Under ASU 2016-09, all windfall and shortfall tax effects of stock compensation will run through earnings in the P&L. When vesting in performance awards is tied to earnings per share, this could make it harder to set the targets in the future because it will be harder to forecast earnings. And, for awards that have already been granted, it might make the current targets easier to achieve (or harder to achieve if the company is experiencing tax shortfalls).
Adjusting EPS Targets
Companies might be tempted to adjust EPS targets for existing performance awards, to reflect the company’s new expectations in light of ASU 2016-09. But, unless the terms of the award already address what happens when there is a change in GAAP prior to the end of the performance period, this could be hard to do. Modifications of targets could cause the awards to no longer be exempt from Section 162(m) and could have other implications.
If the targets aren’t modified, companies will likely have to adjust their forfeiture estimate for the awards.
Non-GAAP EPS
Many companies use a non-GAAP calculation of EPS for purposes of their performance awards. Where the EPS calculation already excludes expense from stock compensation, it should also exclude any tax effects attributable to stock awards. And where this is the case, ASU 2016-09 won’t impact the likelihood of the targets being achieved.
Survey Says
In our May quick survey, we asked what companies plan to about their performance awards in which vesting is tied to EPS. Here’s what they said:
16% use a non-GAAP measure of EPS that already excludes stock compensation expense
2% are planning to adjust their EPS targets
35% are not planning to adjust their EPS targets
48% don’t know what they are going to do about their EPS targets
One of the hottest questions I am hearing these days is whether to allow US employees to request additional federal tax withholding on their restricted stock, RSU, and performance awards. So, last week, we conducted a quick survey to find out what NASPP members are doing. Here are the results, in a nifty infographic:
P.S. NASPP members are awesome! We launched this survey on Thursday and by Saturday I had enough responses to close the survey and finalize the results. Thanks to all of you who participated so quickly! You rock! Check out the full survey results.
One of the primary ways in which ASU 2016-09 changed stock plan accounting practices is to require that all tax effects be recognized in the income statement. Excess tax savings increase earnings (by reducing tax expense) and tax shortfalls reduce earnings (by increasing tax expense). For some companies, this results in a lot of volatility in earnings, earnings per share, and effective tax rates. It also makes it harder to forecast earnings.
PwC found that some companies are providing detailed commentary on the impact of ASU 2016-09 on earnings per share. Here is a sample disclosure that PwC found:
“[The Company] anticipates fiscal year 2017 diluted EPS from continuing operations to be in the range of $5.38 to $5.58, which includes an expected benefit of about 25 to 30 cents from the adoption of ASU 2016-09. Excluding the benefit of adopting the updated accounting standard, [The Company] anticipates fiscal year 2017 diluted EPS from continuing operations to be in the range of $5.13 to $5.28.”
Effective Tax Rates
PwC found similar disclosures for effective tax rates. From another company:
“We expect an effective tax rate of 26% – 27.5%, after a projected reduction of 350 – 450 basis points related to the implementation of the new accounting standard for the tax benefit of employee share-base compensation.”
Earnings Guidance
Finally, PwC found some companies that had updated previously disclosed earnings and tax rate forecasts:
“[The Company] now anticipates its effective fiscal year 2017 tax rate to be between 32 percent and 33 percent versus its previous assumption of 30 percent and 31 percent, reflecting a 2-point reduction versus year ago compared to the previously assumed 4-point reduction from adopting ASU 2016-09. The company’s updated assumptions for its fiscal year effective tax rate reflect lower than anticipated exercises of [the Company’s] stock options in the first quarter and the company’s revised outlook for full-year stock option exercises. As noted, the company had previously communicated that the benefit to be realized from the adoption of ASU 2016-09 could vary significantly.”
Now that ASU 2016-09 allows companies to record expense for service-based awards without applying an estimated forfeiture rate to the accruals (see “Update to ASC 718: The FASB’s Decisions“), some our readers may be wondering how to make the transition to accounting for forfeitures as they occur. This is done by recording a cumulative adjustment to retained earnings in the period you adopt the ASU. In today’s guest blog entry, Elizabeth Dodge of Equity Plan Solutions explains how to calculate this adjustment (which she refers to as a “true-up amount”).
