I have a vivid memory of a moment that occurred during my first few weeks in the world of equity compensation. Freshly moved into the role of Stock Administrator, I was attending a meeting about the company’s upcoming IPO. I recall the General Counsel saying something like “…and we’ll need to figure out how we are going to keep track of the ISO QDs and DDs to make sure we properly report on the W-2 to the IRS.” That was a head scratching moment for me. Huh? What is an “ISO”? What is a “QD”? What is a “DD”? I think I’ve heard of the W-2 and the IRS.That moment was captured in my mind, because I left the meeting thinking to myself “with all these darn acronyms, I am never going to understand this stuff.” Fortunately, I did eventually get it figured out – but only after much confusion along the way. Of course, we’ve added so many new acronyms since that time. I often wonder how we can keep track of it all, and what new professionals in our industry must think about our heavy use of acronyms. In today’s blog I’m going to stick to the lighter side of things and offer up a quiz – for new and tenured stock compensation professionals. Can you pass the ECAC (Equity Compensation Acronym Challenge)?
The Rules of the Game
This is just for fun. There’s not even a prize. Yes, the answers are written in tiny print at the end of the blog. No, you can’t cheat.
All you need to do is answer the questions, check your answers, and have a bit of fun!
Here Goes…
Create your free online surveys with SurveyMonkey , the world’s leading questionnaire tool.
Check your answers below!
-Jennifer
Answers:
1. ISO = Incentive Stock Option
2. PSU = Performance Stock Unit
3. MSU = Market Stock Unit
4. DOMA = Defense of Marriage Act
5. DRO = Domestic Relations Order
6. EE = Employee
7. TSR = Total Shareholder Return
8. ESPP = Employee Stock Purchase Plan
9. HSR Act = Hart-Scott-Rodino Act
10. IFRS = International Financial Reporting Standards
11. FICA = Federal Insurance Contributions Act
12. SOX = Sarbanes-Oxley (as in the Sarbanes-Oxley Act of 2002 – and yes, there was a white house cat named “Socks” – different spelling!)
13. SEC = Securities and Exchange Commission (for those who picked “Southeastern Conference”, remember – this is an equity compensation, not sports, quiz!)
14. DRIP = Dividend Reinvestment Plan
15. IRC = Internal Revenue Code
16. MTM = Mark to Market
The NASPP’s virtual Vendor Exhibition Hall holds a fantastic list of service providers. Our Vendor Hall also hosts the Press Box, where you can see the latest news and events from our service provider members. Yesterday, this press release from UBS caught my eye–it highlights a survey they conducted showed that over 94% of surveyed participants “felt it was critical for them to fully understand how stock plan assets fit into their overall financial situation.”
I think that a lot of companies don’t take this aspect of employee education into consideration, but it can be important to how your employees perceive the value of their equity compensation. This isn’t true just for your executives or higher level employees, but all employees receiving equity compensation. The fact is that the more tools employees have to leverage the value of their equity compensation, the more they will actually value it. Most employees don’t even have a financial plan, let alone understand how to incorporate something like the timing of option exercises or disposition of ESPP shares into that plan. They often don’t know when or how to diversify, how to navigate the impact of taxes due on transactions, or how to use their equity compensation to build personal wealth. An employee who has a plan for his or her future that emphasizes the company’s equity compensation is more likely to feel personally invested in the future success of the company.
However, there are two major difficulties with providing the best tools. First, too much information can be overwhelming and, therefore, counter to the goal of empowering employees. Second, companies don’t generally want to get in the business of advising employees because they can’t afford to be held responsible for poor investment decisions or unexpected market fluctuations. So, how do you go about providing employees with the financial planning guidance they need without just confusing them or opening your company up to unnecessary risk?
Some companies are comfortable with directing employees to one or more service providers to help guide employees. Brokerage firms all offer some kind of financial planning service. It may make the most sense for employees to build on an existing relationship rather than start an entirely separate one. You may even be able to get a representative or two from your broker’s financial planning providers to participate in new hire orientations, employee benefits fairs or educational seminars at your company.
