In recent weeks I’ve blogged about some of the communication aspects of the upcoming CEO Pay Ratio disclosure (see Part I and Part II). As we close out the year, I couldn’t help but post one more blog on the disclosure (hopefully the last one for a while on this topic) but this time to step away from communications and focus on a silver lining.
Peter Kimball from Institutional Shareholder Services’ (ISS’) Corporate Solutions reminded me (via presentation at our DC/VA/MD chapter meeting) that both ISS and Glass Lewis have effectively stated publicly that CEO Pay Ratio disclosure will not impact either firm’s voting recommendations for the 2018 proxy season. It appears that both firms will collect the pay ratio data (the ratio of the CEO’s pay to that of the median employee) from proxy statements, but won’t be using that data as a factor in evaluating proxy proposals. At least that’s one thing companies won’t have to worry about this proxy season, particularly those that will find out that their pay ratios out of whack compared to those of peer companies. In fact, it’s possible that the pay ratio disclosure won’t be a factor at all – even in subsequent years, as both firms have effectively said they really don’t care about the median employee pay relative to CEO pay for their purposes.
Things to Watch in 2018
Looking forward to things to keep an eye on in 2018 and beyond from a shareholder interest perspective are:
Gender pay gap disclosure: Shareholders are increasingly interested in understanding whether a gender pay gap exists at a company and if so, the details of the gap and action plan to bridge it. In the U.K. this is now a required disclosure for companies with more than 250 employees, and the disclosure does include stock compensation. Will the U.S. follow suit? ISS reports an increase in shareholder resolutions requesting such information, and Kimball suggests it is something to have on the radar.
Board Compensation: ISS is taking increased interest in board compensation for companies that have consistently been overcompensating board members with little or no transparent/justifiable explanation. This will be an area of interest in 2018 for the firm. It appears that their increased attention won’t affect most companies, but those who have unusual or large board packages relative to peer companies should take note and be prepared to explain their such practices.
It seems there’s always something on the horizon, and plenty to keep an eye on in 2018.
I’m terrible at math. Really, really bad at it. Like the Justin Timberlake character in the movie Friends with Benefits bad. So, for most of my career here at the NASPP, posting the alert about the yearly change to the maximum wages subject to Social Security has been a challenge, because it requires me to multiply the maximum wages by 6.2% to figure out the maximum withholding. Easy enough for most people, but in a lot of years I get it wrong.
So I’ve implemented some controls. Always copy the maximum wage base from the SSA press release; never type it. Instead of using a calculator (not as reliable as you might think, due to human error typing in the numbers or transcribing them), always do the math in Excel and always copy the result from Excel to the alert. And have someone else check my work, even though that person usually thinks I’m nuts for needing help with this. And then I check it a bunch more times myself (because it turns out that a lot of people are bad at math).
But this year, dammit, I got it right. I wrote a blog about it and posted the alert and no one emailed to tell me I had it wrong.
And then…
The SSA announced that they were changing the maximum. Yep, on November 27, the SSA issued a press release announcing that the maximum wage base for 2018 that they had originally reported ($128,700) is wrong and that the correct wage base for 2018 is $128,400. So the maximum Social Security withholding for 2018 is $7,960.80 (pretty sure, but feel free to check my math).
The SSA says the reason for the change is updated wage data:
This lower taxable maximum amount is due to corrected W2s provided to Social Security in late October 2017 by a national payroll service provider. Approximately 500,000 corrections for W2s from 2016 resulted in changes for three items based on the national average wage: the 2018 taxable maximum, primary insurance amount bend points–figures used in the computation of Social Security benefits–and family maximum bend points. No other items based on national average wages were affected.
But, I don’t know. Sure, it’s a believable story, but I think maybe the SSA is just as bad at math as I am. Just kidding. I really have no reason to doubt their explanation, although I am a little surprised that just half a million corrections can move the wage base by $300. With over 123 million employees in the United States in 2016 (and that doesn’t even count part-timers), that must have been quite an error.