How to Get Rid of Your Estimated Forfeiture Rate
By Elizabeth Dodge, Equity Plan Solutions
So, you’ve decided to get rid of your estimated forfeiture rate… or at least decided to consider it. Congratulations! I recommend the elimination of an estimated forfeiture rate to all my clients. It simplifies equity accounting in so many ways.
Now how do you DO it? And better yet, do it without the auditors crawling all over you with time-consuming questions?
The short answer to the first question is:
Run an expense report, life-to-date WITH your current estimated forfeiture rate.
Run an expense report, life-to-date with a ZERO forfeiture rate.
Compare “To Date” (aka cumulative) expense (or, if your report doesn’t give you To Date, add prior and current expense and compare that).
The difference is your true up amount. Yes, it’s that easy. Yes, proving it’s correct is a little harder. More on that later.
Note: If you are using a system that delays the reversal of expense to the VEST DATE, it’s not QUITE this easy, but that is outside the scope of this article.
Why life-to-date?
Can’t I just run the current period report with and without the rate and take the difference in To Date (aka cumulative) Expense. Yes, you SHOULD be able to do that, but your auditors will want to kick the tires on your analysis and having ALL your grants on the report will help them do that. And life-to-date (LTD) should be from your adoption of FAS 123(R) (now known as ASC 718)—January 1, 2006 for many companies—until the end of your most recent reporting period—December 31, 2016 for many companies.
So now how do you tick and tie the numbers to your auditors’ satisfaction?
The approach I’ve used thus far with all my clients that have early adopted or considered adopting is to create a spreadsheet with four tabs:
LTD Expense Report With a Forfeiture Rate
LTD Expense Report Without a Forfeiture rate
Comparison tab
Summary tab
The Comparison tab has one row per grant and indicates the grant date, unvested shares (optional), final vest date and cancel date, if any, for each. It also pulls in expense from tab 1 and tab 2 and compares them in a “Variance” column. Then I add a “Reason” column that categorizes the grants into (generally) three categories:
Fully Vested, No Cancellation: These grants should have no expense variance.
Cancelled: These grants should have no expense variance (unless you are using True Up at Vest).
Still Vesting, No Cancellation: All grants should have higher expense on the Without Forfeiture Rate tab
You could assign these categories by using formulas. I usually use the low-tech method of filtering for a given criteria and then pasting the Reason down through all the rows to which it applies.
On the Summary tab, I summarize the expense totals from both tabs and then use a pivot table to summarize the reasons (or categories) and the associated variances (or lack thereof):
Thus far no auditors have had an issue with this approach. (Of course, now that I’ve said that, I’ve jinxed myself.) Have at it! And have fun!
Elizabeth is a Principal for Equity Plan Solutions, LLC, providing equity compensation consulting services to companies from startups to large public corporations. Previously, Elizabeth was a consultant and Vice President for Stock & Option Solutions, Inc. and held product management roles in stock plan services at BNY Mellon and ETRADE Corporate Services. Elizabeth became a Certified Equity Professional in 1999 and co-authors the chapter on accounting in The Stock Option Book. She also serves on the Executive Advisory Committee of the National Association of Stock Plan Professionals and was honored with the NASPP Individual Achievement award in 2012. You can contact Elizabeth at edodge@equityplansolutions.net.
In late February, the FASB met to review the comments received on the exposure draft of the proposed update to modification accounting under ASC 718 (see “ASC 718 Gets Even Simpler“) and voted to go ahead with the changes.
What’s Changing
The update clarifies that when the terms of an award are amended, modification accounting is required only if the amendment causes one of the following things to change:
The current fair value of the award
The vesting provisions
The equity/liability status of the award
The Comment Letters
The FASB received only 15 comment letters on the exposure draft and 12 of those were in support or it. The three letters that opposed the proposal did so at least in part because they felt that the above conclusion can already be drawn from the current standard. (Although, board member James Kroeker noted that one of the firms that opposed the proposal had previously contacted the FASB with technical inquiries as to what types of amendments require modification and had suggested that the FASB issue the update because they felt that there is diversity in practice. Go figure—perhaps the people writing the letters don’t communicate with the people actually doing the work.)
