The full results from the 2016 Domestic Stock Plan Design Survey, which the NASPP co-sponsors with Deloitte Consulting LLP, are now available. Companies that participated in the survey (and service providers who weren’t eligible to participate) have access to the full results. And all NASPP members can hear highlights from the survey results by listening to the archive of the webcast “Top Trends in Equity Plan Design,” which we presented in early November.
For today’s blog entry, I highlight ten data points from the survey results that I think are worth noting:
Full Value Awards Still Rising. This survey saw yet another increase in the usage of full value awards at all employee levels. Overall, companies granting time-based restricted stock or units increased to 89% of respondents in 2016 (up from 81% in 2013). Most full value awards are now in the form of units; use of restricted stock has been declining over the past several survey cycles.
Performance Awards Are for Execs. We are continuing to see a lot of growth in the usage of performance awards for high-ranking employees. Companies granting performance awards to CEOs and NEOs increased to 80% in 2016 (up from 70% in 2013) and companies granting to other senior management increased to 69% (from 58% in 2013). But for middle management and below, use of performance award largely stagnated.
Stock Options Are Still in Decline. Usage of stock options dropped slightly at all employee levels and overall to 51% of respondents (down from 54% in 2013).
TSR Is Hot. As a performance metric, TSR has been on an upwards trajectory for the last several survey cycles. In 2016, 52% of respondents report using this metric (up from 43% in 2013). This is first time in the history of the NASPP’s survey that a single performance metric has been used by more than half of the respondents.
The Typical TSR Award. Most companies that grant TSR awards, use relative performance (92% of respondents that grant TSR awards), pay out the awards even when TSR is negative if the company outperformed its peers (81%), and cap the payout (69%).
Clawbacks on the Rise. Not surprisingly, implementation of clawback provisions is also increasing, with 68% of respondents indicating that their grants are subject to one (up from 60% in 2013). Enforcement of clawbacks remains spotty, however: 5% of respondents haven’t enforced their clawback for any violations, 8% have enforced it for only some violations, and only 3% of respondents have enforced their clawback for all violations (84% of respondents haven’t had a violation occur).
Dividend Trends. Payment of dividend equivalents in RSUs is increasing: 78% of respondents in 2016, up from 71% in 2013, 64% in 2010, and 61% in 2007. Payment of dividends on restricted stock increased slightly (75% of respondents, up from 73% in 2013) but the overall trend over the past four surveys (going back to 2007) appears to be a slight decline. For both restricted stock and RSUs, companies are moving away from paying dividends/equivalents on a current basis and are instead paying them out with the underlying award.
Payouts to Retirees Are Common. Around two-thirds of companies provide some type of automated accelerated or continued vesting upon retirement (60% of respondents for stock grants/awards; 68% for performance awards, and 60% for stock options). This is up slightly in all cases from 2013.
Post-Vesting Holding Periods are Still Catching On. This was the first year that we asked about post-vesting holding periods: usage is relatively low, with only 18% of companies implementing them for stock grants/awards and only 13% for performance awards.
ISOs, Your Days May be Numbered. Of the respondents that grant stock options, only 18% grant ISOs. This works out to about 10% of the total survey respondents, down from 62% back in 2000. In fact, to further demonstrate the amount by which option usage has declined, let me point out that the percentage of respondents granting stock options in 2016 (51%) is less than the percentage of respondents granting ISOs in 2000 (and 100% of respondents granted options in 2000—an achievement no other award has accomplished).
Next year, we will conduct the Domestic Stock Plan Administration Survey, which covers administration and communication of stock plans, ESPPs, insider trading compliance, stock ownership guidelines, and outside director plans. Look for the survey announcement in March and make sure you participate to have access to the full results!
The practice of paying dividends (or dividend equivalents, in the case of units) on unvested awards has been declining since we first started tracking it in 2007. No one likes the practice, other than companies and the employees who benefit from it. Investors certainly aren’t a fan, FASB imposes some onerous accounting requirements on it, and even the IRS has taken issue with the practice. Now, ISS’s 2017 Equity Plan Scorecard deducts points for this.
What’s the Big Deal?