Many of us in stock compensation do our best (either formally or informally) to avoid deep dive conversations with stock plan participants around “year end” logistics. The logistics I refer to mostly center on the dreaded concept of tax and/or financial planning. Fearful of meandering into the realm of giving financial or tax “advice,” the policy among stock administrators is quite often to be silent or provide limited information on those topics. Not surprisingly, this can result in a communication gap between the participant and the issuer – creating a void. Looking for ways to bridge that gap without putting on an adviser hat? I have some ideas.
Pre-Approve Communications that Include Details
For a while now, I’ve really liked the idea of a pre-approved FAQ. This is an FAQ that anticipates the most common questions participants are likely to ask (think lots of tax questions) and provides an answer that is approved by the company’s counsel and advisers. Getting ahead of the questions and answers allows time to craft a response that is likely to include some details that you may have been wary to discuss without first passing the question to advisers – something that can be time consuming and cause delays in communication when a question is asked on the spot. An advance FAQ is as simple as drafting a list of questions and answers, sending them to advisers to review, edit and approve, and then determining how to distribute these answers to employees. I’ve seen the entire FAQ distributed, and I’ve seen the FAQ answers used as piecemeal responses when someone asks a question. This approach can work well with year end questions, but can also work with other communications as well (think merger, large vesting event, ESPP offering/purchase, new equity roll out or new terms).
Third Party Resources
Another option in bridging the gap in participant year-end communications is to send employees to 3rd party resources for information. This seems like it would reduce the possibility of the administrator playing the role of potential adviser, and gives the participant more of what they seek. One website I often use when looking for participant oriented communications is myStockOptions.com. And, lucky for stock plan participants everywhere, they’ve recently updated their year-end planning information for 2017 (Top Ideas for Year-End Planning With Stock Compensation – Part 1). What I like about this resource is that it gives a detailed lay-of-the land about the current and prospective tax landscape, as relates to stock compensation. It takes that information and creates a series of considerations and recommendations around year end. Additionally, there are alerts, editor notes, and even a chart that shows how changes in income can push a participant to a different tax bracket. This article is free (other content on the site is premium).
Finally, your own advisers likely work with many clients who offer stock compensation. It’s also worth an inquiry to find out if these advisers have prepared any communications of their own that may be participant friendly in addressing year-end questions.
The year will be over soon, and some of your participants are already contemplating whether they need to take any action with stock compensation before year-end, and mulling over the tax considerations. It’s time to arm them with as much information as possible.
The Senate passed its version of the Tax Cuts and Jobs Act late Friday night (well, technically, it was very early Saturday morning in DC). Here’s a comparison of where the final Senate and House bills stand with respect to the provisions that directly or indirectly impact stock compensation:
Individual Tax Rates
The House version of the bill has four individual tax rates: 12%, 25%, 35%, and 39.6%
The Senate version of the bill has seven individual tax rates: 10%, 12%, 22%, 24%, 32%, 35%, and 38.5%. The rates sunset after 2025, at which time they revert back to the current rates.
In both bills, the highest rate kicks in at $500,000 of income for single taxpayers ($1 million for joint filers)
Supplemental Withholding Rate
For employees who have received supplemental payments of $1 million or less during the year: 35% under the House bill; 22% under the Senate bill.
For employees who have received supplemental payments of more than $1 million during the year: 39.6% under the House bill, 38.5% under the Senate bill.
AMT (for Individuals)
Repealed under the House bill.
The Senate bill doesn’t repeal the AMT, but it does increase the exemption amounts and phaseout thresholds.
Corporate Tax Rate
Both bills reduce the corporate tax rate to 20%. The reduction doesn’t take effect until 2019 in the Senate bill.
Estate Tax
Both bills increase the estate tax threshold to about $11 million.
The House bill repeals the estate tax altogether after 2024.