There are a good number of companies, however, that feel this type of promotion is too much like an endorsement of any personal guidance employees receive and not much less risky than providing advice directly. If that’s the case at your company, here are some ideas for you:
Include it in your disclaimers – You should have disclaimers in your educational material that alert employees to consult a financial advisor. They may appear along with FAQs on exercises or tax implications–or may even be a part of your verbal responses to employee questions. If you remind employees that the broker they use to transact also offers financial planning and include a link or phone number, employees will at least know where they can go for advice.
Create an impartial list – Employees need help with financial planning for their retirement plans as well as their equity compensation. If you put together a list of firms that offer this type of planning advice and include your retirement plan provider, brokers, and even firms that are not also your service providers, your company may be more comfortable with assisting employees in this way.
Provide a space for peer recommendations – If your company intranet has any sort of discussion forum or listing service, you can create a space for employees to tell each other where they go for financial planning advice. With the right disclaimers, this removes the company from the process while still providing valuable resources to employees.
Whatever approach you take, I think it’s important to understand that employees really are hoping to find someone to help them leverage the value of their equity compensation. The actions that employees take with their company stock are investment decisions; if employees feel they are making good decisions and creating wealth, they are far more likely to view their equity compensation as a benefit.
A policy is only as solid as its exceptions. You may have a well-defined plan or policy for your company’s current situation that has bare spots that may not stand the test of time–and unusual circumstances. It’s difficult to cover all your bases when you are creating a new policy or plan, but it’s even more difficult when you jump into managing an existing plan under inherited policies.
The problem is that it is rare that a stock plan manager has time to pick through every piece of every plan document and policy and play out every scenario to determine if there are cracks that need to be exposed. This is where experience really counts; whether it is your own personal experience or experience you picked up second hand by listening to the holes other stock plan administrators have encountered. Whenever you are networking, attending a presentation, or perusing a discussion forum and you hear a new predicament, run–don’t walk–back to your desk and check to see if your company could potentially run into the same issue.
Just to give you a taste, here are three problems to think about:
Insider Trading Policy
Generally speaking, insider trading policies restrict the transactions of individuals deemed to be in possession of insider information. They help to protect both the company and the individuals by preventing transactions that would either be or appear to be insider trading. However, there are a couple places where ambiguity could trip you up. For example, if your insider policy doesn’t detail what constitutes a transaction, you could find yourself up against (or in the middle of) a blackout period scrambling to determine the correct course of action. Cash exercises and trading shares to cover tax liability on restricted stock vests are the most common sources of contention. Even if you’ve covered yourself by getting all your insiders into Rule 10b5-1 trading plans, there could still be an issue when someone not normally considered to be an insider is marked for a particular blackout period because she or he is either recently promoted or currently in the middle of a project that provides access to nonpublic information. If that same person has, for example, a restricted stock vest during the company blackout window, you could have a situation on your hands.
Fair Market Value
The fair market value for both grants and transactions can be pretty much any reasonable definition, which means that companies may set fair market value differently. Non-market days can be blind spot when it comes to restricted stock vests. Another tricky situation may arise if your FMV is defined in such a way that it is possible for someone to exercise an underwater option. For example, if your company uses the prior day’s closing price as the FMV for option exercises, an employee could exercise barely-in-the-money options and end up with an exercise price that is higher than the defined FMV.
Terminations
Your company can treat all terminations equally, but most companies do not. Voluntary, involuntary, for cause, death, disability, and retirement are all on the list of potentially unique termination reasons with varying impact to equity compensation. Of course, you want to have each reason clearly defined, but the blind spot could be what happens if the circumstance combines more than one reason. For example, what if an employee leaves the company and subsequently passes away during the post-termination grace period?
Take Charge
For larger issues regarding plan design and policy, there are a number of resources on the NASPP site to provide essential guidance. Our April 2010 webcast, “25 Ways to Improve Stock Plan Documents,” details more than 25 plan design issues that you need to be aware of and we have an entire portal dedicated to plan design with a host of resources under multiple topics.
