In a flurry of acronyms, the DOL (Department of Labor) and the IRS (I’m sure you all know what this acronym stands for) signed an MOU (Memorandum of Understanding) to improve agency coordination to address worker misclassification. A number of states are also participating in the agreement.
DOL and IRS Sign MOU The agreement provides that the DOL will share information with the IRS and the participating states to address workers classified as contractors that should really be treated as employees. Worker misclassification is a target of the IRS’s current employment tax research study, which I’ve blogged about before (“IRS Auditing Stock Compensation,” June 7, 2011). This MOU will give the IRS additional information to use in its audits.
At the same time, the IRS also announced a voluntary worker classification settlement program, further demonstrating their focus on this issue.
Misclassifying a worker that should be an employee as a consultant can result in a host of legal issues, from benefits that the individual should have been accorded (such as the right to medical benefits and vacation time), tax withholding considerations, overtime pay, and unemployment benefits, to name just a few.
This probably seems like a topic that doesn’t impact stock plan administration that much. Worker classification is determined by HR and/or payroll; the stock plan administration group most likely just assumes their determination is correct and treats each individual’s options and awards accordingly. And, I can’t think of any reason why stock plan administration should question the classification made by HR/payroll; it’s unlikely you have sufficient information to determine an individual’s employment status.
But, while stock plan administration may not be involved in classifying workers as employees or consultants, you should be aware of the impact misclassification can have on stock compensation awarded to the individuals in question.
Tax Withholding on Options and Awards
Of course, the first issue that comes to mind is tax withholding. Individuals classified as consultants aren’t subject to tax withholding. If these individuals should have been treated as employees, however, then taxes should have been withheld on all of their compensation, including their NQSOs and stock awards. Failure to withhold the appropriate taxes can result in penalties to the company up to the amount of the taxes that should have been withheld, as well as interest and administrative penalties.
In addition, the company should have made matching FICA payments on all of the individual’s compensation, also including NQSOs and stock awards. This is even more of a mess because consultants don’t pay FICA, they pay self-employment tax, which is equal to both the individual and company portion of FICA. The misclassified workers will have overpaid their taxes because, as employees, they would only have been responsible for the employee portion of FICA.
ESPP
The company’s Section 423 ESPP is a significant concern. By law, substantially all employees of the company have to be allowed to participate in the ESPP, but, of course, also by law, consultants aren’t permitted to participate. Where consultants should have been treated as a employees, however, it is likely that they should have been permitted to participate in the ESPP. Where an individual that should have been allowed to participate is excluded from the ESPP, the entire offering(s) that the individual should have been allowed to participate in can be disqualified. A mistake here could impact not just the misclassified individual but all other employees participating in the ESPP. When assessing your company’s risk with regards to worker misclassification, this is an important consideration.
Thanks to McGuireWoods for the alert that gave me the idea for this blog entry.
Conference Hotel Almost Sold Out The 19th Annual NASPP Conference is quickly approaching and the Conference hotel is nearly sold out. The Conference will be held from November 1-4 in San Francisco. The last Conference in San Francisco sold out a month in advance–and that was without the reality of Dodd-Frank and mandatory Say-on-Pay hanging over our heads. With Conference registrations going strong–on track to reach nearly 2,000 attendees–this year’s event promises to be just as exciting; register today to ensure you don’t miss out.
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.
In late 2009, the IRS announced a major audit initiative for executive compensation that will ultimately involve at least 6,000 companies (see “IRS Audits: Are You Ready to Rumble?” January 26, 2010). We’re now over a year into that project, so I thought it might be a good time to revisit the subject.
No Need to Be Surprised
If you’ve been wondering what the IRS might audit relating to stock compensation, it turns out that there’s no need to be surprised. The IRS explains what they are looking for relating to stock compensation on their website. Here are a few highlights of what you can expect IRS auditors to investigate:
In the case of restricted stock and units, whether there has been a transfer of property (e.g., does the employee have voting and/or dividend rights) and whether there is a substantial risk of forfeiture for the award. According to Stephen Saxon in the March issue of PLANSPONSOR (“Saxon Angle: Audit Trials“), companies that offer accelerated vesting upon retirement should be especially wary of this issue for their retirement-eligible employees.
