I’m terrible at math. Really, really bad at it. Like the Justin Timberlake character in the movie Friends with Benefits bad. So, for most of my career here at the NASPP, posting the alert about the yearly change to the maximum wages subject to Social Security has been a challenge, because it requires me to multiply the maximum wages by 6.2% to figure out the maximum withholding. Easy enough for most people, but in a lot of years I get it wrong.
So I’ve implemented some controls. Always copy the maximum wage base from the SSA press release; never type it. Instead of using a calculator (not as reliable as you might think, due to human error typing in the numbers or transcribing them), always do the math in Excel and always copy the result from Excel to the alert. And have someone else check my work, even though that person usually thinks I’m nuts for needing help with this. And then I check it a bunch more times myself (because it turns out that a lot of people are bad at math).
But this year, dammit, I got it right. I wrote a blog about it and posted the alert and no one emailed to tell me I had it wrong.
And then…
The SSA announced that they were changing the maximum. Yep, on November 27, the SSA issued a press release announcing that the maximum wage base for 2018 that they had originally reported ($128,700) is wrong and that the correct wage base for 2018 is $128,400. So the maximum Social Security withholding for 2018 is $7,960.80 (pretty sure, but feel free to check my math).
The SSA says the reason for the change is updated wage data:
This lower taxable maximum amount is due to corrected W2s provided to Social Security in late October 2017 by a national payroll service provider. Approximately 500,000 corrections for W2s from 2016 resulted in changes for three items based on the national average wage: the 2018 taxable maximum, primary insurance amount bend points–figures used in the computation of Social Security benefits–and family maximum bend points. No other items based on national average wages were affected.
But, I don’t know. Sure, it’s a believable story, but I think maybe the SSA is just as bad at math as I am. Just kidding. I really have no reason to doubt their explanation, although I am a little surprised that just half a million corrections can move the wage base by $300. With over 123 million employees in the United States in 2016 (and that doesn’t even count part-timers), that must have been quite an error.
Back in mid-October, just before the NASPP Conference, the SSA and IRS announced the cost-of-living adjustments for 2018. I had expected to get around to blogging about this sooner, but then the House released its version of the Tax Cuts and Jobs Act and the topic of tax reform and its potential impact on stock compensation eclipsed all other topics.
COLAs
I’ve provided a description of the adjustments that impact stock compensation below. Here is an IRS chart that provides a complete list of updates.
FICA
The maximum amount of earnings subject to Social Security tax will increase to $128,700 in 2018 (up from $127,200 in 2017). The Social Security tax withholding rate will remain at 6.2%. With the new wage cap, the maximum withholding for Social Security will be $7,979.40. [Note: The SSA has since lowered the wage base for 2018 to $127,400, resulting in maximum withholding of $7,960.80. See my December 12 update.]
Medicare tax rates also remain the same and are not subject to a maximum (the threshold at which the additional Medicare tax applies is likewise unchanged).
Highly Compensated Employee Threshold
The threshold level of compensation at which an employee is considered highly compensated for purposes of Section 414(q) will remain unchanged at $120,000 in 2018. This threshold defines “highly compensated” for purposes of determining which employees can be excluded from a qualified ESPP under Section 423.
Update on the Tax Reform Bill
And, for your tax reform fix, here is an update: the House passed its version of the bill and the Senate Finance Committee approved its version to proceed to the full Senate. Debate on the bill is expected to start in the Senate after Thanksgiving. One GOP senator (Ron Johnson, WI) has already said he won’t vote it and a few other GOP senators appear to be undecided. None of the Democrat senators are expected to vote for it, so the bill won’t pass if the GOP loses two more votes (at least not this time—they could always go back to the drawing board and bring a new bill to a vote).
The provisions in both bills that directly impact stock compensation are the same as they were last Thursday (taxing stock options at vest is out, Section 162(m) expansion is in, and tax-deferred arrangements for private companies are in).
For what it’s worth, GovTrack reports that Skopos Labs gives it a 46% chance of passing (as of November 20, when I last checked it).
Happy Thanksgiving!
This will be our only blog this week because of the holiday. I wish you all a happy Thanksgiving and I hope you have a celebration that is completely free from discussions of both tax reform and equity compensation.
For today’s blog, I feature five trends in tax withholding practices for restricted stock and units, from the 2016 Domestic Stock Plan Design Survey (co-sponsored by the NASPP and Deloitte Consulting):
Share Withholding Dominates; Sell-to-Cover Is a Distant Second. The majority (79% of respondents for executive transactions, 77% for non-executive transactions) report that share withholding is used to fund the tax payments the majority (greater than 75%) of award transactions. Most of the remaining respondents (17% of respondents for executive transactions, 18% for non-executive transactions) report that sell-to-cover is used to pay the taxes due on the majority of award transactions.