Finally, don’t overlook your opportunities to learn from others. The NASPP has over 30 local chapters planning regular meetings. Making sure you attend your chapter’s meetings gives you access not only to timely topics and great speakers, it also gives you the networking opportunity to discover which issues are most important to your peers and how they are dealing with them. We also have an active Discussion Forum where you can browse, search, and even subscribe to the topics that matter most to you.
I don’t spend a lot of time talking about investor relations because it generally isn’t something that stock plan administrators are closely involved with. But, I do spend a lot of time talking about and thinking about ways to get creative with employee communications. I ran across an article, Communicating Executive Pay Information on the Web, that revealed how closely related these two topics can be. Of course, this should come as no surprise to me because employees receiving equity compensation are investors.
In this article, author Dominic Jones makes the point that companies will be putting all their efforts into “trying to spruce up their mandatory proxy statements” in an effort to comply with Say on Pay regulations when the reality is that most investors won’t even read the key pieces of information that the proxy contains. This is very much like the efforts of stock plan administrators who have to spend so much time and energy ensuring that communications meet regulatory requirements that there doesn’t feel like there’s any left over to actually communicate with employees.
Simplify
Jones points out that the compensation disclosures are not only difficult to read, they are also difficult for investors to access. Stock plan management has the same issue with grant agreements, which are lengthy and filled with dense text. Even online grant agreements that require employees to open and/or actually scroll through often don’t get read at all. The fact that grant agreements really do need to contain all the necessary legal references and disclaimers doesn’t preclude alternate delivery methods for the key information contained in them–and the same goes for tax communications.
Be the First “Result” in Employee Searches
The article also talks about where most investors will turn to get information on executive compensation (since they apparently won’t be reading proxy statements). According to Jones, most shareholders will be soaking up information from other sources like the media (or social media) and their friends. Well, the same thing happens with employees. Stock plan administrators need to compete with other sources of information like media, co-workers, personal advisors. To be the source that employees turn to first, information on equity compensation must be both visible and accessible. You don’t want your employees to have to go digging for essential information on their equity compensation. Issues like taxation can get buried layers down into the company intranet, or lost in a stack of other communications.
Modernize
Being accessible isn’t just about having open office hours, a standard email for employees to use, or a special page dedicated to top issues. Accessibility means reaching employees through formats they are most likely to notice. In the world of investor relations, Jones suggests using videos, surveys, and social media. Not bad advice for stock plan administrators either. (By the way, my esteemed colleague at TheCorporateCounsel.net, Broc Romanek, gets major kudos from Jones on his explanation of shareholder compensation surveys.)
Section 6039 Webcast
Today we have the NASPP’s next installment in our “Ask the Experts” series, Last Chance to Ask About Section 6039 Returns (4:00 – 5:30 pm, eastern time). We received a resounding number of technical and administrative questions for this webcast; if you’ve got any loose ends on Section 6039 compliance, this is the session you cannot miss!
Honestly, I anticipated that the Bush-era tax cuts would lapse at the end of this year–and I know I’m not the only one. It’s is unusual for Congress to be this active this late in the year. But, yesterday the Senate did approve the tax plan which includes an extension of those tax cuts for two more years. The bill is up for a vote in the Senate today and is expected to pass. (See this article from Reuters.)
So, if your company has been grappling with what, if anything, should be done in anticipation of tax increases, you’ve just been given a couple more years to sort through the issue. If you are wondering what in the world this has to do with your stock plans, since employers can just use a flat rate for withholding on equity compensation, then you must have missed our July webcast, How Upcoming Tax Rate Changes Impact Your Stock Plans. Don’t worry; the full webcast and transcript are still available!