The FASB’s Decision
The FASB voted to go ahead with the proposed update, with only a few clarifications:
The determination of whether the fair value has changed should be consistent with the approach used to determine incremental cost for modifications. In general, this is determined on an award basis (rather than a per-share basis or an aggregate basis for all awards modified at one time).
The disclosures related to material modifications are required even if the amendment doesn’t trigger modification accounting.
Not So Fast; This Isn’t Final Yet
The FASB staff still has to draft the final language of the update and the FASB has to approve it. The staff anticipates issuing the final update in April 2017. Public companies will have to adopt it by the start of their first fiscal year beginning after December 15, 2017. Early adoption is permitted, but not before the official ASU is issued.
Could I Possibly Use the Word Modification More in One Blog Entry?
I doubt it. Here is this blog entry in a nutshell: As a result of technical questions that arose in the context of the prior modification to ASC 718, the FASB voted to go forward with a proposed modification to ASC 718 to stipulate that award modifications are subject to modification accounting only when the fair value, vesting conditions, or status of awards are modified, but the FASB had a few modifications to the proposed modification. The next time the FASB decides to update ASC 718, I hope the change doesn’t have anything to do with award modifications.
As most of my readers know, the FASB has amended ASC 718 to expand the exception to liability treatment that applies to shares withheld to cover taxes to include withholding up to the maximum individual tax rate. This has led many companies to consider changing their tax withholding practices for stock compensation.
Plan Amendment Likely Necessary
As noted in my blog entry “Getting Ready for the New Share Withholding” (May 5, 2016), companies that are interested in taking advantage of the expanded exception face an obstacle in that virtually all stock plans include a prohibition on using shares to cover taxes in excess of the minimally required statutory withholding. Where companies want to allow shares to be withheld for tax payments in excess of this amount, the plan must first be amended to allow this.
Shareholder Approval Not Necessary
In the aforementioned blog entry, I had noted that it wasn’t clear if shareholder approval would be required for the plan amendment, particularly if the shares withheld will be recycled back into the plan. I have good news on this question: both the NYSE and Nasdaq have amended their shareholder approval FAQs to clarify that this amendment does not require shareholder approval, even if the shares will be recycled.
Nasdaq (ID number 1269, it should be the last question on the second page. Or do a keyword search for the word “withholding” and the relevant FAQ should come right up.)
For a while, there was still a question as to whether the NYSE required shareholder approval when shares withheld from restricted stock awards would be recycled. In late December, John Roe of ISS arranged for the two of us to meet with John Carey, the Senior Director at NYSE Regulation, to get clarification on this. Just prior to our meeting, the NYSE updated their FAQs to clarify that shareholder approval is not required even in the case of share withholding for restricted stock awards, even when the shares will be recycled.
ISS Still Not a Fan of Share Recycling
It should come as no surprise that, where the withheld shares will be recycled, ISS isn’t a fan of amendments to allow shares to be withheld for excess tax payments. Now that it’s clear shareholder approval isn’t required for the amendment, this likely isn’t a significant concern for most companies, unless they are submitting their plan for shareholder approval for some other reason. It isn’t a deal-breaker, but it could enter into ISS’s qualitative assessment of the plan. This would particularly be an issue if ISS’s recommendation is tied to more than the plan’s EPSC score.
Not a Modification for Accounting Purposes
There also has been some question as to whether the amendment would be considered a modification for accounting purposes if applied to outstanding awards. Based on the FASB’s recent exposure draft to amend the definition of a modification under ASC 718 (see “ASC 718 Gets Even Simpler,” November 22, 2016), the FASB doesn’t seem to think modification accounting is necessary. The comment period on the exposure draft ended on January 6. There was little opposition to the FASB’s position: only 14 comment letters were received, one letter clearly opposed the change, 12 supported the change, and one was “not opposed” but not enthusiastic. Given that response, hopefully the FASB will finalize the proposed update quickly so that this question is settled.