Rounding Up Is the Way to Go. Where shares are withheld to cover taxes, 75% of respondents report that the shares withheld are rounded up to the nearest whole share. Most respondents (62% overall) include the excess with employees’ tax payments; only 13% refund the excess to employees.
FMV Is Usually the Close or Average. The overwhelming majority (87%) of respondents use the close or average stock price on the vesting date to determine taxable income. Only 12% look to the prior day’s value to determine taxable income, despite the fact that this approach provides an additional 24 hours to determine, collect, and deposit the tax withholding due as a result of the vesting event (see “Need More Time? Consider Using Prior Day Close“).
Form 1099-B Is Rare for Share Withholding. Although share withholding can be considered the equivalent of a sale of stock to the company, only 21% of respondents issue a Form 1099-B to employees for the shares withheld.
Companies Are Split on Collecting FICA from Retirement Eligible Employees. Where awards provide for accelerated or continued vesting upon retirement, practices with respect to the collection of FICA taxes are largely split between share withholding and collecting the tax from employees’ other compensation (41% of respondents in each case).
Lately, there’s been a lot of speculation about what a Trump presidency and a Republican Congress means for tax rates in 2017. I got nothin’ on that. But what I do have for you today are some tax changes for 2017 that are already finalized.
New Filing Deadlines
Where nonemployee compensation is reported in box 7 of Form 1099-MISC, the deadline to file the form with the IRS has been accelerated to January 31 (previously the deadline was February 28, for paper filers, and March 31, for electronic filers). This will apply to Forms 1099-MISC issued to report compensation paid to outside directors, consultants, independent contractors, and other nonemployees.
Form 1099-MISC is also used to report income recognized on (i) stock plan transactions after an employee’s death, and (ii) transactions by an employee’s ex-spouse for stock awards transferred pursuant to divorce. In each of these cases, however, the income is reported in box 3, rather than box 7. Consequently, a Form 1099-MISC for these transactions doesn’t need to be filed until the regular February 28/March 31 deadline. (Assuming, of course, no other income is reported in box 7 of the form. For instance, if an employee’s ex-spouse provided services to the company as a consultant in 2016 in addition to exercising a stock option transferred to him in their divorce settlement, and the income for the consulting fees is reported in box 7 along with the option gain in box 3, the Form 1099-MISC would have to be filed with the IRS by January 31. And if the employee died in 2016 and hadn’t updated her beneficiary designation so her RSUs were paid out to the ex-spouse in addition to the consulting fees and the option gain…well, you get the idea.)
The deadline to file Form W-2 with the Social Security Administration has also been accelerated to January 31. These changes were part of the Protecting Americans from Tax Hikes Act and are intended to help prevent tax fraud. In the past, individual taxpayers received their copy of these forms before the IRS and could have even filed their tax return before the IRS received their Form W-2 or 1099-MISC. This could result in errors (inadvertent or intentional) that the IRS wasn’t able to catch until possibly as late as April, when the company filed these forms with the SSA/IRS. By then, a refund might have been issued to the taxpayer and the IRS was in the difficult position of trying to recover it. With the accelerated filing deadlines, the IRS will theoretically be able to catch these errors before refunds are issued.
The deadline for filing Forms 3921 and 3922 with the IRS is still February 28/March 31. Also, the deadline to distribute the employee copy of all of these forms is still January 31.
COLAs
The cost-of-living adjustments for 2017 have also been announced. Here are the highlights that related to stock compensation:
The wage base for Social Security is increasing to $127,200 (up from $118,500 in 2016). The Social Security tax rate isn’t changing (that requires Congressional action), so if I’ve done the math right (something you should never take for granted—math just isn’t my gig), the maximum withholding for Social Security will be $7,886.40 in 2017.
No changes to the Medicare rates or the threshold at which the higher rate kicks in, at least for now. Changing either of these things also requires Congressional action; while it’s certainly possible that a repeal or amendment of Obamacare might result in changes to Medicare tax rates or thresholds in 2017, it’s unlikely that either will change before the new administration begins.
The level of annual compensation at which employees can be considered highly compensated for purposes of excluding them from participating in a Section 423 ESPP will remain $120,000.
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).
As is often the case at this time of the year, a lot of tax related questions have been popping up in the NASPP Q&A Discussion Forum lately. For today’s blog entry, I try to quickly answer some of the questions I’ve seen the most frequently.