Where this bill could really hit home is this: In addition to the extension of the individual tax rates, the bill includes a one-year decrease in payroll taxes. Specifically, the 6.2% Social Security tax paid by employees would be reduced to 4.2%. Employers would not be given the same tax holiday; employer “matching” stays at 6.2%. The bill doesn’t appear to impact the changes to the Medicare portion of payroll taxes, which are set to increase from 1.45% to 2.35% for wages above the threshold amount starting in 2013. (For more information on the implications of the Health Care and Education Reconciliation Act of 2010, check out that great webcast I mentioned above.)
If this bill does pass, there are a few things you will want to be sure and prepare for. Obviously, you’ll need to make sure to update the Social Security tax rate in your stock plan administration database. Additionally, it will be a good idea to sit down briefly with your payroll department to confirm that there won’t be any glitches exchanging Social Security withholding and year-to-date levels after the payroll system is updated.
On the communication front, this isn’t really the kind of issue that warrants a whole campaign. It’s not confusing and lower taxes are always well received. It is, however, a great reminder of the value of a good disclaimer. Your educational materials, particularly those pertaining to taxes on equity compensation, should have a disclaimer that includes verbiage indicating that the information in the materials may not reflect current regulatory developments. This bill would mean a pretty straight-forward decrease in tax withholding, but the next development may not be so simple. Having a quality disclaimer helps protect the company in case there is a delay in updating your educational materials or if employees are inadvertently referring to outdated printed material. If you’re feeling ambitious, a handy little asterisk notation on any examples you have available to employees noting the one-year reduction in the Social Security withholding rate would be fantastic.
Finally, and maybe only after the dust settles from the changes that 2010 has brought us, take a look at what 2013 might look like for your employees, particularly those making over $200,000 annually, and decide if there are any changes your company may want to implement in anticipation of the tax rates increasing.
If your company provides equity compensation to employees in China, then you are likely grappling with the complexity of obtaining and maintaining compliance with your company’s SAFE filing. One important ongoing issue is the requirement that proceeds from the sale of shares be repatriated. China isn’t the only country that has a repatriation requirement. However, it does, to my knowledge, have the most rigorous enforcement of it.
China puts the onerous on the company to repatriate proceeds from the sale of shares acquired through equity compensation programs. In order to maintain compliance, companies need to tackle creating a process for ensuring repatriation.
Immediate Sale
One way to ensure that proceeds from sales are sent back to China is to force an immediate sale of shares at the original acquisition (e.g., at option exercise or RSU vest). By doing this, the company does not need to worry about tracking shares after they are acquired by the employee. Depending on the functionality provided by your designated broker, this approach may also make quarterly reporting easier, which I’ll address below. However, forcing the immediate sale of shares denies Chinese employees the ability to capitalize on any future increase in the value of those shares. Arguably, the value of this arrangement is no more advantageous to the employee than cash compensation that is tied to share value. In addition, the terms of outstanding grants may not give the company the flexibility to require the immediate sale.
Tracking Shares
Many brokers now have the ability to place a hold on proceeds from sales made through specific employee accounts and remit those funds back to a corporate account. This makes it possible for China plan participants to hold shares and sell them at a date of their choosing and still comply with the repatriation requirement. Of course, you will need to confirm that employees can’t transfer the shares out of the employee account at any time, even after termination. You’ll also want to fully understand how employees are identified as subject to the hold and have appropriate safeguards in place to make certain those identification markers are accurate.
Converting to RMB
Regardless of the method in which proceeds from sales are repatriated to China, funds are sent to the company’s bank account in China in U.S. dollars and must be converted to RMB. Your company must decide if this conversion is done by the company or by the employees individually. If the company is transacting the exchange through the dedicated bank account, the RMB can be distributed to the employee through individual bank accounts or through payroll. However, the company may need to receive approval from the local SAFE office for each conversion and there may be limitations on the number of times that the currency may be exchanged each year. If the company will be disbursing U.S. dollars, then employees must have a U.S. dollar account.
