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).
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.
In today’s entry I highlight a few articles that are available on the NASPP website that I think are particularly valuable. Many of these articles are updated on an annual basis; together they comprise the core foundational knowledge necessary to be proficient in stock compensation.
Restricted Stock and Units: The article “Restricted Stock Plans” covers just about anything you could want to know about restricted stock and unit awards and is updated annually.
ESPPs: “Designing and Implementing an Employee Stock Purchase Plan” takes an in-depth look at the regulatory and design considerations that apply to ESPPs, particularly Section 423 plans. This is a reprint of my chapter in the NCEO’s book “Selected Issues in Equity Compensation” so it is updated annually.
Securities Law: Alan Dye and Peter Romeo’s outlines of Rule 144 and Section 16 provide great overviews of these areas of law and are also updated annually.
It was great to see everyone at the NASPP Conference last week. One session I look forward to every year at the Conference is “The IRS Speaks“–which I consider to be my chance to get the inside scoop on various IRS projects that impact stock compensation. For today’s blog, I have a few updates from this year’s panel, as well as some other recent tax news.
For highlights of the NASPP Conference, check out my blog entries on November 2 and November 4.
COLAs for 2012 The maximum amount of earnings subject to Social Security tax will increase to $110,100 in 2012 (up from $106,800 this year) (those of you that follow the NASPP on Facebook and Twitter already know this). The tax rate is also scheduled to return to 6.2% (up from 4.2% this year), making the maximum withholding $6,826.20 for 2012 (see the NASPP alert). But stay tuned on this one; President Obama has proposed reducing Social Security tax for 2012.
Also, if any of you exclude highly compensated employees from your ESPP, note that the threshold for who is considered highly compensated increases to $115,000 in 2012.
BTW–COLAs stands for “cost of living adjustments.”
Updates from “The IRS Speaks“ Here are areas where the IRS hopes to issue guidance in the next year or so:
409A income inclusion rules. Note however, that this doesn’t include Code Y reporting. That isn’t likely to happen until some time after the 409A income inclusion rules are finalized.
Finalizing the proposed regs that were issued earlier this year under Section 162(m).
The treatment of dividends and dividend equivalents under Section 162(m).
A model election under Section 83(b) that includes examples illustrating the tax consequences of making (or not making) the election. (Fascinating–I had no idea the IRS even thought there was a need for this.)
Guidance on Section 162(m)(6), which relates to the deduction limit that applies to health insurance providers.
Something about foreign pension plans under Section 402(b) (I have no idea what this is–sorry, when I hear the words “foreign pension plans,” I tune out).
The panel also covered a number of issues relating to Section 6039 returns for ISOs and ESPPs. I don’t have time to cover them all today, but maybe in a future blog.
In terms of cost-basis reporting, the panel did say that the IRS is considering adding a checkbox to Form 1099-B that would indicate whether the reported cost basis includes W-2 income recognized in connection with the shares. We think this brilliant suggestion from Andrew Schwartz of BNY Mellon Shareowner Services would be a big help in explaining the form to employees, but if the IRS makes this change, it won’t be until the 2012 form comes out.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
As of yesterday, the final versions of Forms 3921 and 3922, as well as the associated instructions, are available from the IRS. These are the forms that will be used to file the returns required under Section 6039 for ISOs and ESPPs with the IRS. No surprises–the forms are largely unchanged from the draft versions that the NASPP obtained earlier this year. See our alert on the final forms for more information and background.
Getting Ready for Electronic Filing of 6039 Returns – Part I
Based on the last Silicon Valley NASPP Chapter meeting, I think we are starting to get to panic mode on these returns. Alison Wright of Baker & McKenzie and Jessica Carbullido of Con-way, gave a great presentation on the nuts and bolts of filing the returns, particularly on the electronic filing process.
Here are few action items that I came away with. This is only Part I; I’ll have a few more action items for you next week. For general overview of the electronic filing process, read IRS Publication 3609 (look how happy the woman on the cover is, now that she files electronically with the IRS–that could be you!)
Figure Out Your Transmitter Control Code
If you are submitting the returns electronically, you need a TCC. Chances are, your company already has one, but now would be a good time to make sure.
If you are outsourcing the filing to a vendor that is going to submit the returns to the IRS on your behalf, the vendor will likely have their own TCC, so you won’t need to worry about this (but verify this with your vendor).
If you are working with a vendor that is going to create the submission file for you but you will have to submit it (or if you are creating the file yourself), you’ll need your company’s TCC code. If your company submits Forms 1099-MISC electronically (and there’s a pretty good chance that you do), your company already has this code. You just need to find out who has it and what it is. You don’t want to request a new TCC if your company already has one–the IRS frowns on this.
If you need a TCC and you’ve determined that your company doesn’t already have one, you need to apply for one using Form 4419. Might as well get started on this now.
Set Up Your FIRE Account
Electronic filings of Forms 3921 and 3922 will be submitted to the IRS via the FIRE system. (FIRE stands for “Filing Information Returns Electronically”–those IRS folks are so clever!) This is not the same system that is used to file Forms W-2 electronically (those are filed with the Social Security Administration, not the IRS), thus, your friends in payroll and your payroll service providers aren’t going to be much help here. It is, however, the same system that is used to file Forms 1099-MISC electronically. Accounts payable, which is typically the group that files this form, may be your new BFF.