The Senate bill sunsets the increased threshold after 2025.
Section 162(m)
Both bills expand the employees subject to 162(m) to once again include the CFO and to include anyone serving as CEO during the year (rather than only the CEO at the end of the year).
Under both bills, once individuals are covered employees, they remain covered employees for as long as they receive compensation from the company.
Both bills also eliminate the exception for stock options and performance-based pay.
The Senate bill includes a transitional provision that would exempt compensation paid via a written binding contract that was in effect as of November 2, 2017. This is broader than the transitional provision that was originally proposed, which would have only exempted arrangements vested as of December 31, 2016. There is no transitional provision in the House bill, so all prior awards would be subject to the new rules under that bill.
Qualified Equity Grants
Both bills include a provision that would allow employees in privately held companies to elect to defer tax on stock options and RSUs until five years after the arrangements vest, provided certain conditions are met.
Stock Options and RSUs Taxed at Vest
This provision has been removed from both bills, so there is no change to the tax treatment of stock options, SARs, or RSUs.
Determination of Cost Basis
The Senate bill still includes the provision I blogged about last week that requires taxpayers to sell securities of the same type on a FIFO basis (when held in the same account). This provision is not in the House bill.
What’s Next?
As you can see, there are lots of areas where these two bills don’t agree (and this is just the tip of the iceberg—there is even more disagreement in areas of the bills the don’t relate to stock compensation). All of these differences have to be reconciled before the bill can become law, so the bill now goes to a conference committee comprised of members of both the Senate and House that will resolve the differences between the two bills.
A few weeks ago, in the NASPP Blog entry “CEO Pay Ratio: Planning for Employee Communications,” I wrote about planning to communicate with employees on the topic of the upcoming CEO pay ratio disclosure. Since my initial post on this subject, I’ve come across some helpful content that is further food for thought when contemplating a communication strategy.
I keep hearing that companies have a range of emotions about communicating around the disclosure. In particular the concept of discussing the median employee aspect of the disclosure seems to trigger words like “panicked,” “petrified,” and “concerned.” It seems many companies do worry about how their employees will react to information about the median employee’s compensation.
Two recent blog posts by Margaret O’Hanlon, CCP further explore what you should and shouldn’t say to employees about the CEO pay ratio disclosure (thanks to the CompensationStandards.com’s Advisor’s Blog for leading me to this information.) Some of the ideas O’Hanlon explored are:
In her first post (“Imagine CEO Pay Ratio Communications Going Well“), O’Hanlon suggests that instead of focusing on a panicked state or reluctance to communicate about this (and asking yourself the question “What good can come of this?”), ask yourself “What can I make of this?” Changing your focus should pave the way to different insights.
She also suggests imagining employees approaching the disclosure with the following reactions:
Not immediately overreacting to the numbers
Being willing to listen to the rationale for the numbers with an open mind, even though they are skeptical (or more)
Being able to spend a limited time mulling over with their colleagues what they have heard
Not going on social media to comment on the announcement
Prepare your employees. If you don’t, the CEO Pay Ratio and median employee information is bound to be a shock.
Use end-of-the-year focal review and merit pay communications. Articulate, repeat and reinforce what you do to make sure employee pay is competitive, how your practices are fair and how employee salaries are only one part of your company’s whole reward package.
Use people not technology. Distancing the message from the personal will leave your company open to employee claims that leadership is ducking responsibility. Identify a spokesperson to present the details of the CEO Pay Ratio, back it up with email or intranet information, but be sure that your communication strategy gives employees a chance to discuss their reaction with someone that they can open up to.
O’Hanlon mentions some other important idea in her blogs; they are definitely worth a read.
The CEO Pay Ratio disclosure time frame will be here before we know it, and companies are running out of time to take advantage of some of these proactive communication opportunities. It’s time to get ahead of the disclosure, imagine this going over well with your employees, and take realistic steps in advance to ensure the messaging results in a positive experience for employees, rather than a communication fail.