It will come as no surprise to any of you that accounting for modifications under ASC 718 is complicated. In the aftermath of the issuance of ASU 2016-09, the FASB has received a number of questions about whether amending a stock plan or award to allow shares to be withheld for more than the minimum statutorily required tax payment would trigger modification accounting under ASC 718. It probably seems crazy to you that we even have to consider this question and I guess it also seemed that way to the FASB, because they’ve issued an exposure draft to amend ASC 718 to clarify that this sort of change isn’t a modification.
ASC 718 currently says that any change whatsoever to an award is considered an modification and goes on to define four types of modifications: probable-to-probable, probable-to-improbable, improbable-to-probable, and improbable-to-improbable. The accounting treatment varies based on which type of modification you are dealing with and for some types of modifications, a new valuation of the award is required even if the value of the award isn’t changed as a result of the modification. Hence, the concern about the amendments relating to share withholding, even though these amendments arguably don’t materially increase the value of an award to the award holder.
So the FASB has proposed an amendment to ASC 718 that would clarify that not every change to the terms and conditions of an award requires modification treatment. Instead, a change to the terms and conditions of an award would require modification treatment only if at least one of the following conditions is met:
The fair value of the award is changed as a result of the amendment. For purposes of determining if there is a change in fair value, the fair value of the award immediately following the amendment would be compared to the fair value immediately beforehand (rather than to the grant date fair value). Generally, there would be no change in fair value if the amendment does not impact any of the inputs necessary to determine the award fair value.
The amendment modifies the vesting conditions of the award.
The amendment causes the classification of the award to change (from equity to liability or vice versa).
Amending a plan or award to allow additional shares to be withhold for taxes would not meet any of the about conditions (provided the share withholding is still limited to the maximum individual tax rate in the applicable jurisdiction) and, thus, under the proposed amendment, there would be no question that this is a modification. Even without the proposed amendment to ASC 718, I believe that many practitioners would not treat this as a modification.
Comments may be submitted on the exposure draft until January 6, 2017. The update would be applied prospectively only, thus the accounting treatment for any prior modifications of awards would not change. The exposure draft does not specify an effective date.
I’ve been getting a lot of questions about what tax withholding rate can be used for federal income tax purposes, now that the FASB’s update to ASC 718 is final and companies are free to adopt it. So I thought I’d take a blog entry to clarify what’s changed and what hasn’t.
Who’s the Decider on Tax Withholding Procedures
One thing that a lot of folks seem to have forgotten is that the FASB doesn’t determine tax withholding procedures; they just determine how you account for situations in which tax is withheld. The ultimate authority on how much tax you should (and can) withhold in the United States is the IRS, not the FASB.
Tax Withholding for Supplemental Payments
I’ve blogged about the rules for withholding on supplemental payments, which include stock plan transactions, quite a bit (search on the term “Excess Withholding” in the NASPP Blog). There are two choices when it comes to withholding taxes on stock plan transactions for employees who have received less than $1 million in supplemental payments for the year:
Withhold at the flat rate (currently 25%). No other rate is permissible.
Withhold at the employee’s W-4 rate. Here again, no other rate is permissible.
If employees want you to withhold additional FIT, they have to submit a new W-4 requesting the withholding (as a flat dollar amount, not a percentage) and you have to agree to withhold at the W-4 rate. This is stated in IRS Publication 15 and even more emphatically in IRS Information Letter 2012-0063. Whether you are using method 1 or 2, you can’t arbitrarily select a withholding rate.
Where Does the FASB Come Into This?
The FASB has no authority over these requirements and they didn’t amend ASC 718 to make is easier for you to ignore the IRS requirements. They amended ASC 718 to make it easier for companies that grant awards to non-US employees to allow those employees to use share withholding. Other countries don’t have a flat rate, making it challenging for the US stock plan administration group to figure out the correct withholding rate for non-US employees. This would allow companies to withhold at the maximum rate in other countries and refund the excess to employees through local payroll (who is more easily able to figure out the correct withholding rate).
The only change for US tax withholding procedures is that if you want to use the W-4 rate to withhold excess FIT, withholding shares for the excess payment will no longer trigger liability treatment once you adopt the update to ASC 718. But if you want to withhold excess FIT, you still have to follow the IRS procedures to do so. Previously, even if you had followed the IRS W-4 procedures, withholding shares for an excess tax payment would have triggered liability treatment.