Whether ISOs and ESPPs meet the statutory requirements, especially the $100,000 and $25,000 limitations.
Whether income has been properly reported (on Form W-2 or Form 1099-MISC) and taxes withheld (if required) on all types of stock plan transactions.
Whether tax withholding for stock compensation has caused companies to exceed the $100,000 next-day deposit threshold that Rachel blogged about a couple of weeks ago (“Timely Tax Deposits,” May 26), and, if so, if companies complied with the deadline.
Recordkeeping practices relating to grants, exercises, and other stock plan transactions.
Compliance with Section 162(m)–but that’s a topic for another blog.
Things I Sure Hope Won’t Be a Problem
There are a few items highlighted in the IRS’s audit instructions that I sure hope won’t be a problem for any NASPP members–I know you are all too smart to fall for these traps:
Back-dated stock options. No explanation needed on this one.
Transfers of options to a related party. Under this strategy, an executive would “sell” stock options to a family member or trust in exchange for an unsecured, long-term, balloon payment obligation (essentially, the related party just “promises” to pay the executive for the stock option at some point in the future, a long ways in the future). The idea was to get around the gift tax that could apply if the option were simply transferred to the family member/trust. This type of a arrangement has been a no-go with the IRS for some time.
Not issuing stock upon same-day-sale exercises of an ISO or ESPP. Although the tax code itself is not clear, the IRS’s audit instructions specifically state that if, rather than issuing stock on a same-day sale, the underlying shares are simply cancelled in exchange for the spread–in other words, a net exercise–the arrangement is subject to withholding for both income tax and FICA purposes.
Issuing loans to executives for option exercises and then later forgiving or reducing the loans. Public companies shouldn’t be issuing loans to executives at all, much less forgiving those loans.
Last Chance to Qualify for Survey Results This week is your last chance to participate in the NASPP’s 2011 Domestic Stock Plan Administration Survey (co-sponsored by Deloitte). Issuers must complete the survey by this Friday, June 10, to qualify to receive the full survey results. Register to complete the survey today–we’ve already extended the deadline once, we can’t extend it again!
NASPP Conference Program Now Available The full program for the 19th Annual NASPP Conference is now available. Check it out today and register by June 24 for the early-bird discount–this deadline will not be extended.
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.
Register for 19th Annual NASPP Conference (November 1-4 in San Francisco). Don’t wait; the new early-bird rate is only available until June 24.
Participate in the NASPP’s 2011 Domestic Stock Plan Administration Survey (co-sponsored by Deloitte, with survey systems support provided by the CEP Institute). You must complete the survey by June 10 to qualify to receive the survey results.
This week I discuss a hodge podge of tax related updates: IRS Notice 2010-80, Code Y reporting, and the Social Security wage base for 2011.
IRS Expands 409A Documentation Corrections Program to Include Stock Rights Early this year, when the IRS issued Notice 2010-6, I got a much appreciated reprieve from having to understand it because it handily didn’t apply to stock rights. (Well, handily for me at least; others may not have been so thrilled with this outcome.) Alas, my reprieve lasted less than a year; last week the IRS issued Notice 2010-80, expanding Notice 2010-6 to cover stock rights.
I’m surprised at this development because I wasn’t aware that very many, if any, companies needed this relief. I thought that, by now, companies had pretty much dealt with 409A in terms of their stock plans. If companies are in need of this relief, however, it may be necessary to take action by December 31, 2010–which is coming up quick; you’d think the IRS could have provided a little more time on this.
Luckily, I’m not sure that many companies are in need of this relief. It applies only to options that were not intended to be exempt from Section 409A. In my experience, this is pretty rare. So long as options are granted with a price equal to FMV at grant, it’s relatively easy to ensure that they are exempt. Where a company inadvertently grants a discounted option, assuming the option was intended to be exempt from 409A, it isn’t eligible for correction under Notice 2010-80 (however, it may be eligible for correction under IRS Notice 2008-113, which provides relief for operational errors).