The proposed tax reform bill is the gift that keeps on giving in terms of blog entries. Emily Cervino of Fidelity pointed out this gem to me: the Senate version of the bill would no longer permit investors to identify which lot of securities they are selling if they have securities in their account that have different bases for tax purposes.
What the Heck?
Say an investor makes the following purchases of stock in a single company:
100 shares at $10 per share on January 10
100 shares at $15 per share on March 15
Next, assume the investor chooses to sell 100 shares in April at $17 per share. Under current tax law, the investor could decide which of the two “lots” to sell. In this example, the obvious choice would be the shares purchased at $15; this would minimize the capital gain on the sale, making it more profitable on a post-tax basis.
Under the proposed rules in the Senate version of the Tax Cuts and Jobs Act, investors would be required to sell shares held in a single brokerage account on a first in, first out (FIFO) basis. In my example, the investor would be required to sell the shares acquired at $10 per share first, which would increase her capital gain.
Couldn’t Investors Just Transfer the Shares to Another Account Before Selling Them?
Andrew Schwartz of Computershare pointed out to me that there’s a big loophole to the proposed rules: if the investor in my example is savvy, she’ll quickly figure out that all she needs to do is transfer the shares she bought at $15 to a different brokerage account (in which she doesn’t hold any other shares of the company’s stock) and sell the shares from that account. Problem solved.
What About Stock Compensation?
That solution works great for stock purchased on the open market but it doesn’t work so well for stock acquired under stock compensation programs.
The new law is written very broadly and appears to also apply to sales executed in connection with same-day-sale or sell-to-cover transactions. Currently, there’s little to no capital gain or loss on these transactions because the sale price is very close to the basis of the stock being sold. But if employees already hold company stock in their plan accounts and we have to assume that the shares being sold are the shares acquired earliest, this would no longer be the case, potentially making both of these transactions significantly more expensive for employees.
In the case of ISOs and ESPPs, companies don’t want employees to transfer the shares to another brokerage account (and sometimes even prohibit employees from doing so), because this makes it significantly harder to track dispositions. But if employees hold shares acquired under ISOs or ESPPs in their plan account, same-day-sale or sell-to-cover transactions might inadvertently force a disposition of the qualified shares.
Finally, for those of you who handle Section 16 reporting, the last thing you want is for insiders to open additional brokerage accounts to manage their sales. Keeping tabs on insider transactions is hard enough as it is.
When Does This Apply?
It doesn’t—yet. The bill hasn’t yet been passed by the Senate and this provision isn’t in the House version of the bill, so there is hope that, just like the rules requiring options to be taxed at vest, it will be removed from the bill before the Senate votes on it. If it isn’t removed before the vote and the bill passes, there’s still a chance it could be removed during the reconciliation process for the two bills. But if it is enacted into law, it will be effective for sales starting next year.
Back in mid-October, just before the NASPP Conference, the SSA and IRS announced the cost-of-living adjustments for 2018. I had expected to get around to blogging about this sooner, but then the House released its version of the Tax Cuts and Jobs Act and the topic of tax reform and its potential impact on stock compensation eclipsed all other topics.
COLAs
I’ve provided a description of the adjustments that impact stock compensation below. Here is an IRS chart that provides a complete list of updates.
FICA
The maximum amount of earnings subject to Social Security tax will increase to $128,700 in 2018 (up from $127,200 in 2017). The Social Security tax withholding rate will remain at 6.2%. With the new wage cap, the maximum withholding for Social Security will be $7,979.40. [Note: The SSA has since lowered the wage base for 2018 to $127,400, resulting in maximum withholding of $7,960.80. See my December 12 update.]
Medicare tax rates also remain the same and are not subject to a maximum (the threshold at which the additional Medicare tax applies is likewise unchanged).