The main criticism of paying dividends on unvested awards is philosophical: if dividends are paid out before an award vests, employees have arguably received compensation they aren’t entitled to. And, if the awards are subsequently forfeited, no one makes the employees pay back the dividends; they are allowed to keep the dividends on shares that they ultimately didn’t earn. Here are a few of the consequences of this practice:
Implicates the dreaded two-class method of reporting earnings-per-share, something few people, if any, even understand (I’ll admit it—I am not one of the few) (see “Applying the Two-Class EPS Method to Share-Based Payments,” by KPMG)
When the awards are forfeited, any dividends paid prior to vesting that aren’t also forfeited are treated as compensation expense (normally, dividends do not increase the expense associated with an award)
If paid on performance awards, the dividends cannot be considered performance-based compensation for purposes of Section 162(m) unless they are subject to vesting contingent on performance goals (see “IRS Clarifies Treatment of Dividends Under Section 162(m)“)
ISS Gets into the Game
One of ISS’s changes to its 2017 Corporate Governance Policy is to add paying dividends on unvested awards to the Plan Features pillar of its Equity Plan Scorecard. Plans will receive full points for this test only if they prohibit paying dividends prior to vesting for all awards offered under the plan. If the plan is silent or includes the prohibition for some awards but not others, the plan receives no points for this test.
It is permissible for dividends to accrue on awards prior to vesting, so long as the dividends are still subject to forfeiture in the event that the underlying award is forfeited.
The Data
This handy interactive infographic shows how payment of dividends on unvested awards has declined since 2007 (click on the years to see the data change):
Perhaps one day, paying dividends on unvested awards will go the way of reloads and pyramid exercises: mythic transactions rarely, if ever, seen in the wild.
– Barbara
* Data referenced in this blog, including the infographic, are from the Domestic Stock Plan Design Survey (years 2007, 2010, 2103, and 2016), co-sponsored by the NASPP and Deloitte Consulting LLP.
For today’s blog entry, I cover yet another challenge in the ongoing saga of awards that provide for accelerated or continued vesting upon retirement.
A recent Chief Counsel Advice memorandum casts doubt on the treatment of dividend equivalents paid on vested but unpaid RSUs. This comes up when dividend equivalents are paid on RSUs that allow for deferred payout on either a mandatory basis or at the election of the award holder. This arrangement is relatively rare, however, and probably only impacts a few of my readers. More commonly, however, this is also an issue where dividend equivalents are paid on awards that provide for accelerated or continued vesting upon retirement and the award holder is eligible to retire.
Background
In either of the above situations, the RSU is subject to FICA when no longer subject to a substantial risk of forfeiture. For traditional deferral arrangements, risk of forfeiture lapses when the award vests. In the case of awards that provide for accelerated or continued vesting upon retirement, the risk of forfeiture substantively lapses when the award holder is eligible to retire.
Any dividend equivalents accrued on the award prior to when the award is subject to FICA will be subject to FICA at the time paid (if they are paid out to award holders at the same time they are paid to shareholders) or when the award is subject to FICA (if they will be paid out with the underlying award). But what about the dividend equivalents paid after the award has been subject to FICA? Does the company need to collect FICA on those equivalents when they are accrued/paid?
The Non-Duplication Rule
Under, Treas. Reg. §31.3121(v)(2)-1(a)(2)(iii), referred to as the “non-duplication rule,” once an RSU has been taken into income for FICA purposes, any future earnings on the underlying stock are not subject to FICA. So the answer to FICA treatment of the dividends depends on whether the dividends paid after this point are considered a form of earnings, akin to appreciation in value in the underlying stock (in which case, they would not be subject to FICA), or additional compensation (in which case, they would still be subject to FICA).
I’ve spoken with a number of practitioners about this. Most believe that an argument can be made that the dividend equivalent payments are a form of earnings and, thus, are not subject to FICA.
The CCA
In Chief Counsel Advice 201414018, issued earlier this year, the IRS argued that dividends paid after the award is subject to FICA are still subject to FICA. The situation the memorandum addresses, however, involved a number of facts not typically characteristic of RSUs that receive dividend equivalents:
The RSUs were granted by a private company
The awards were paid out only in cash
The dividend equivalents were paid out to award holders at the same time dividends were paid to shareholders, rather than with the underlying award
While concerning, the memorandum doesn’t necessary dictate a change in practice with respect to the FICA treatment of dividend equivalents, especially if your company is public, your RSUs are paid out in stock, and your dividend equivalents are paid out with the underlying award. It may, however, be worth reviewing the ruling with your tax advisors to ensure they are comfortable with your procedures (especially if any of the conditions in the memorandum also apply to your RSUs and dividend equivalents).