If you are submitting the electronic filing yourself, then you’ll need a FIRE account as well as a TCC. You can (and probably should) set up your own FIRE account even if someone else at your company already has one. To set up your account, go to http://www.irs.gov/efile/article/0,,id=165534,00.html and follow the instructions under “Create Your Account.” (You’ll have to wait until after 8:00 AM Eastern today to do this–until then, the FIRE system is down for maintenance. It’s been down since last Thursday; that’s a lot of maintenance!)
Find a Vendor
If you were thinking that you could just download some data to Excel and create the submission file yourself, think again. Publication 1220 includes the specifications for the submission file. And, while at 136 pages, this publication is no picnic, the kicker is that the files must be in a fixed-width ASCII format, which requires some advance programming skills to create from Excel. Why the IRS couldn’t use a nice, easy, comma-delimited file–which anyone can create using the Save As function in Excel–is a mystery.
If you haven’t already, you probably want to get started on finding a vendor that can help you create these files (either that, or start making friends with your IT department). The NASPP’s just announced webcast on November 18, “Comparing Solutions for Section 6039 Compliance,” is a great place to begin your vendor search.
Free Conference Session Audio If You Renew by Dec 31 All NASPP memberships expire on a calendar-year basis. Renew your membership by Dec 31 and you’ll qualify to receive the audio for one NASPP Conference session for free!
Join Now and Get Three Months Free and Free Conference Session Audio! If you aren’t currently an NASPP member, now is the time to become one! Join the NASPP for 2011 and you’ll get the rest of 2010 for free. If that’s not enough, you’ll also get the audio for one NASPP Conference session for free. Tell all your friends!
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
Renew your NASPP membership for 2011 (if you aren’t an NASPP member, join today). Renew or join by Dec 31 to qualify for the audio of one NASPP Conference session for free.
Don’t miss the local NASPP chapter meetings in Boston, the Carolinas, Orange County, San Diego, and Seattle. Robyn Shutak, the NASPP’s Education Director, will be attending the San Diego meeting; be sure to say hello!
Last month I wrote about divorce and stock plan management, and today I’m going to tackle the other big “d”…death. Although (thankfully) the death of an employee is a relatively unlikely scenario, it’s one that warrants preparation. None of the issues surrounding the death of an employee can be addressed without an underlying consideration for what the decedent’s family will coping with. Not only is the death of a family member an emotional period, there is also a pretty intense amount of paperwork to be completed.
When it comes to handling equity compensation after the death of an employee, there are issues that are straightforward and those that are subject to interpretation and company policy. This week, I’m only going to cover the tax withholding and reporting since the IRS has made this relatively clear.
ISO and ESPP
For both ISOs and 423 ESPP shares transferred to the estate or beneficiary upon the death of an employee, the statutory holding periods for preferential tax treatment no longer apply. When it comes to tax withholding, this means the company is off the hook. However, there remains a reporting obligation both to comply with Section 6039 and to report ordinary income on discounted ESPP. The transfer of ESPP shares is considered a qualifying disposition. The compensation income, which is the lesser of the discount at purchase or the actual gain at the disposition, is reported on the employee’s final Form W-2. For ISOs, because any sale of shares by the estate or beneficiary is treated as a qualified disposition, the company generally has no income reporting or tax withholding obligation.
Section 6039 Considerations
The exercise of an ISO triggers the 6039 reporting obligations regardless of whether the exercise is made by the employee or by the employee’s estate or beneficiary. This means that the company should still furnish an information statement. In addition, for any exercises beginning in 2010, the company must file Form 3921 with the IRS. (Catch up on the latest regarding Forms 3921 and 3922 in Barbara’s post from Tuesday.)
For ESPP, however, the 6039 considerations hinge on how the company issues ESPP shares at purchase as well as the company’s policy regarding the current offering period both come into play. According to the final regulations, if the purchased shares are immediately deposited into the employee’s brokerage account, this is considered the “first transfer of legal title”. Since this is the prevalent practice for ESPP shares, many companies will provide 6039 information statements to employees and file a Form 3022 (for purchase beginning in 2010) to the IRS subsequent to each purchase. In addition, most companies do not permit the estate or beneficiary to purchase shares in the current offering period, refunding accumulated contributions instead.
This means that for most situations involving the death of an employee, the event that triggers 6039 reporting obligations on ESPP shares has already taken place. If, however, the ESPP shares are issued in certificate form or otherwise held in the employee’s name, or if the employee is not automatically withdrawn from the current offering upon death, the company may still have outstanding 6039 reporting obligations when it comes to ESPP shares.
NQSOs
For NQSOs, the company’s withholding and reporting obligations differ depending on whether the exercise by the estate or beneficiary takes place in the same year as the death of the participant or not. In either case, the company’s obligation to withhold income tax no longer applies. If the exercise takes place in a subsequent year, the company generally has no withholding obligation and reports the income on a Form 1099-MISC issued to the employee’s estate or beneficiary. However, if the exercise takes place in the year of the employee’s death, then the company withholds FICA taxes (but no FIT) on the exercise and reports the income and FICA withholding on the employee’s final Form W-2.
If diving into the latest updates on tax withholding and reporting is on your list, then you won’t want to miss the session, “The IRS and Treasury Speak: Hot Tax Topics and Updates” . In fact, we’ve got all the hottest topics lined up for you this year. If you haven’t already, register today! If you’re already registered, don’t forget to let us know which sessions you’ll be attending.
-Rachel