Highly Compensated Employee Threshold
The threshold level of compensation at which an employee is considered highly compensated for purposes of Section 414(q) will remain unchanged at $120,000 in 2018. This threshold defines “highly compensated” for purposes of determining which employees can be excluded from a qualified ESPP under Section 423.
Update on the Tax Reform Bill
And, for your tax reform fix, here is an update: the House passed its version of the bill and the Senate Finance Committee approved its version to proceed to the full Senate. Debate on the bill is expected to start in the Senate after Thanksgiving. One GOP senator (Ron Johnson, WI) has already said he won’t vote it and a few other GOP senators appear to be undecided. None of the Democrat senators are expected to vote for it, so the bill won’t pass if the GOP loses two more votes (at least not this time—they could always go back to the drawing board and bring a new bill to a vote).
The provisions in both bills that directly impact stock compensation are the same as they were last Thursday (taxing stock options at vest is out, Section 162(m) expansion is in, and tax-deferred arrangements for private companies are in).
For what it’s worth, GovTrack reports that Skopos Labs gives it a 46% chance of passing (as of November 20, when I last checked it).
Happy Thanksgiving!
This will be our only blog this week because of the holiday. I wish you all a happy Thanksgiving and I hope you have a celebration that is completely free from discussions of both tax reform and equity compensation.
Just this morning, the House Ways and Means Committee Chairman issued a press release announcing additional changes to the House’s tax reform bill. The changes include removing the section of the bill that would change the tax treatment of NQDC, including stock options and RSUs.
So here’s where things stand with the areas of the bill that I have covered in my blogs this week:
Section 3801: Nonqualified Deferred Compensation
Based on the summary of the Chairman’s most recent mark-up of the bill, this section is removed in its entirety. Thus, the bill would not change the tax treatment of stock options, RSUs, or other nonqualified deferred compensation.
Section 3802: Modification of Limitation on Excessive Employee Remuneration
This section is still in the bill. It redefines who is a covered employee for purposes of Section 162(m) and makes stock options and performance awards subject to the $1 million deduction limitation. See my blog on Tuesday (“Tax Reform Targets 162(m)“) for more information.
Section 3804: Treatment of Qualified Equity Grants
The section is still in the bill. It creates a new type qualified equity award referred to as “Qualified Equity Grants” that would allow employees in private companies to defer taxation of stock options and RSUs for up to five years. See my blog from this morning (“Tax Reform Update“) for more info. The Chairman’s mark includes some technical amendments to the language of this section, but the intent of it does not appear to have been changed.
What’s Next?
At this time, we are still awaiting the Senate version of the bill. There’s some preliminary information available about it but we’re going to have to wait for the full bill to know if it makes any changes to stock compensation. I will keep you updated.
The impact of the Tax Cuts and Jobs Act on stock compensation continues to be a focus here at the NASPP. My understanding is that the bill is supposed to come out of committee in the House possibly as early as today and that we might also see the Senate version of the bill today.
Here are a few updates based on what we know so far.
ISOs and ESPPs Exempt
The Joint Committee on Taxation (JCT) report on the bill clarifies that ISOs and ESPPs are intended to be exempt from the definition of NQDC. That’s good news for those of you who, like myself, are big fans of qualified ESPPs. It also could mean that I wasn’t completely off base on Monday when I suggested this bill might lead to a resurgence of ISOs.
At-the-Money Options NOT Exempt
I know some folks were holding out hope that the failure to exclude at-the-money options from the definition of NQDC was a drafting error but that doesn’t appear to be the case. The JCT report says:
The proposal applies to all stock options and SARs (and similar arrangements involving noncorporate entities), regardless of how the exercise price compares to the value of the related stock on the date the option or SAR is granted. It is intended that no exceptions are to be provided in regulations or other administrative guidance.
So that seems pretty clear. Sounds like someone was annoyed about the exception included in the 409A regs for at-the-money options.
