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.
For today’s blog entry, I have the results of the NASPP’s Quick Survey on ASC 718, presented in a nifty interactive infographic (place your cursor over a section of each chart to see its label). (Click here if you don’t see the graphic below.)
BTW—if you are one of the 83% of respondents that haven’t yet figured out the impact of the tax accounting changes to your earnings per share, see my blog entry “Run Your Own Numbers,” for easy-peasy instructions on how most companies can figure this out in just 5 minutes. It’s a great opportunity to demonstrate your knowledge and value to your accounting/finance team.
It’s that time of the year when attention begins to focus on year-end tax reporting. Sometimes when it comes to tax reporting, the devil is in the details – there are many nuances that need to be monitored and addressed to ensure proper compliance with the tax code. One of those is the IRS’s rule of administrative convenience, which allows companies to delay the collection of FICA taxes on certain transactions until a future date, on or before 12/31. In today’s blog, I’m going to dive into the inner-workings of this rule.
What is the Rule of Administrative Convenience?
The rule of administrative convenience allows FICA withholding for certain transactions to occur by 12/31 of the year of the triggering event. This means that companies can delay the mechanics of actually withholding FICA until the end of the year, when many employees may have already met their annual FICA limit. In this case, no additional FICA withholding for the original transaction would be necessary and the company is off the hook in terms of having to figure out how to collect FICA on the shares. However, if the employee hasn’t met their FICA limit as year end approaches, then an appropriate amount of FICA will still need to be withheld. This is the time of year when the stock plan administrator should evaluate the deferral of any FICA taxes under the Rule, and work with Payroll to ensure any necessary withholding occurs on or before 12/31. I should note that while the focus of most examples of this rule centers around the last possible date – 12/31 – to comply, companies can withhold the deferred FICA on any prior date as well. It’s just that for practical purposes, the “date” slated for collection is often near year-end, since that is a logical point in time when most employees who are going to max on on their FICA withholding for the year would be at that threshold, eliminating the need for any additional FICA withholding for the deferred event.
To What Types of Stock Compensation Does the Rule Apply?
The short answer is that the rule applies only to withholding of FICA on restricted stock units (RSUs). The long answer is below.
Both restricted stock units (RSAs) and restricted stock awards (RSUs) are subject to FICA taxes once the risk of forfeiture no longer exists (this usually occurs at vesting, but could occur be at the time of retirement eligibility – even if unvested). If the shares are not released to the employee at that time (let’s say that vesting will occur in the future, after the retirement eligible date, even though the risk of forfeiture no longer exists), then selling or withholding shares to pay for the FICA withholding is not an option. In these situations, the company must figure out how to withhold FICA (and other) taxes.
RSUs are considered to be a form of non-qualified deferred compensation and, therefore are taxed under a different section of the tax code than restricted stock and non-qualified stock options. This makes them eligible to rely on the Rule of Administrative Convenience.
RSAs are subject to tax under Section 83 of the tax code. As a result, both income taxes and FICA are due when the award is no longer subject to a substantial risk of forfeiture. This also means that the rule of administrative convenience is not available for this type of award.
ESPP and incentive stock option transactions are not subject to withholding or to FICA taxes, so the rule of administrative convenience also does not apply to shares acquired under these instruments.
Using the Rule, What FMV is Used to Calculate FICA?
“The rule of administrative convenience permits an employer to use any date, on or after the award vests (becomes nonforfeitable) but prior to the end of the year, to take the value of the award into account for FICA purposes. This rule of administrative convenience, for example, would allow an employer until December 31st as the date for all employees who vest during the course of the year. Bear in mind that the “taken into account” date will have the benefit, or detriment, of earnings/losses on the award that has become, effectively, deferred compensation. This is because under the nonduplication rule of FICA taxation, once compensation is taken into wages for FICA, further earnings/gains are not treated as FICA wages.”
More on Tax Reporting
Tax reporting can be tricky. The good news is that the NASPP’s upcoming Annual Tax Reporting Webcast will be on December 1st at 4pm eastern time. Mark your calendars! The webcast is free to NASPP members; non-members can contact naspp@naspp.com for information on how to access the webcast. We’ve got a Sneak Peek of the webcast available now in our latest podcast episode.
The Social Security Administration has announced that the maximum wages subject to Social Security will remain at $118,500 for 2016. The rate will remain at 6.2% (changing the tax rate requires an act of Congress, literally), so the maximum Social Security withholding for the year will remain at $7,347.
