As is often the case at this time of the year, a lot of tax related questions have been popping up in the NASPP Q&A Discussion Forum lately. For today’s blog entry, I try to quickly answer some of the questions I’ve seen the most frequently.
Former Employees
You have to withhold taxes on option exercises by and award payouts to former employees and report the income for these stock plan transactions on a Form W-2, no matter how long it has been since they were employed by the company. The only exceptions are:
- ISOs exercised within three months of termination (12 months for termination due to disability).
- RSAs paid out on or after retirement (because these awards will have already been taxed for both income tax and FICA purposes when the award holders became eligible to retire). Likewise, RSUs paid out on or after retirement that have already been subject to FICA are subject to income tax only.
If the former employees did not receive regular wages from the company in the current year or the prior calendar year, US tax regs require you to withhold at their W-4 rate, not the supplemental rate. In my experience, however, few companies are aware of this and most withhold at the supplemental rate because the W-4 rate is too hard to figure out.
Changes in Employment Status
Where an individual changes status from employee to non-employee (or vice versa) and holds options or awards that continue to vest after the change in status, when the option/award is exercised/paid out, you can apportion the income for the transaction based on years of service under each status. Withhold taxes on the income attributable to service as an employee (and report this income on Form W-2). No withholding is necessary for the income attributable to service as a non-employee (and this income is reported on Form 1099-MISC).
Any reasonable method of allocating the income is acceptable, so long as you are consistent about it.
Excess Withholding
I know it’s hard to believe, but if you are withholding at the flat supplemental rate, the IRS doesn’t want you to withhold at a higher rate at the request of the employee. They care about this so much, they issued an information letter on it (see my blog entry “Supplemental Withholding,” January 8, 2013). If employees want you to withhold at a higher rate, you have to withhold at their W-4 rate and they have to submit a new W-4 that specifies the amount of additional withholding they want.
Also, withholding shares to cover excess tax withholding triggers liability treatment for accounting purposes (on the grant in question, at a minimum, and possibly for the entire plan). Selling shares on the open market to cover excess tax withholding does not have any accounting consequence, however.
ISOs and Form 3921
Same-day sales of ISOs have to be reported on Form 3921 even though this is a disqualifying disposition. It’s still an exercise of an ISO and the tax code says that all ISO exercises have to be reported.
On the other hand, if an ISO is exercised more than three months after termination of employment (12 months for termination due to disability), it’s no longer an ISO, it’s an NQSO. The good news is that because it’s an NQSO, you don’t have to report the exercise on Form 3921. The bad news is that you have to withhold taxes on it and report it on a Form W-2 (and, depending on how much time has elapsed, it might have been easier to report the exercise on Form 3921).
The articles “Figuring Out Section 6039 Filings” and “6039 Gotchas!” in the NASPP’s Section 6039 Portal are great resources as you get ready to file Forms 3921 and 3922.
FICA, RSUs, and Retirement Eligible Employees
This topic could easily be a blog entry in and of itself, but it doesn’t have to be because we published an in-depth article on it in the Jan-Feb 2014 issue of The NASPP Advisor (“Administrators’ Corner: FICA, RSUs, and Retirement“). All your questions about what rules you can rely on to delay collecting FICA for retirement eligible employees, what FMV to use to calculate the FICA income, and strategies for collecting the taxes are covered in this article.
– Barbara
Tags: 1099-MISC, 6039, change in status, consultants, excess withholding, FICA, flat rate, Form 1099-MISC, Form 3921, Form W-2, income tax, nonemployees, retirement, Retirement Eligibility, Section 6039, supplemental income, tax withholding, taxation, termination, W-2
It’s that time of the year – holidays, festivities and year-end prep. I’ve often wondered how the two can go hand in hand. In today’s blog I’ll combine the two; let’s see how that works out.