On June 21, 2012, the IRS issued Rev. Rul. 2012-19 to clarify the treatment of dividends paid on awards that satisfy the requirements to be considered performance-based compensation under Section 162(m). For today’s blog entry, I summarize this ruling.
Background on Section 162(m) (That You Probably Already Know But I Feel Compelled to Include Anyway, Just in Case)
Section 162(m) limits the tax deduction companies can claim for compensation paid to specified executive officers to $1 million per year. Performance-based compensation, as defined under the code and associated regulations, is exempt from this limitation. There are numerous conditions that must be met for awards to be considered performance-based, including that the awards must be payable only upon achievement of performance targets and cannot be paid out prior to certification (by the compensation committee) that the targets have been satisfied.
Treatment of Dividends Under Section 162(m)
Under the ruling, the dividends (and dividend equivalents) are viewed as separate awards–thus, they don’t taint the status of the underlying awards even if they will be paid to award holders before the performance conditions have been met (or will be paid even if the conditions aren’t met). But the dividends or equivalents themselves are considered performance-based compensation only if they also meet the requirements for this treatment under Section 162(m)–i.e., if they will be paid only upon attainment of performance targets and meet the other requirements specified under Section 162(m).
The easiest way to ensure that the dividends/equivalents will be considered performance-based under Section 162(m) is to pay them out only when the underlying award is paid out. If the award is forfeited, the dividends/equivalents accrued on it are forfeited as well. This is also a best practice for accounting purposes and from a shareholder-optics standpoint (ISS specifically identifies paying dividends on unvested performance awards as a “problematic pay practice”–see my December 15, 2010 blog entry, “ISS Policy Updates“).
Interestingly–in a grotesque-but-can’t-look-away sense–the ruling says that the dividends/equivalents don’t have to be subject to the same performance criteria as the underlying award–you could have one set of goals for the award and different goals for the dividends. That seems like a disaster just waiting to happen–a mess from both an administrative and participant education standpoint (as if your executives really need another set of goals to focus on, in addition to the award goals and the cash bonus plan goals). But now that the IRS has suggested it, I fear there is a compensation consultant already trying to design a plan that incorporates this feature. Just say “No!”
No Deduction for Dividends Paid on a Current Basis
Where the dividends will be paid out prior to satisfaction of the performance conditions–i.e., where they are paid to award holders at the same time they are paid to shareholders–the dividends are not considered performance-based compensation and are subject to the limit on the company’s tax deduction under Section 162(m).
This is just one more nail in the coffin for paying out dividends on a current basis. Even if the dividend payments aren’t that significant, I imagine trying to separate them from the original award for purposes of computing the company’s tax deduction will be a challenge. I have a headache just thinking about it.
No Surprises
My sense, from reading Mike Melbinger’s blog on CompensationStandards.com (“Code Sec. 162(m), RSUs, Dividends and Dividend Equivalents,” July 2, 2012) and the Skadden memo we posted on this, is that this is pretty much what everyone was doing anyway. It certainly seemed like common sense to me–if there is such a thing when it comes to the tax code. So, just like last month’s “Section 83 Update” (June 12, 2012), I’m a little surprised that the IRS doesn’t have anything more important to worry about. I’m sure this will be discussed at the IRS and Treasury Speak panel at the NASPP Conference–it will be interesting to hear why the IRS felt the need to issue this ruling.
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 we keep an ongoing “to do” list for you here in our blog.
Don’t miss the Silicon Valley chapter all-day conference this Wednesday, July 11. Robyn Shutak and I will be presenting on life events and equity compensation, with Liz Stoudt of Radford–we hope to see you there!
Chapter meetings are also being held in Chicago, Los Angeles, NY/NJ, and Philadelphia. I’ll be speaking at the NY/NJ and Philadelphia meetings–be sure to stop by and say hello!