As noted in the SSA’s press release, increases in the Social Security wage cap are tied to the increase in inflation as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers. The Bureau of Labor Statistics found no increase in inflation over the past year based on this index, so there are no cost of living adjustments to Social Security benefits or the wage cap.
For those of you keeping score, the last time the Social Security wage base remained the same for a two years in a row was 2010 to 2011 (see “Social Security Wage Base Will Not Increase for 2011“), but in that year the Social Security tax rate was temporarily reduced.
A few other things that currently are not scheduled to change for next year:
The Medicare tax rates remain the same and there’s still no cap on Medicare. The wage threshold at which the additional Medicare tax must be withheld is still $200,000.
The flat supplemental rate is still 25% and the maximum individual tax rate is still 39.6%.
The threshold at which supplemental wages become subject to withholding at the maximum individual tax rate is still $1,000,000.
The compensation threshold at which an employee is considered highly compensated for purposes of Section 423 will remain $120,000.
Note that all of the above items can be changed by Congress and Congress has been known to sometimes make changes to next year’s tax rates very late in the year (e.g., see the 2011 alert noted above). But as things stand now, you have one less thing to worry about on your year-end checklist (but don’t forget that you still need to reset year-to-date wages/withholding back to $0 after December 31).
We’re into fall already, and before we know it the end of the year will be upon us. This upcoming period of time is a busy one for stock administration professionals. In the mix of activity that tends to spike in the month of December is that of charitable giving and gifts. In today’s blog I’ll cover some reminders about ensuring proper tax reporting and securities law compliance for stock related donations.
My inspiration for this blog actually came from a Fortune magazine article about John Mackey, co-CEO and co-founder of Whole Foods. Only a single sentence in the entire article mentioned stock options. In talking about Mackey’s $1 per year salary, the article also mentioned that “The company donates stock options Mackey would have received to one of its foundations.” As I started thinking about how that transaction would be handled on the company side, I realized that it’s been a while since we talked about gifts and donations.
This is honestly a topic that could command a lot of written coverage. The intricacies of gifting stock can be complex from several angles. In the interest of space, I’ll focus on a few areas that touch stock administration.
Timing of Donation to Charity: For tax purposes, the IRS considers the charitable donation to be complete on the date it is received by the charity – not the date it was requested, not the date the company approved the transfer. This is something to be mindful of the closer the request is made to December 31st. If the donor personally delivers a stock certificate with all necessary endorsements to the charitable recipient, the gift is complete for federal income tax purposes on the day of delivery. If the shares are being transferred electronically to the charity, then the transfer is complete when the shares are received into the charity’s account. It’s not enough to have made a transfer request to a broker. This timing can be important to companies who are tracking dispositions of ESPP shares and ISOs. For dispositions due to charitable donations occurring near December 31st, it’s best to verify the date the shares were actually received by the charity in order to apply the disposition to the proper tax year.
Donations of shares acquired through an ESPP or Incentive Stock Option (ISO) exercise: There are some tricky nuances around taxation on the participant side that hopefully will have been discussed with their tax advisor. What stock administrators need to know is that in tracking dispositions of ESPP and ISO shares, a disposition is a disposition – even a charitable one. That means for purposes of tracking qualified vs. disqualified dispositions, the same rules apply to charitable donations of the shares. See the above section on “Timing of Donation to Charity” to ensure tax reporting in the proper year.
Rule 144 Considerations: Rule 144 is concerned with the sale of control securities, not their gratuitous transfer, so the subsequent sale of the stock by a charity, not the actual gift of the shares to the charity, would be subject to the restrictions of Rule 144, if it is applicable. The charity must follow Rule 144 if it has a control relationship with the issuing company. Those wanting more detail on Rule 144 and gift requirements can read the March-April 2013 issue of The Corporate Counsel.
In summary, if an affiliate gifts stock to a non-affiliate that was originally acquired by the affiliate in the open market (i.e., not restricted in the affiliate’s hands), since the securities were not subject to a holding period requirement in the affiliate donor’s hand, SEC staff has stated that the donee need not comply with the Rule 144(d) holding period requirement for its sales of the securities. Moreover, the Staff notes that if the donee is not an affiliate and has not been an affiliate during the preceding three months, then the donee is free to resell the securities under Rule 144(b)(1) “subject only to the current public information requirement in Rule 144(c)(1), as applicable.”