Send Your Holiday Selfies
Let’s get the fun out of the way first. Chapter holiday gatherings are already in full swing, and we want to see your photos. Send me your selfies and group photos – we’ll post them to our Facebook page. Some of them might even make it into a holiday oriented future blog post. The pictures are already coming in – see anyone you know from yesterday’s San Diego chapter holiday event? Hint: Raul Fajardo of Qualcomm and James Tozer of E*TRADE.
Year-End Prep Tips
Moving on to the more serious topic of year-end. It seems like it always creeps up on us – one minute we’re celebrating and the next it’s full throttle into year-end reporting, tax and proxy season. To get ahead of the game, I thought of a few things you can do now, in December, to prepare.
1) Audit non-employees in your recordkeeping system. Non-employees who had stock compensation transactions this year will need a Form 1099-MISC. This is not to be confused with “former” employees, who will still receive a Form W-2. In many organizations preparation of 1099 forms is not handled by Payroll, so you’ll want to make sure you know who your non-employees are (including outside directors) and have that list ready come January for whomever is going to prepare the forms.
2) Attend our webcast next week (Thursday, 12/12) on Annual Tax Reporting. This will feature essential information on 6039 reporting, special reporting requirements, non-employee reporting and other detailed tax reporting instructions. This is a prime opportunity to get the lay of the land heading into tax season.
3) Revisit deferred tax withholdings (e.g. FICA on retirement eligible RSUs). If you’ve delayed collection of FICA taxes until year-end, for example (based on the IRS’s Rule of Administrative Convenience, allowing deferral of collection of some taxes until calendar year-end), you’ll want to revisit those scenarios now to determine whether any tax withholding is required before year-end. In relying on the Rule of Administrative Convenience, the idea is that taxes like social security will have reached their annual maximum withholding for many employees by now, eliminating the need to collect any additional social security – meaning none would need to be collected for the award. However, if an employee has not reached the maximum and collection of such taxes were deferred under the rule, then you’ll need to make sure you adequately withhold by 12/31.
Well, there you have it. Festivity and planning tips all in one blog. The holiday season is off to a great start. I’m looking forward to seeing everyone’s photos, and I’m wishing you a smooth sailing process as you kick off year-end as well.
-Jennifer
Tags: 1099-MISC, rule of administrative convenience, social security, tax, year-end
Employee equity compensation income is reported on a W-2, and non-employee equity compensation income is reported on a 1099-MISC. But, what happens when a person has been both during the vesting period of the grant?
Fully Vested Grants
When an employee terminates his or her employment relationship with the company, but continues to be a service provider, the income reporting and tax withholding requirements change. If the individual does holds only fully vested grants at the point of the status change, then the income reporting and tax withholding is straightforward. Any income from exercises on grants that vested while the individual was an employee is reported on a W-2 and subject to income tax and FICA withholding, even if the exercise is executed when the individual is a non-employee. Likewise, any income from grants that vest after the employment relationship terminated is reported on a 1099-MISC and is not subject to income tax or FICA withholding.
Partially Vested Grants
If that same employee held unvested grants that continue vest after he or she has become a non-employee, then the income should be allocated pro-rata between employee and non-employee income. Any income from shares that are attributable to the period of time when the individual was an employee should be treated as employee wages, while shares that vest after the individual became a non-employee service provider will be treated as non-employee compensation.
Let’s take the example of an employee who becomes a consultant for the company after 600 shares of an option for 1,000 shares have vested, and the option continues to vest while the individual is a consultant. If the individual exercises all 1,000 shares after the option is fully vested, then income from 600 shares is reported as wages on a W-2 and income from the remaining 400 shares is reported as income on a 1099-MISC. If the individual instead exercised only 800 shares, then the company could use the “first-in, first-out” (FIFO) method to attribute the income, allocating 600 shares as earned under the employee relationship and 200 as earned under the consultant relationship.
For information on this or other income-related issues, visit our Tax Withholding and Reporting Portal or review our 2nd Annual Webcast on Tax Reporting.
-Rachel
Tags: 1099, 1099-MISC, change in status, contractor, FICA, income, W-2