Quarterly Reporting
Regardless of your approach, SAFE offices require information about the source of the incoming funds, including the original acquisition date of the shares, to be reported on a quarterly basis. Some brokers have the functionality to provide this data to clients already. At a minimum, you will need to know the total proceeds net of broker fees associated with each employee and the number of shares sold, in which case you must create a policy and procedure on associating the sales with specific acquisitions (e.g. option exercises or RSU vests). Talk with your broker to understand what information can be provided at this time.
Last week while I was thinking about the ongoing issues for companies with equity compensation in India, the Federation of Indian Chambers of Commerce & Industry (FICCI) was considering the ongoing issues for employees. This week, FICCI issued a letter to the finance ministry asking that the taxation of ESOPs (Employee Stock Option Plans) be amended (See the press release here.).
In the proposal, FICCI asks that the discount value at grant, as opposed to the spread at exercise, be taxed as income. FICCI argues that only the discount provided by the company at grant represents the consideration given to the employee by the company; any increase in value after that is more like investment income. FICCI maintains that taxing the spread at exercise as a perquisite is counter to the SEBI guidelines for stock options.
The press release focuses on the section of the SEBI guidelines that stipulates the fair value of an option should not be adjusted for “changes in the price of the underlying stock, volatility, the life of the options, dividends on the underlying stock, or the risk-free interest rate.” Although the FICCI proposal does mention that SEBI guidelines define the FMV of an option as the market price prevalent on the grant date, it fails to mention that this “market price” referenced in the guidelines is actually the trading value of the option, or estimated trading value based on a valuation model (e.g., a Black-Scholes valuation). At any rate, this is merely a request to the finance ministry at this point. It remains to be seen whether or not the finance ministry will even entertain the idea. Because it would probably result in a decrease in tax revenue, my gut tells me no…but stranger things have happened!
Ads by Google: Or, “An ESOP by Any Other Name”
While reading an article on the FICCI proposal, Google ads saw a great acronym and gave me a targeted add for the ESOP Association. Because of that, I learned that October is Employee Ownership Month, which, I must admit, caught me by surprise. Although employee ownership is a foundation for most equity compensation, Employee Stock Ownership Programs (ESOPs) in the United States are specific programs under which shares of company stock are placed in a trust. Shares in the trust are allocated to employees based on whatever parameters have been set up by the company. The allocated shares typically vest over time, but vested shares are not actually issued to the employee until termination.
October has been Employee Ownership Month for more than 20 years; it’s a month set aside to educate the public (not just employees) about the benefits of employee ownership (i.e., ESOPs). According to the ESOP Association, “…companies celebrate with picnics to honor their employee owners, hold roundtable discussions with local public officials and organizations to spread the word about employee ownership, and some hold awards ceremonies to honor outstanding employees.”
So, I searched and searched, but I couldn’t find anyone that celebrates an “Equity Compensation Month.” With the cyclical nature of bad press on equity compensation, I certainly think we could benefit from one. Wouldn’t it be great if companies everywhere celebrated equity compensation at the same time?
I was fortunate to be the moderator for one of the Conference sessions, “QUALCOMM and Microsoft: Gold Standards in Employee Communication.” It was very exciting to see all the top-notch communications policies and practices in place at these two companies! I can’t share them all with you in just one blog entry, but today I share my absolute favorites.
Custom Alerts
Custom communications are a fantastic tool for alerting employees to important events or necessary actions. What impressed me the most about the alert systems that used by both of these companies is that they are able to send out alerts for upcoming events from an internal email address. Your broker may be able to help with some or all of these alerts. However, the cool thing about taking it in-house is that when essential messages come directly from the stock plan services team, employees are trained to pay attention to both their equity compensation and other communications from the team.
There are a number of alerts and notifications that may be useful to employees. These three really stood out:
Countdown to Grant Acceptance Deadline
If you have a grant acceptance policy with teeth (e.g.; recipients forfeit the grant if not accepted within a specific timeframe), this particular alert is particularly important. Even if there are no defined consequences for failure to accept a grant, reminding an employee periodically that there is a grant that requires acceptance is a best practice. Targeting employees who have this on their “to do list” greatly increases the odds that they will complete the grant acceptance process.