I don’t know any companies that are granting options that aren’t intended to be exempt under 409A. Even where companies had pre-409A grants that weren’t exempt, I think the typical fix was to modify the options to be exempt, rather than to try to comply with 409A. So the bad news is that this relief probably isn’t that helpful for most of you but I guess the silver lining is that you probably don’t need to scramble to understand it by December 31.
Thanks to Art Meyers of Choate Hall & Stewart and Mike Melbinger of Winston & Strawn for helping me with my rudimentary understanding of Notice 2010-80.
Code Y While we’re on the topic of 409A, I thought I’d mention that Code Y reporting still hasn’t gone into effect. You will recall–or maybe you won’t, it’s been so long since 409A was enacted–that 409A requires companies to report amounts subject to deferral in Box 12 of Form W-2 using Code Y. IRS Notice 2008-115 suspended this requirement until Treasury can issue regulations on it. So far no regulations have been issued so chances are you won’t have to worry about Code Y for this year (but, then again, there are still 23 shopping days left until December 31, so I suppose the IRS could still come through with a late December Code Y surprise).
Thanks to Mike Melbinger of Winston & Strawn for confirming that there wasn’t some announcement about Code Y that I had missed.
Social Security Wage Base Pursuant to a Social Security Administration press release issued on October 15, the maximum amount of wages subject to Social Security is not increasing for 2011–it will remain at $106,800 for another year. See the NASPP alert on this announcement for more information.
Vote for Broc and Dave! Broc Romanek and David Lynn’s blog on TheCorporateCounsel.net was selected by the ABA Journal as one of the Top 100 Legal Blawgs. Readers can vote on their favorite blogs and we want Broc and Dave to win (they won last year), so we’re asking our readers to vote. I know you all would vote for the NASPP Blog if you could, but we don’t count as a legal blog, so this is as close as you’ll come to voting for us. Come on, don’t make me beg!
Anyone can vote, you don’t have to be a member of the ABA. If you read and enjoy Broc and Dave’s blog–or even if you don’t–I hope you’ll vote for it. BTW–if you have multiple email addresses, you can register and vote under each one. See Broc’s December 6 blog entry for instructions on voting.
If you’ve never checked out the blog; it’s definitely worth a read. Unlike the lazy folks here at NASPP Blog, Broc and Dave manage to post an entry every day. And it’s free to anyone, whether you subscribe to TheCorporateCounsel.net or not. At a minimum, someone in your legal department should be reading it.
Less Than One Month Left to Get your Free Conference Session Audio All NASPP memberships expire on a calendar-year basis. Renew your membership by Dec 31 and you’ll qualify to receive the audio for one NASPP Conference session for free! Don’t wait any longer–the new year will be here before you know it!
This offer is also available to anyone the joins the NASPP before December 31–tell all your friends!
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.
Renew your NASPP membership for 2011 (if you aren’t an NASPP member, join today). Renew or join by Dec 31 to qualify to receive the audio of one NASPP Conference session for free.
The IRS began its Employment Tax National Research Project (NRP) this year (See our January 26th blog entry), auditing 2,000 randomly selected companies. Soon, the next 2,000 will be receiving their notices that they have been selected for 2011. In totally, the IRS will audit 6,000 companies over three years. This NRP comes on the heels of similar studies conducted on Subchapter S Corps in 2003 and 2004 and individual taxpayer returns from 2006 to 2008 returns). All are part of a Department of the Treasury’s commitment to provide updated estimates of the “tax gap” (i.e.; the difference between the taxes owed and the taxes actually collected). A full description of the efforts is included in the Update on Reducing the Federal Tax Gap and Improving Voluntary Compliance.
Don’t think that if you aren’t selected, you’re totally off the hook. These are just the random audits as a part of the evaluation process. Not only are regular tax audits still taking place, the results of the NRPs will be used to help identify which individuals and companies to target for regular audits and what areas of audits are most likely to result in the discovery of noncompliance.