Performance Conditions Don’t Count
An oddity in the proposed legislation is that vesting tied to performance conditions doesn’t count as a substantial risk for forfeiture. For public companies, I think most performance awards are tied to both a service and a performance condition, so this might not be a significant concern (although it probably will be necessary to make sure the service condition extends through the date that the comp committee certifies performance, otherwise the awards would be taxable before performance has been certified). But it’s going to be a significant problem for private companies that want to make vesting in awards contingent on an IPO or CIC.
Retirement Provisions Will be a Problem
The requirement to tax NQSOs and RSUs upon vest will also put a wrinkle in retirement provisions. As you all know, when grants provide for accelerated or continued vesting upon retirement, there’s no longer a substantial risk of forfeiture once an employee is eligible to retire. Thus, under the tax bill, both NQSOs and RSUs that provide for payment upon retirement would be fully taxable for both FIT and FICA purposes when employees are eligible to retire (and restricted stock paid out at retirement is already fully taxable upon retirement eligibility).
Relief for Private Companies
The bill has been amended to include a provision that would allow employees in private companies to make an election upon exercise of stock options or vesting of RSUs that would defer taxation for five years (in the case of stock options, it’s not entirely clear when the five-year period would start). This is nice, but I’m not sure it’s enough. How many private companies are on a five-year trajectory to IPO or can accurately predict when they are five years out from IPO?
Remember when I said you should be aware of the new Section 162(m) rules that apply to certain health insurance providers because they indicate the direction Section 162(m) is heading (“CHIPs: More Than a Cheesy TV Show“)? Well, it’s happening. The tax reform package proposed by the House would make some of the same changes to Section 162(m) that already apply to CHIPs.
What Is 162(m) Again?
For those of you who don’t live and breath corporate tax deductions, Section 162(m) limits the tax deduction that companies can take for compensation paid to covered employees (currently the CEO and the top three highest paid executives, not including the CFO—but this is something the proposed legislation would change) to $1 million. A number of types of compensation are exempted from the limit, however, including performance-based pay—this would also be changed by the proposed legislation.
Update to Covered Employee Definition
The proposed tax reform legislation would update the definition of who is a covered employee under Section 162(m) to once again include the CFO. This change has been coming ever since the SEC revised the definition of who is a named executive officer for purposes of the proxy executive compensation disclosures back in 2006. The only thing that is surprising is that it’s taken over ten years for the tax code to catch up (and, actually, it still hasn’t caught up, but it seems pretty likely that this is going to finally happen).
Once a Covered Employee, Always a Covered Employee
The proposed legislation would also amend Section 162(m) to provide that anyone serving as CEO or CFO during the year will be a covered employee (not just whoever is serving in this capacity at the end of the year). Plus, starting in 2017, once employees are covered by the rule, they remain covered employees in any subsequent years that they receive compensation from the company, regardless of their role or amount of compensation they receive. This will prevent companies from being able to take a tax deduction for compensation paid to covered employees simply by delaying the payout until the individuals retire.
This change has been coming for even longer, ever since the SEC updated their definition of named executive officer to include former officers, which happened so long ago I can’t remember when it was (10 points to anyone who can tell me).
Performance-Based Compensation No Longer Exempt
Finally, the proposed legislation would repeal the current exemption for performance-based compensation. This exemption currently applies to both stock options, even if subject to only time-based vesting, and performance awards. Thus, both types of grants would no longer be exempt from the limitation on the company’s tax deduction.
At one time, this might have spelled the curtailment of performance-based awards. But these days, there is so much pressure on companies to tie pay to performance for executives that I don’t see this having much of an impact of pay practices. It does mean that a fairly sizable portion of executive pay will no longer be deductible for many public companies.
Not Final Yet
As I noted in yesterday’s blog, this legislation has a ways to go before it is final. You can rely on the NASPP to keep you in the know, even if it means I have to write blogs on Sunday night. Check out our alert for law firm memos providing more analysis.