Upcoming RSU Vest
An upcoming RSU vest is a time for planning, both for the stock plan services team and the employee. Including action items in an alert to employees helps them prepare. If there are any choices or actions that have a deadline (like broker selection, tax payment method, or grant acceptance), this type of alert may be your last chance to get their attention.
Unexercised Option Expiration
An automated alert sent directly to employees notifying them of an in-the-money option that is about to expire is great for them and can reduce risk for the company. Notifying them of a deeply underwater option that is about to expire, on the other hand, is just rubbing salt in the wound. Create parameters that weed out the options that have no hope of being in the money before expiration and you’ve got yourself a stellar communications practice!
Rolling out a new plan
Many companies are changing the way they look at equity compensation. This presentation offers many unique practices for rolling out a new plan or compensation philosophy to employees. If your company is considering changing the compensation mix, introducing a new equity compensation vehicle, or expanding performance grants to a larger population, this presentation has some essential tips for you. These three ideas were my favorites:
Blog
This one really is timeless. Having information available on the intranet is great. Actually, it’s essential in my book. A blog that employees can either subscribe to or go for the latest updates and archived of information and FAQs gives you a forum that is dynamic and current. Implement it when rolling out something new, and keep it up to feed employees information in bite-sized pieces later on!
Webcasts by Location
Again, this is another idea that is fantastic for communicating a new plan, but doubles as an ongoing tool that is especially helpful for new hires. Webcasts can be saved for download on the intranet or aired at special meetings or new hire orientations. Customizing the information to fit each country or location, including translation if necessary, really personalizes equity compensation in a way that one generic presentation simply can’t. This way, employees will see grant sizes, tax implications, and brokerage information that is applicable to them.
Practice Communications
I was totally tickled by this idea! You start by creating focus groups to find out what verbiage and format gets the best results. Then, test out your dissemination process on another group. The example from the presentation is a “cascading” communications strategy, an advanced version of “train the trainer”. The information starts with the VPs and moves on down the organizational chart with each level speaking to the employees directly under them. This can be a highly effective communications strategy, but it could turn out like a bad game of “telephone.” Taking a dry run lets you see what your end result is with your test group and gives you time to make necessary adjustments before implementing the communication process for the entire company.
Domestic mobility can be as complex as international mobility, but it certainly gets less press. With state governments dealing with budgetary difficulties, state tax authorities will be looking to capture as much “lost” tax revenue as possible. There are many situations where an individual may be required to report income and pay taxes in one or more states other than their state of residence, and stock option income is no exception. Most states follow federal income tax treatment for equity compensation, but only some specifically address how equity compensation should be sourced when mobility is an issue. For this reason, it really is best to get tax advice before creating a policy on domestic mobility.
Identifying Mobile Employees
There are three main situations that can lead to equity compensation being sourced to more than one state. The first, and probably easiest, is a permanent move made by an employee or former employee. When an employee or former employee moves from one state to another, you generally only need to assess the income sourcing once and then apply it to equity compensation going forward. Next on the list are employees that work outside their state of residence. This is most likely in the New England states where commuting across state lines can be quite common. Finally, there are employees who perform services for the company in more than one state. These situations can be the most challenging for stock plan mangers not only in determining compliance, but also in simply obtaining the travel information. Unlike with moves or permanent transfers, the details surrounding business trips or temporary assignments may not be evident in standard employee demographic details and must be communicated to the stock plan management team separately.
Sourcing Issues
When it comes to equity compensation, the key to handling domestic mobility is identifying when your company has an obligation to report or withhold on income from stock plan transactions in more than one state, or in a state other than your employee’s state of residence. Once that is established, the next step is to understand how each state sources the income. In many cases, the sourcing is between the grant and the exercise date for options (or vesting date for restricted stock). However, some states only consider residency at grant or at exercise and some completely have unique parameters.