The current NRP will focus on four main issues: fringe benefits, worker classification, executive compensation, and payroll taxes. The stock plan management team won’t have much, if anything, to do with an audit of fringe benefits. Worker classification (i.e.; determining if there are consultants who should be classified as employees) could spill over into stock plan administration. A quick review of your company’s policy on granting to nonemployees and an audit of the database to identify grants to nonemployees will help your company make a full assessment of classifications. Executive compensation sounds like an area that stock plan management would be involved in, but actually the main focus will be on owner-officers and the particular audits in this area may not apply to most corporations. So, the area where the stock plan management team can provide the most assistance is payroll taxes.
Payroll Taxes
At this point, you should already have a regular, at least annual, audit of your tax withholding and remitting policies that helps you identify areas of potential noncompliance. The NRP only increases the risk of your company being audited, but compliance should be a serious focus, regardless. Here are my top areas to review before the new year:
Timing of Tax Deposits
Social Taxes
Mobile Employees
ISOs and 423 ESPPs
162(m) and 409A Compliance
Why Now?
If you uncover areas where the company is not withholding correctly on equity compensation, the beginning of the calendar year is the perfect time to implement new withholding practices. This is especially true for mobile employee withholding and if the change will be prospective only
How Far Should You Go?
When you do identify an area that your company has been out of compliance with, the big question is whether to make policy changes that are prospective or retrospective. Even if you aren’t going to be changing retrospectively, it’s a good idea to at least audit back a minimum of three years, but no specific length of time is appropriate across the board. For example, if you discover that you haven’t been making timely tax deposits, there isn’t a way for you to go back in time and make them any earlier. But, you can go back and audit the instances of noncompliance to help give your company an idea of what fees could result from an audit.
States, Too!
The federal government isn’t the only one with a tax gap to close; states are also looking to find lost tax revenue. What’s more, the IRS has reciprocal agreements with many states to share audit findings. That means that if you are audited by the IRS as part of the NRP or as a regular audit, state and local tax authorities may not be far behind.
When all or a portion of a nonstatutory stock options is transferred to the former spouse of one of your employees subsequent to a divorce, there are no income reporting or tax withholding obligations on the transfer. However, the exercise of those option shares requires special handling by the company.
When an incentive stock option is transferred in a divorce settlement, it no longer qualifies for preferential tax treatment. Once the ISO has been transferred, the income reporting and tax withholding obligations are the same as for NSOs. However, if the transfer of the shares happens only at exercise, then the ISO shares maintain their preferential tax treatment. The transfer of the shares at exercise does not constitute a disqualifying disposition. The transferred shares are then subject to the same holding requirements from the date of grant and exercise to determine if the sale is a qualified or disqualified disposition.
Revenue Rulings
There are two important revenue rulings that govern the income reporting and tax withholding on options transferred pursuant to a divorce.
Revenue Ruling 2002-22 establishes that a transfer of nonstatutory stock options as part of a divorce settlement does not constitute an income event. For stock plan managers, this means that there is no need to establish the fair value of the option, report any income, or withhold any taxes on the date of transfer. It also establishes that the former spouse realizes income on the exercise of those option shares.
Revenue Ruling 2004-60 clarifies the withholding and reporting obligations for an exercise made by the non-employee former spouse of options that were transferred in a divorce settlement.
Withholding and Reporting at Exercise
So, we know from Revenue Ruling 2004-60 that the former spouse realizes income at the exercise of options transferred pursuant to a divorce. What’s more, FICA and FUTA are both applied to the income at exercise. But, don’t worry; you won’t need to collect a Form W-4 from the former spouse. The income and FICA tax rates are applied based on the employee’s supplemental income and the Social Security tax she or he paid in that tax year as of the exercise date.