Former Employees You have to withhold taxes on option exercises by and award payouts to former employees and report the income for these stock plan transactions on a Form W-2, no matter how long it has been since they were employed by the company. The only exceptions are:
ISOs exercised within three months of termination (12 months for termination due to disability).
RSAs paid out on or after retirement (because these awards will have already been taxed for both income tax and FICA purposes when the award holders became eligible to retire). Likewise, RSUs paid out on or after retirement that have already been subject to FICA are subject to income tax only.
If the former employees did not receive regular wages from the company in the current year or the prior calendar year, US tax regs require you to withhold at their W-4 rate, not the supplemental rate. In my experience, however, few companies are aware of this and most withhold at the supplemental rate because the W-4 rate is too hard to figure out.
Changes in Employment Status Where an individual changes status from employee to non-employee (or vice versa) and holds options or awards that continue to vest after the change in status, when the option/award is exercised/paid out, you can apportion the income for the transaction based on years of service under each status. Withhold taxes on the income attributable to service as an employee (and report this income on Form W-2). No withholding is necessary for the income attributable to service as a non-employee (and this income is reported on Form 1099-MISC).
Any reasonable method of allocating the income is acceptable, so long as you are consistent about it.
Excess Withholding I know it’s hard to believe, but if you are withholding at the flat supplemental rate, the IRS doesn’t want you to withhold at a higher rate at the request of the employee. They care about this so much, they issued an information letter on it (see my blog entry “Supplemental Withholding,” January 8, 2013). If employees want you to withhold at a higher rate, you have to withhold at their W-4 rate and they have to submit a new W-4 that specifies the amount of additional withholding they want.
Also, withholding shares to cover excess tax withholding triggers liability treatment for accounting purposes (on the grant in question, at a minimum, and possibly for the entire plan). Selling shares on the open market to cover excess tax withholding does not have any accounting consequence, however.
ISOs and Form 3921 Same-day sales of ISOs have to be reported on Form 3921 even though this is a disqualifying disposition. It’s still an exercise of an ISO and the tax code says that all ISO exercises have to be reported.
On the other hand, if an ISO is exercised more than three months after termination of employment (12 months for termination due to disability), it’s no longer an ISO, it’s an NQSO. The good news is that because it’s an NQSO, you don’t have to report the exercise on Form 3921. The bad news is that you have to withhold taxes on it and report it on a Form W-2 (and, depending on how much time has elapsed, it might have been easier to report the exercise on Form 3921).
FICA, RSUs, and Retirement Eligible Employees This topic could easily be a blog entry in and of itself, but it doesn’t have to be because we published an in-depth article on it in the Jan-Feb 2014 issue of The NASPP Advisor (“Administrators’ Corner: FICA, RSUs, and Retirement“). All your questions about what rules you can rely on to delay collecting FICA for retirement eligible employees, what FMV to use to calculate the FICA income, and strategies for collecting the taxes are covered in this article.
Today I discuss recent litigation over mishandled FICA taxes on a nonqualified deferred compensation plan that could also have implications for RSUs.
The Lawsuit
The case involved a company that failed to collect FICA taxes on benefits paid under a nonqualified deferred compensation when the taxes were due. Because of this, and because the applicable statute of limitations during which the company could go back and amend the return for the year in which FICA should have been paid had elapsed, the company was obligated under IRS regulations to collect FICA when the benefits under the plan were paid out. The payouts occurred after the employees had retired.
The plan provided for payouts to occur in increments over a period of years, and, because the retirees were no longer actively employed, they had no other wages subject to FICA. As a result, the payouts were subject to Social Security. If the company had collected FICA when it should have, the payouts might not have been subject to Social Security because 1) the retirees would have still been employed and would have possibly met the wage cap for Social Security in those years; 2) the wage cap would have been lower; and 3) the entire amount would have been subject to Social Security in the same year, rather than in small increments over many years. A retiree brought suit against the company essentially claiming that because this was the company’s error and the error increased the amount of FICA tax that he has to pay, the company should have to pay his FICA tax for him.
This situation could also come up in the context of RSUs. Certainly it could apply where RSUs are subject to deferred payout, but more commonly it is likely to be a concern where RSUs provide for accelerated/continued vesting upon retirement and are granted to or held by employees that are eligible to retire. In that circumstance, the RSUs are substantially vested and are subject to FICA before they are paid out.
I learned a couple of important things from this that are applicable to RSUs.