“The one-year cut off for the application of the current public information requirement to donees does run from the donor’s original acquisition. Good news—but don’t forget that the six-month “tail,” adopted in 2007 (which requires donors to aggregate with their donees’ sales) runs from the date of the gift.” The “tail” mentioned in the article applies to the donor, who must aggregate his/her sales of stock with those of the donee for purposes of complying with the Rule 144 volume limitation. This requirement applies for six months after the gift (12 months where the issuer is not a reporting company or is not current in its Exchange Act reporting).
If you are not a subscriber to The Corporate Counsel (or have not yet renewed) you can gain immediate access online to sample gift compliance letters by taking advantage of the no-risk trial. (Almost all of our member companies and law firms are long-term subscribers to The Corporate Counsel.)
In case you were wondering (in your spare time), the IRS now has a techniques guide for auditing equity compensation. The “guide” is actually an instruction to internal IRS auditors on how to evaluate equity compensation during an “examination” (fancy word for “audit”). The guide, published in August 2015, is available on the IRS web site. I’ll try to summarize some of the more interesting points in today’s blog.
The Angles of Audit
Before I dive into what the guide says, I want to cover a thought that came to me as I was reading the guide. Stock Plan Administrators and their vendors are focused on tax compliance relative to the company’s corporate tax obligations (reporting, withholding, etc.). However, it’s important to remember that as compliant as we may be from a issuer standpoint, there is still audit exposure potential from the individual angle of tax compliance. An employee may get audited, even if the company is not being audited. The company’s documentation may be requested from the IRS as part of that audit. It’s important that issuers are aware that there are a variety of audit angles that could attract attention to their equity compensation record-keeping and disclosures at any given time, and the IRS guide seems to support that thought – providing detailed information on the types of transactions and potential tax issues that could arise. With that detail comes guidance on how to source documents attached to equity compensation. According to a blog dedicated to explaining the guide by Porter Wright Morris & Arthur LLP,
“Interestingly, the Guide devotes a fair amount of detail to explaining where auditors may find these documents, encouraging them to review Securities and Exchange Commission (“SEC”) filings as well as internal documents. As such, the Guide serves as an important reminder to employers to be mindful that the IRS (or other third parties) someday could seek to review their corporate documents. ”
Documents Galore
Let’s cut to the chase. Where are auditors instructed to look?
SEC documents – This is an obvious one, but it’s where the IRS recommends their auditors start. Disclosures such as the 10K (Form 10-K), proxy statement (DEF 14A) and Section 16 reports of changes in beneficial ownership (Form 4) are places to identify types of plans and awards, as well as detailed compensation data for named executive officers and directors. The IRS recommends comparing data from these disclosures to individual Form W-2s and 1099-MISCs to verify proper tax withholding and reporting. If discrepancies surface, the IRS recommends expanding the audit (yikes).
Internal Documents – Types of internal documents subject to scrutiny include employment contracts, and meeting minutes from Board of Director and Compensation Committee meetings.
The Porter et al blog summarized this into some key awareness factors for employers:
“Employers should be aware of these instructions. Often times, it is easy for someone to prepare internal documents using jargon or short-hand that is familiar among people at the company but that may be difficult to explain to a third party or worse could be misleading. The Guide demonstrates that internal documents may not be restricted to internal personnel. Instead, the IRS very well could review these internal documents. As such, employees and advisers who prepare these documents should be mindful of both the information contained in the documents and how they present that information.”
Takeaways
When preparing documentation or disclosures (including supporting documents for those disclosures), it’s good to look at the process as if a third party will eventually come in and evaluate the information. The Porter blog made a great point – often times records are maintained in manner that internal parties may easily understand, or there’s someone on hand who can “interpret” that scrawl made by a board member. However, once that information is subject to review by an auditor, questions can arise. Companies should be aware of the IRS audit instructions relatives to equity compensation and maintain their records in a way that will make it easy to explain if audited.
A riddle: what do the Trade Adjustment Assistance Program, the African Growth and Opportunity Act, and HOPE for Haiti have to do with Forms 3921 and 3922? You might think “not much” but then you aren’t a member of Congress. The Trade Preferences Extension Act, which includes provisions relating to those three things and a couple of other global trade-related items, also increases the penalties for failure to file Forms W-2 and forms in the 1099 series, which includes Forms 3921 and 3922 (why forms 3921 and 3922 are considered part of the “1099” series is another riddle for another day).