When the former spouse exercises the option, the company withholds income, Social Security, and Medicare from the exercise proceeds based on the employee’s withholding rates. The income tax withholding is attributed to the former spouse, but the FICA taxes are attributed to the employee even though they are paid by the former spouse. The income (i.e.; spread at exercise) and the income taxes withheld are reported on a Form 1099-MISC to the former spouse. That same income amount is reported to the employee as Social Security and Medicare wages on Form W-2. Additionally, the Social Security (if applicable) and Medicare withheld are reported on the employee’s Form W-2. For a great example of this, see our Tax Withholding on Option Exercises Subsequent to Divorce alert. You can also find more information in these recorded webcasts: Death and Divorce: The Lighter Side of Equity Compensation and The 2nd Annual NASPP Webcast on Tax Reporting.
Last Chance for Special Conference Rates
Registrations for our 18th Annual NASPP Conference are pouring in! If you haven’t already registered, don’t miss out on the special $200 discount on registration fees. This special rate is only available through tomorrow, May 14th!
Based on a recent IRS announcement and alerts we’ve received from law firms, the IRS is stepping up audit activity on executive compensation and employee benefit plans.
Employment Tax Audits On November 9, the IRS announced an employment tax research study that will include audits of 6,000 companies over the next three years. The study is expected to help the IRS determine areas of greatest compliance risk, which will aid in selecting and auditing future employment tax returns. Companies file employment tax returns to report taxes that have been withheld on employee wages.
According to an alert issued by Pillsbury, the audits will focus on worker classifications (i.e., employee vs. non-employee), fringe benefits, executive compensation, and qualified employee benefit plans. Levine & Baker also mention the impending audits in their January 2010 client newsletter, warning that companies would be ahead to review their tax practices now, before they get an audit notice and still may have an opportunity to address inadvertent errors.
409A Audits Started Already According to a Jones Day alert that we posted on Naspp.com, the IRS has already started auditing deferred compensation arrangements for compliance with Section 409A. Recent Information Document Requests issued to companies undergoing audits have included items related to §409A compliance.
As described by Jones Day, the information requested by the IDRs includes:
Identification of arrangements that the company does not consider to be subject to §409A, but that create a legally binding right to compensation that won’t be paid until a later year. Stock options and restricted stock, of course, are prime examples of these types of arrangements. They also include plans that are exempted from §409A under the short-term deferral rule.
Terms and deadlines for making deferral elections, re-deferrals, and any payment accelerations.
The names of “specified employees” and payments made to them upon separation of service.
Certain information on stock options and SARs that may be subject to §409A.
Any §409A violations and whether the company participated in the §409A corrections program.
Technical Corrections to Section 423 Regs Turns out the IRS makes typos just like the rest of us. Technical corrections to the final regulations under Section 423 were issued on December 22, 2009. Nothing substantive, though, just a couple of minor textual errors. Just because I thought it would be cool, I’ve annotated the PDF of the final regs that we have posted here on Naspp.com with the corrections; see §1.423-2(a)(1) (pg 15), §1.423-2(d)(3) (pg 24), and §1.423-2(i)(5) Example 5 (pg 39). The full text of the corrections is on pg 46.
ShareComp 2010 The NASPP is happy to announce its support of ShareComp 2010, a fully virtual conference on stock compensation. NASPP members can attend the event for free using the sponsor pass “naspp”; feel free to share this sponsor code with others at your company.
ShareComp 2010 will be held live on February 23, 2010 and all presentations, documents, and booths will be available on-demand for a year afterwards. Presentations, solutions, and providers will focus on the needs of professionals in executive roles, finance, human resources, compensation, accounting and stock administration positions. Benefits of attending include:
16 hours of live global interactive learning and networking
Best practices for designing, implementing and managing stock compensation programs
Instructional sessions that will share real-world examples, tactics and lessons learned
Facilitated discussion forums with experts and practitioners
A searchable library, including presentations, Q&A sessions and booth materials
A year of access to the conference center and the materials
To find out more about, visit www.sharecomp2010.com. Register today for this no-risk, high-impact event (be sure to enter sponsor pass “naspp” for free registration). While you are attending the event, we hope you’ll stop by the NASPP booth.
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.
Don’t miss Alan Dye’s webcast on Thursday January 28, on Section 16 developments.
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.