There Is a Statute of Limitations
Who knew? If you screw up on FICA withholding for RSUs, you have a limited period of time in which to go back and fix this. That time is approximately three years (although the actual calculation of the statute of limitations is a little more complicated so if this applies to you, talk to your tax advisors).
FICA Taxes Revert Back to Payout
Even more interesting, if you don’t find the error and correct it before the statute of limitations runs out, your only choice is to collect FICA when the awards are paid out. Again, I say, who knew?
No Need to Panic, Yet
All this is interesting, but, of course, our primary interest is whether companies could be liable to participants for mishandled FICA taxes on RSUs. At this point, it’s hard to tell. Although there has been one decision in favor of the retiree, this case is far from over (that decision just allows the case to proceed), so who knows if the retire will prevail. And even if he does, the situation in this case isn’t fully analogous to RSUs. For one thing, the retiree is claiming a violation of ERISA, which typically doesn’t apply to RSUs.
Moreover, RSUs typically pay out at the time of retirement, not over a period of years after retirement. Thus, in the case of RSUs, there wouldn’t be a question of the payments being subject to Social Security when they otherwise wouldn’t have if FICA had been collected on time. The error would only increase FICA taxes through an increase in the stock price (which would mostly apply only to Medicare since Social Security is capped), an increase in the Social Security wage cap, and maybe differences in compensation levels (but only for employees that don’t otherwise normally earn enough to max out on Social Security). Even where employees are subject to tax at the higher 2.35% Medicare rate, it seems unlikely that any of those things would be worth suing over.
The IRS and the Social Security Administration have announced the COLAs for next year. That’s COLAs as in “cost of living adjustments” (in case you were wondering what the IRS and SSA have to do with soda pop).
A Quiet Year
Some years are quieter than others when it comes to tax-related changes. At this time last year we were looking at changes to FIT withholding rates, FICA withholding rates, a new Social Security wage cap, new Medicare taxes, a threshold increase relating to highly compensated employees, plus last minute tax legislation at the start of the year to restore some FIT withholding rates to 2012 levels. I count at least seven NASPP Blog entries on the tax rate changes that went into effect (and didn’t go into effect after all) at the start of 2013.
What a difference a year makes! Things are a lot quieter this year. At the federal level, it looks like the only change that impacts stock compensation is the Social Security wage cap. Bad news for Jenn and I since now we’ll have to come up with other ideas for six more blog entries but good news for you since you won’t have to sort through and implement a bunch of tax rate changes over the holidays.
FICA
As noted, the wage cap for Social Security tax purposes will increase to $117,000, up from $113,700 last year. The tax rate remains the same at 6.2%, so this increases the maximum Social Security withholding to $7,254 per employee. Incidentally, the SSA estimates that about 10 million workers will pay higher taxes as a result of the increase.
As far as I know, the Medicare rates and the threshold at which the additional Medicare tax applies will remain the same in 2014.
Highly-Compensated Employees
The threshold at which an employee is considered highly compensated for purposes of Section 423 will remain at $115,000 in 2014. (Section 423 allows, but does not require, highly compensated employees to be excluded from participation.)
In today’s blog, I provide an update on the status of FICA taxes as we head into next year and include a note from Alan Dye on the impact of Hurricane Sandy on EDGAR filings.
FICA Tax Increases for 2013 The Social Security Administration announced in a press release on October 16 that the annual wage base for Social Security tax is increasing to $113,700 in 2013 (up from $110,100 in 2012).
In addition, the current 2% rate cut for the employee portion of FICA is due to expire at the end of this year. If Congress doesn’t take action before the end of the year, the withholding rate for Social Security will return to 6.2% next January. If I managed to do the math correctly (something you should never take for granted), that will bring the maximum Social Security tax payment for 2013 up to $7,049.40. This is up from $4,624.20 this year, an increase of over 50%.
For the first time since I’ve started working in stock compensation, the Medicare tax is also increasing, at least for those in the top income tax brackets. As noted in my August 7 blog, “The Supreme Court and Stock Compensation,” wages in excess of $200,000 per year ($250,000 for married taxpayers that file jointly, $125,000 for married taxpayers that file separately) are subject to an additional .9% Medicare tax. Companies will apply the higher rate to any wages in excess of $200,000, regardless of the employee’s filing status and the rest will be sorted out when employees file their tax returns.
The additional Medicare tax applies only to employees; the company’s matching payment is not increased.
There are already a couple of threads started on administering the new Medicare tax in the NASPP Discussion Forum, see topics 7186 and 7354.
Highly Compensated Employees The wage threshold for which employees are considered highly compensated for purposes of Section 423 qualified ESPPs will remain at $115,000 for 2013.