The New Penalties
Timing of Correct Filing
New Penalty (Per Failure)
New Annual Cap
Old Penalty (Per Failure)
Old Annual Cap
Within 30 days
$50
$500,000
$30
$250,000
By Aug 1
$100
$1,500,000
$60
$500,000
After Aug 1 or never
$250
$3,000,000
$100
$1,500,000
With intentional disregard,
regardless of timing
Min. of $500
uncapped
Min. of $250
uncapped
Make That a Double
The penalties apply separately for returns filed with the IRS and the statements furnished to employees. If a company fails to do both, both the per-failure penalty and the cap is doubled. Thus, if both the return and the employee statement are corrected/filed/furnished after Aug 1, that’s a total penalty of $500, up to a maximum of $6,000,000. If intentional disregard is involved, that’s a minimum total penalty of $1,000 (and this amount could be higher) with no annual maximum.
Effective Date
The new penalties will be effective for returns and statements required after December 31, 2015, so these penalties will be in effect for 2015 forms that are filed/furnished early next year.
Penalties At Least As Interesting As the Trade Provisions?
Interestingly, when I Googled “Trade Preferences Extension Act,” so I could figure out what the rest of the act was about, the first page of search results included as many articles about the new penalties as about the trade-related provisions of the act.
If you want to know what the rest of the act is about, here is a summary from the White House Blog. There’s not a lot more to say about the penalties but if you want to spend some time reading about them anyway, here are summaries from Groom Law Group and PwC.
Last week, I covered the basic rules that apply for tax purposes when options are exercised or awards pay out after an individual has changed status from employee to non-employee or vice versa. Today I discuss a few more questions related to employment status changes.
Is it necessary that the consulting services be substantive?
When employees change to consultant status an important consideration is whether the consulting services are truly substantive. Sometimes the “consulting services” former employees are providing are a little (or a lot) loosey goosey (to use a technical term). For example, sometimes employees are allowed to continue vesting in exchange for simply being available to answer questions or for not working for a competitor. It this case, it’s questionable whether the award is truly payment for consulting services.
A few questions to ask to assess the nature of the consulting services former employees are performing include whether the former employee has any actual deliverables, who is monitoring the former employee’s performance and how will this be tracked, and will the award be forfeited if the services are not performed.
If the services aren’t substantive, it’s likely that all of the compensation paid under the award would be attributable to services performed as an employee (even if vesting continues after the employee’s termination) and subject to withholding/Form W-2 reporting.
Is the treatment different for an executive who becomes a non-employee director?
Nope. The same basic rules that I discussed last week still apply. The only difference is that I think it’s safe to presume that the services performed as an outside director will be substantive (unless the director position is merely ceremonial).
What about an outside director who is hired on as an executive?
The same basic rules still apply, except in reverse. For options and awards that fully vested while the individual was an outside director, you would not need to withhold taxes and you would report the income on Form 1099-MISC, even if the option/award is settled after the individual’s hire date.
For options and awards granted prior to the individual’s hire date but that vest afterwards, you’d use the same income allocation method that I described last week. As I noted, there are several reasonable approaches to this allocation; make sure the approach you use is consistent with what you would do for an employee changing to consultant status.
What about a situation where we hire one of our consultants?
This often doesn’t come up in that situation, because a lot of companies don’t grant options or awards to consultants. But if the consultant had been granted an option or award, this would be handled in the same manner as an outside director that is hired (see the prior question).
What if several years have elapsed since the individual was an employee?
Still the same; the rules don’t change regardless of how much time has elapsed since the individual was an employee. The IRS doesn’t care how long it takes you to pay former employees; if the payment is for services they performed as employees, it is subject to withholding and has to be reported on a Form W-2.
So even if several years have elapsed since the change in status, you still have to assess how much of the option/award payout is attributable to services performed as an employee and withhold/report appropriately.
What if the individual is subject to tax outside the United States?
This is a question for your global stock plan advisors. The tax laws outside the United States that apply to non-employees can be very different than the laws that apply in the United States. Moreover, they can vary from country to country. Hopefully the change in status doesn’t also involve a change in tax jurisdiction; that situation is complexity squared.
Finally, When In Doubt
If you aren’t sure of the correct treatment, the conservative approach (in the United States—I really can’t address the non-US tax considerations) is probably going to be to treat the income as compensation for services performed as an employee (in other words, to withhold taxes and report it on Form W-2).