Back in February, I blogged about tax rate increases in the UK. Now that we’ve gotten past the end of the UK tax year, it’s time to focus on the United States. Although not quite as dramatic, tax rates are expected to increase here beginning next year–yep, just six months from now.
What Did You Expect With a Democratic Administration?
The tax rates that are in effect now are a legacy of the Bush administration and are due to expire at the end of this year. As it stands now, all individual tax rates are expected to increase beginning in 2011. Ordinary income tax rates and short-term capital gains rates currently range from 10% to 35% and will increase to 15% to 39.6%. Long-term capital gains are currently taxed at 15%; this will increase to 20%.
In addition, the tax rate on qualified dividends will increase from 15% to the new ordinary income tax rates. This isn’t such a big deal for stock compensation, since dividends on unvested stock awards are usually already taxed at ordinary income tax rates, but where employees are receiving dividends on vested stock that they hold, this could be important for them to know.
Prior limitations on personal exemptions and itemized deductions will also be reinstated and the estate tax will be restored.
Will Congress Save Us From These Taxes?
Wholesale relief is not expected and an act of Congress is required to extend any of the Bush tax cuts. As daunting as that sounds, I understand that the Obama administration has indicated support for extending the current tax rates for low to middle-income taxpayers. It seems fairly certain, however, that the expected increases in tax rates that apply at higher income levels will happen. Ditto for the increase in the long-term capital gains rate, reductions in allowable personal exemptions, and limitations on itemized deductions. Short-term capital gains are taxed at the same rates as ordinary income, so whatever happens to ordinary income rates will also apply to short-term capital gains. There seems to be some question about what will happen to the qualified dividend rate.
What Isn’t Changing?
The two tax rates that aren’t changing are the rates that apply under the Alternative Minimum Tax–this may be the first good news we’ve heard for ISOs in a long time. If ordinary income tax rates increase but AMT rates stay the same, then ISO exercises will be less likely to trigger AMT liability. And with ordinary income tax rates increasing, holding ISO shares long enough to convert the spread at exercise to a long-term capital gain may be more tempting for employees.
Tax Withholding Rates
Tax withholding rates for federal income tax purposes are based on the marginal income tax rates so when those rates increase, so do the withholding rates that apply to compensation.
There are two rates that apply to supplemental payments (which include NQSO exercises and vesting/payout events for awards):
If all the current tax rates are allowed to expire, the optional flat rate that can be applied to supplemental payments will increase from 25% to 28% (some of you may remember that this is what the rate used to be, nine years or so ago).
The mandatory rate that applies to supplemental payments to individuals that have already received more than $1,000,000 in supplemental payments during the year is the maximum individual tax rate–which is expected to increase to 39.6%.
For companies that allow share withholding on restricted stock and unit awards (most of you that grant these awards), these expected changes could have implications at the corporate level, not just the individual level, since the amount of cash the company will need to make available to cover the tax payments will increase.
More to Come?
And this is just the beginning. Additional tax rate increases will go into effect in 2013 to fund President Obama’s health care reform package.
Planning for the Tax Increases
Just as with the UK increases I blogged about in February, advance planning and employee communication is key. Employees that have accrued considerable appreciation in NQSOs may want to exercise this year, while tax rates are lower. Employees that hold stock that has appreciated significantly in value may want to consider selling–although here the decision is complicated by the different tax rates that may apply depending on how long the shares have been held (i.e., short-term vs. long-term capital gains rates).
The good news is that the NASPP has scheduled a webcast to review the impending tax rate changes and planning considerations–be sure to tune in next Tuesday, July 27, for “How Upcoming Tax Rate Changes Impact Your Stock Plans” with Bill Dunn and Sheryl Eighner from PricewaterhouseCoopers.
18th Annual NASPP Conference Hear about all the latest tax developments impacting stock and executive compensation–straight from the IRS and Treasury–at the 18th Annual NASPP Conference. The Conference will be held from September 20-23 in Chicago; register today.
NASPP New Member Referral Program Refer new members to the NASPP and your NASPP Conference registration could be free. You can save $150 off your registration for each new member you refer, up to the full cost of registration. You’ll also be entered into a raffle for an Apple iPad and the new members you refer save 50% on their membership–it’s a win-win!
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.