Just like with international mobility, there will likely be situations of double taxation. States generally tax residents on all equity income, regardless of where it was earned. Alternatively, many states will also tax non-residents on equity income considered to be earned in that state. To address double taxation, there may be tax credit available to employees in either their state of residence or the non-residence state where equity income is earned. Additionally, some states have specific reciprocity agreements between them to avoid double taxation. It may be possible for your company to rely on these arrangements when reporting and withholding on equity compensation.
Steps to Compliance
A great way to tackle domestic mobility compliance is to start with the most visible (i.e. riskiest) and most common situations. Check to see if you have particular locations or employee segments where mobility is more common and determine which types of sourcing issues you are dealing with. Once you have an idea of what mobility issues you are going to address first, get informed on the sourcing and taxation requirements for the states in question. You can find information on our site in the State and Local Tax portal, but before making any decisions, consult your company’s tax advisor. Once you’ve made decision on how your company will handle specific situations, document a clear policy and run it past your auditor for confirmation.
For equity compensation transactions that are subject to U.S. federal income tax withholdings, companies can choose to withhold at either the employee’s W-4 amount or the supplemental wage flat rate of 25% for the first $1,000,000 of supplemental wages paid to the employee within a calendar year. As Barbara mentioned in her entry on Excess Tax Withholding, most companies choose to withhold at the flat rate for supplemental wages simply because it is easier than tracking employees’ W-4 rate and applying it. A definition of supplemental wages, the withholding requirements, and examples can all be found in IRC Regulation §31.3402(g)-1.
The Difference $1 Million Makes
In the context of U.S. income tax withholding on equity compensation, $1 million within a calendar year is a threshold for how employers should withhold on supplemental income. Below that amount, a company can choose to withhold at the 25% flat rate or the employee’s W-4 rate. After that amount, a company must withhold at the 35% flat rate.
This means that cumulatively, all supplemental wage payments made in the same calendar year are combined to determine the total supplemental wage payments made to each employee. After an individual reaches $1 million, the flat rate changes from 25% to 35% and the choice to withhold at the employee’s W-4 rate is no longer available. Because equity compensation is considered supplemental wages, stock plan management teams need to be prepared to withhold at the higher level once an employee crosses this threshold.
Supplemental Wages
So, exactly what are supplemental wages? While there are a number of examples specific listed in the Code, many are not. The definition of supplemental wages is “all wages paid by an employer that are not regular wages.” I know, not a lot of help, right? Fortunately, the most common types of supplemental wages are given as examples including cash bonuses, noncash fringe benefits, equity compensation, and commissions. It’s a good idea for stock plan managers to meet with their payroll contacts to confirm that the cumulative year-to-date supplemental wage amount for each employee is being correctly calculated and communicated to the stock plan management team.
Remind Me Again When I Need to Do This?
It sounds pretty simple, right? If a company has paid $500,000 in supplemental wages to an employee, and that employee realizes income from an option exercise in the same calendar year for another $500,000, then the stock plan management team must be prepared to withhold at the 35% flat rate for any additional equity compensation income in that year.
But, what happens if that option exercise is $700,000 instead of $500,000? The IRS has offered companies two methods to handle that situation. If one particular payment (e.g.; one specific option exercise) straddles the $1 million threshold, companies may either withhold at the 35% flat rate for the entire payment or withhold at 35% for only the portion of the payment that exceeds $1 million. So, in my (very simplified) example, the company could withhold on the entire $700,000 RSU vest at 35% or apply the 35% withholding rate to only the $200,000 that exceeds the first $1 million.
As a stock plan manager, make sure you know how your company wants to withhold on single transactions that straddle the $1 million supplemental wage threshold. Also, get a solid understanding of how your stock plan administration software handles this situation.
For more information on tax withholding on equity compensation, visit our Tax Withholding and Reporting portal on the NASPP site.
If you missed the early-bird rates, it’s not too late to get a discount. We are now offering a $200 discount on registration through May 14th. You can even get an additional 10% discount by participating in the 2010 Domestic Stock Plan Design Survey before our final extended deadline tomorrow, April 23rd.