Hurricane Sandy and EDGAR Filings Alan Dye notes in his blog on Section16.net that Hurricane Sandy is preventing folks on the East coast from submitting Section 16 filings and that the SEC was quick to offer relief. From Alan’s blog yesterday:
With Hurricane Sandy bearing down on DC and much of the Northeast, some filers and filing agents are having trouble getting to their offices to make Section 16(a) filings that are due today. The staff is taking an accommodating position for purposes of Section 16(a) and Item 405, saying that “For those affected by the hurricane — filers (or their lawyers/agents) along the East Coast — we won’t object if the filings that are due today are filed tomorrow (assuming that tomorrow is a day on which people can go to work). For filers not affected by the hurricane, then today is a regular business day and filings due today have to be filed today. So, this is effectively a no action position for only those filers (or their lawyers/agents) affected by the hurricane.”
Presumably filers not affected by the hurricane have no need for relief and will file on time. Filers scrambling to find a filing agent, though, now have some breathing room and can file tomorrow (assuming tomorrow is a normal business day). Thanks to the staff for getting on top of this issue quickly.
Hurricane Sandy and Option Exercises We also had a couple of threads started in the NASPP Discussion Forum on how employees that are up against the contractual expiration of their in-the-money stock options can exercise despite the market’s unexpected closure due to Hurricane Sandy. Here is a quick list of the alternatives:
pay cash for the exercise
net exercise
stock-for-stock or pyramid exercise
margin loan to be closed out when the market reopens and the stock acquired up exercise can be sold
loan from the company (if the optionee is not an officer or director) to be repaid as soon as the market opens and the stock can be sold
See NASPP Discussion Forum topics 7361 and 7362 for more information.
Trivia question: Which major US Supreme Court decision this summer is going to impact tax withholding procedures for your stock plans next year?
If you guessed the decision on the Patient Protection and Affordable Care Act (President Obama’s healthcare reform package), you are a winner! 10 points to you!
What the Heck?
The reason is that the healthcare reform package increases Medicare taxes beginning next year (see my blog “One for You, Nineteen for Me–US Style,” July 20, 2010), which changes the rate at which Medicare needs to be withheld for stock compensation. With the Supreme Courts’ ruling, the new tax rates will now go into effect as planned. Even if Mitt Romney wins the presidency and does manage to repeal the entire healthcare package, he’s won’t take office in time to prevent the new Medicare tax rate from going into effect for at least part of 2013.
Another Tax Threshold to Track
Under the Act, Medicare will increase to 2.35%, but only for compensation in excess of $200,000 ($250,000 for married taxpayers that file jointly, $125,000 for married taxpayers that file separately).
If you are counting, this makes three separate wage thresholds that we need to track to properly withhold taxes on stock compensation:
Social Security: Applies only to wages under a specified maximum, currently $110,100, but this could increase for next year (but it is unlikely to increase to $200,000). All wages, both regular and supplemental, count towards this threshold.
Flat Supplemental Rate: When an individual has received $1 million in supplemental payments, tax on any additional supplemental payments must be withheld at the maximum individual tax rate (currently 35%, but this could increase to 39.6% next year–stay tuned on this one). Only supplemental payments, not regular wages, count towards this threshold.
Medicare: When an individual has received more than $200,000 in wages, the Medicare tax rate increases to 2.35%. All wages, both regular and supplemental, count towards this threshold.
Withholding Mechanics
Because you don’t know participants’ filing statuses (or their spouses’ incomes), you’ll withhold at the higher rate for any employees that have earned more than $200,000, even though they may not yet be liable for the additional tax. Any excess Medicare payments will be sorted out when they file their tax return.
Unlike the supplemental income tax rate, where you can apply the higher rate to an entire payment that straddles the threshold, the higher Medicare rate should only be applied to the portion of the payment that exceeds the threshold. For example, let’s say an employee that has received wages of $190,000 exercises an NQSO at a gain of $40,000. The first $10,000 of gain on the exercise is subject to the standard Medicare rate of 1.45%; only $30,000 of the gain is subject to the 2.35% rate. Then, from that point forward until the end of the year, any further NQSO exercises and award payouts are subject to 2.35% (as well as any other wages paid to the employee).
And, just in case that wasn’t confusing enough, the company’s matching payment remains at 1.45%; the additional tax applies to the employee only.
Next Steps and More Information
If you haven’t started talking to your payroll group about this, now might be a good time to take them lunch. It also might be a good time to ask your administrative provider about how they’ll handle the new rate in their system.
Also, tune in next week, when I’ll discuss planning considerations for employees.