Why Not Use the W-4 Rate?
No one wants to use the W-4 rate because it is impossible to figure out. You have to aggregate the income from the stock plan transaction with the employee’s other income for the payroll period, which the stock plan administration group doesn’t have any visibility to. The rate varies depending on the number of exemptions the employee claims on Form W-4. And the rate is complicated to figure out. I count at least seven official methods of figuring out this rate and companies can make up their own method (but if they make up a method, they have to apply it consistently, the stock plan administration group can’t make up a method that is different than the method the payroll group uses).
The upshot is that you literally can’t figure it out. You would have to run the income through your payroll system to figure out what the tax withholding should be. And that’s a problem because your stock plan administration system is designed to figure out the withholding and tell payroll what it is, not the other way around.
What’s the Penalty?
Members often ask me what the penalty is for withholding extra FIT without following the IRS procedures. Generally there isn’t a penalty to the company for overwithholding, provided there’s no intent to defraud the IRS (if you don’t understand how overwithholding could involve tax fraud, see “Excess Withholding, Part 2“) and the withholding is at the request of the employee. Doing this on a one-off basis, at the occasional request of an employee, probably won’t result in substantial penalties to the company, especially if the employee has appropriately completed Form W-4 for his/her tax situation. (Note, however, that I’m not a tax advisor. You should consult your own advisors to assess the risk of penalty to your company.)
But I’ve encountered a number of companies that want to create a system to automate electing a higher withholding rate without following the W-4 procedures (in some cases, for all of their award holders). I think that it could be problematic to create an automated system that circumvents the W-4 process, especially in light of Information Letter 2012-0063. That system is likely to be noticed if the company is audited, and I think it could have negative ramifications.
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.
Many companies are very excited about the expanded exception to liability treatment that is available under ASU 2019-06 (see my blog entry, “Update to ASC 718: The FASB’s Decisions,” December 1). In the NASPP’s quick survey on the ASU, about 30% of respondents so far have said that this is the amendment they are most excited about (to the extent that anyone can be excited about accounting).
Many plans (possibly even most plans, by a wide margin), include language prohibiting employees from tendering award shares to cover tax payments in excess of the minimum statutory required withholding. This language is included in the plan to make it abundantly clear that the company doesn’t allow share withholding in excess of the minimum required tax payment; liability treatment could be required if it appears that the company would allow this, even if it isn’t ever actually done. I’m sure the language is also included to protect companies from themselves—if anyone had ever gotten the bright idea to allow share withholding for a tax payment in excess of the minimum required, hopefully someone would have realized the plan prohibited this.
If this language exists in your plan, the plan has to be amended to change the limitation from the minimum required payment to the maximum payment before you can change your share withholding procedures.
Shareholder Approval May Be Required
At a minimum, the Board of Directors would need to approve the amendment to the plan. But for some companies, shareholder approval may be required as well. The NYSE and NASDAQ require shareholder approval of any material amendments to stock plans. As Mike notes:
From the perspective of the NYSE and NASDAQ, if the Stock Plan allows the recycling of shares surrendered or withheld to pay tax withholding (that is, puts those shares back in the authorized share pool and allows those shares to be re-used for future awards), then an amendment of that Plan that allows for tax withholding at the maximum rate, instead of the minimum rate, would be material because it will increase the number of shares available for issuance under the Plan!
According to the NASPP’s 2013 Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting), close to 60% of respondents allow shares withheld for taxes to be recycled. These companies would need to obtain shareholder approval of this amendment.
Companies May Need to Wait Until After Adopting the ASU
Once you amend your plan, your auditors make take this as an indication that you plan to allow share withholding in excess of the minimum required tax payment. If so, and the amendment is approved before you adopt ASU 2016-09, that’s going to trigger liability treatment for all of the awards under the plan. This liability treatment will go away once you adopt the ASU, but until then, it could be a problem.
It might be possible to structure the amendment so that it is effective only after your company adopts ASU 2016-09, but it’s a good idea to consult with your legal and accounting advisors before rushing headlong into amending your plan.
