When I posted the results of the NASPP’s quick survey on the CEO pay ratio, the data I got the most questions on were the results for how companies are handling independent contractors in the calculation. When we conducted that survey, the SEC’s guidance seemed to indicate that some individuals that are treated as contractors for other purposes might be considered employees for purposes of the CEO pay ratio. That has now changed.
The SEC’s Original Position
The SEC’s original position was that the final rules permitted the exclusion of workers who are employed by and have their compensation set by an unaffiliated third party (e.g., leased employees). A CDI issued by the SEC in October 2016 clarified that some workers who are considered nonemployees for tax purposes might be considered employees for purposes of the CEO pay ratio.
The SEC’s Reversal
In the guidance issued in September 2017 however (see the NASPP alert “SEC Issues Guidance on CEO Pay Ratio“) the SEC relaxes their original position significantly, stating:
We believe it would be consistent with Item 402(u) for a registrant to apply a widely recognized test under another area of law that the registrant otherwise uses to determine whether its workers are employees.
In addition, the CDI issued on this question in 2016 has been withdrawn and the new guidance seems to suggest that reliance on the determination of employee status for tax purposes is sufficient to establish employment status for the CEO pay ratio.
The July-August issue of The Corporate Counsel notes that in addition to the test used under the US tax code (which is fairly complex) companies might rely on the determination under the Fair Labor Standards Act (FSLA) or other laws.
A Shift in Administration = A Shift in Position?
The SEC notes in Release No. 33-10415 that the shift in their position is due to concerns expressed by commenters. I don’t doubt that this is the case, but I also wonder if it is partly attributable to the Trump administration’s pro-business agenda. Obviously, one way for companies to improve their CEO pay ratio is to contract out lower paid positions (e.g., in gig-economy type arrangements). The SEC’s original position was an obstacle to this approach; the new position is much less so.
– Barbara
P.S.—I removed the chart on how companies are handling contractors from the quick survey results (in case you are wondering why you can’t find it). Now the that SEC’s position has been changed, companies are likely changing their approach and I don’t think our data on this particular question is reliable.
Tags: CEO Pay Ratio, contractor, nonemployees
The FASB has issued an exposure draft of the proposed accounting standards modification to bring awards granted to nonemployees under the scope of ASC 718. Here are six things to know about it.
- It’s Long. At 166 pages, the exposure draft is longer than I expected. Partly it’s so long because there a million places in ASC 718 where the FASB has to replace the word “employee” with “grantee” and the word “employer” with “grantor.”
- No More Mark-to-Fair Value Accounting. This is the most significant change: awards granted to nonemployees that are settled in stock will receive equity treatment, the same as awards granted to employees. This means the expense will be determined on the grant date and will be recognized over the service period, with adjustments only for forfeitures and modifications. No more mark-to-fair value accounting until the awards vest.
- Contractual Term Is Still Required for Valuation Purposes. The FASB is under the impression that all options granted to nonemployees are fully transferable (seriously, I kid you not—they really think this). So they require that when computing the fair value of options granted to nonemployees, companies have to use the contractual term, not the expected term. The NASPP will be commenting about this, for sure. (If you are a company that grants options to nonemployees, I would like to know if your options are transferable or not—email me at bbaksa@naspp.com).
- The Expense Attribution Rules are Confusing. I had expected that expense for awards to nonemployees would be attributed in the same manner as awards to employees, but the exposure draft requires the expense to be attributed as goods or services are received, in the same manner that expense would be recorded for cash compensation. I don’t know beans about accounting for cash compensation (unless its in the form or SARs or RSUs), so I don’t know what that means. Ken Stoler of PwC assures me that it simply provides more flexibility for awards to nonemployees and that companies can probably record expense in the same way they record expense for their employee awards.
- Performance Award Accounting is Improved. Currently, ASC 505-50 requires that expense for (non-market) performance awards granted to nonemployees be recorded at the lowest possible payout, which is frequently $0. The exposure draft proposes to align the treatment of nonemployee performance awards with that of employee awards: that is, expense would be recorded based on the expected payout, which makes infinitely more sense.
- Comments Are Due By June 5. You can submit comments via the FASB website or email them to director@fasb.org. You can also mail a letter to the FASB but I’m not going bother listing the address here because who actually mails letters anymore?
– Barbara
Tags: Accounting standards update, ASC 505-50, ASU, consultants, contractor, FASB, nonemployees
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