

2nd Annual NASPP Webcast on Tax Reporting

On December 9, Robyn Shutak, the NASPP’s Education Director, and I will present our annual webcast on tax reporting, where we answer the tax-related questions you’ve been asking all year long in the NASPP discussion forum.  Former employees, consultants, outside directors, death, divorce…we’re going to cover it all, complete with sample Forms W-2 and 1099.  If you have any questions you’d like to make sure we cover, feel free to email them to me.

Key Deadlines

This Friday marks a couple of key deadlines here at the NASPP:

NASPP “To Do” List

We have so much going on here at the NASPP, it can be hard to keep track of it all, so I’m going to keep an ongoing “to do” list for you here in my blogs.

– Barbara