What is the US tax reg cite for all of this?
My understanding is that none of this is actually specified in the tax regs—not even the basic rules I reviewed last week. This is a practice that has developed over time based on what seems like a reasonable approach.
For today’s blog entry, I discuss how stock plan transactions are taxed when they occur after the award holder has changed employment status (either from employee to non-employee or vice versa). This is a question that I am asked quite frequently; often enough that I’d like to have a handy blog entry that I can point to that explains the answer.
The basic rule here is that the treatment is tied to the services that were performed to earn the compensation paid under the award. If the vesting in the award is attributable to services performed as an employee, the income paid under it is subject to withholding and reportable on Form W-2. Likewise, if vesting is attributable to services performed as a non-employee, the income is not subject to withholding and is reportable on Form 1099-MISC.
Where an award continues vesting after a change in status, the income recognized upon settlement (exercise of NQSOs or vest/payout of restricted stock/RSUs) is allocated based on the portion of the vesting period that elapsed prior to the change in status.
For example, say that an employee is granted an award of RSUs that vests in one year. After nine months, the employee changes to consultant status. The award is paid out at a value of $10,000 on the vest date. Because the change in status occurred after three-fourths of the vesting period had elapsed, 75% of the income, or $7,500, is subject to tax withholding and is reportable on the employee’s Form W-2. The remaining $2,500 of income is not subject to withholding and is reportable on Form 1099-MISC.
What if the award is fully vested at the time of the change in status?
In this case, the tax treatment doesn’t change; it is based on the award holder’s status when the award vested. For example, say an employee fully vests in a award and then later terminates and becomes a consultant. Because the award fully vested while the individual was an employee, the award was earned entirely for services performed as an employee and all of the income realized upon settlement (exercise of NQSOs or vest/payout of restricted stock/RSUs) is subject to withholding and is reportable on Form W-2.
This is true no matter how long (days, months, years) elapse before the settlement. Under Treas. Reg. §31.3401(a)-1(a)(5), payments for services performed while an employee are considered wages (and are subject to withholding, etc.) regardless of whether or not the employment relationship exists at the time the payments are made.
What is the precise formula used to allocate the income?
There isn’t a precise formula for this. We asked Stephen Tackney, Deputy Associate Chief Counsel of the IRS, about this at the NASPP Conference a couple of years ago. He thought that any reasonable method would be acceptable, provided the company applies it consistently.
The example I used above is straight-forward; awards with incremental vesting are trickier. For example, say an employee is granted an NQSO that vests in three annual installments. 15 months later, the employee changes to consultant status.
The first vesting tranche is easy: that tranche fully vested while the individual was an employee, so when those shares are exercised, the entire gain is subject to withholding and reportable on Form W-2.
There’s some room for interpretation with respect to the second and third tranches, however. One approach is to treat each tranche as a separate award (this is akin to the accelerated attribution method under ASC 718). Under this approach, the second tranche is considered to vest over a 24-month period. The employee changed status 15 months into that 24-month period, so 62.5% (15 months divided by 24 months) of that tranche is attributable to services performed as an employee. If this tranche is exercised at a gain of $10,000, $6,250 is subject to withholding and reported on Form W-2. The remaining $3,750 is reported on Form 1099-MISC and is not subject to withholding. The same process applies to the third tranche, except that this tranche vests over a 36-month period, so only 41.7% of this tranche is attributable to services performed as an employee.
This is probably the most conservative approach; it is used in other areas of the tax regulation (e.g., mobile employees) and is also used in the accounting literature applicable to stock compensation. But it isn’t the only reasonable approach (just as there are other reasonable approaches when recording expense for awards under ASC 718) and it isn’t very practical for awards with monthly or quarterly vesting. It might also be reasonable to view each tranche as starting to vest only after the prior tranche has finished vesting. In this approach, each tranche in my example covers only 12 months of service. Again, the first tranche would be fully attributable to service as an employee. Only 25% of the second tranche would be attributable to services as an employee (three months divided by 12 months). And the third tranche would be fully attributable to services performed as a consultant.
These are just two approaches, there might be other approaches that are reasonable as well. Whatever approach you decide to use, be consistent about it (for both employees going to consultant status as well as consultants changing to employee status).
Read “Employment Status Changes, Part II” to learn about additional considerations and complexities relating to changes in employment status.