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.
A riddle: what do the Trade Adjustment Assistance Program, the African Growth and Opportunity Act, and HOPE for Haiti have to do with Forms 3921 and 3922? You might think “not much” but then you aren’t a member of Congress. The Trade Preferences Extension Act, which includes provisions relating to those three things and a couple of other global trade-related items, also increases the penalties for failure to file Forms W-2 and forms in the 1099 series, which includes Forms 3921 and 3922 (why forms 3921 and 3922 are considered part of the “1099” series is another riddle for another day).
The New Penalties
Timing of Correct Filing
New Penalty (Per Failure)
New Annual Cap
Old Penalty (Per Failure)
Old Annual Cap
Within 30 days
$50
$500,000
$30
$250,000
By Aug 1
$100
$1,500,000
$60
$500,000
After Aug 1 or never
$250
$3,000,000
$100
$1,500,000
With intentional disregard,
regardless of timing
Min. of $500
uncapped
Min. of $250
uncapped
Make That a Double
The penalties apply separately for returns filed with the IRS and the statements furnished to employees. If a company fails to do both, both the per-failure penalty and the cap is doubled. Thus, if both the return and the employee statement are corrected/filed/furnished after Aug 1, that’s a total penalty of $500, up to a maximum of $6,000,000. If intentional disregard is involved, that’s a minimum total penalty of $1,000 (and this amount could be higher) with no annual maximum.
Effective Date
The new penalties will be effective for returns and statements required after December 31, 2015, so these penalties will be in effect for 2015 forms that are filed/furnished early next year.
Penalties At Least As Interesting As the Trade Provisions?
Interestingly, when I Googled “Trade Preferences Extension Act,” so I could figure out what the rest of the act was about, the first page of search results included as many articles about the new penalties as about the trade-related provisions of the act.
If you want to know what the rest of the act is about, here is a summary from the White House Blog. There’s not a lot more to say about the penalties but if you want to spend some time reading about them anyway, here are summaries from Groom Law Group and PwC.
Last week, I covered the basic rules that apply for tax purposes when options are exercised or awards pay out after an individual has changed status from employee to non-employee or vice versa. Today I discuss a few more questions related to employment status changes.
Is it necessary that the consulting services be substantive?
When employees change to consultant status an important consideration is whether the consulting services are truly substantive. Sometimes the “consulting services” former employees are providing are a little (or a lot) loosey goosey (to use a technical term). For example, sometimes employees are allowed to continue vesting in exchange for simply being available to answer questions or for not working for a competitor. It this case, it’s questionable whether the award is truly payment for consulting services.
A few questions to ask to assess the nature of the consulting services former employees are performing include whether the former employee has any actual deliverables, who is monitoring the former employee’s performance and how will this be tracked, and will the award be forfeited if the services are not performed.
If the services aren’t substantive, it’s likely that all of the compensation paid under the award would be attributable to services performed as an employee (even if vesting continues after the employee’s termination) and subject to withholding/Form W-2 reporting.
Is the treatment different for an executive who becomes a non-employee director?
Nope. The same basic rules that I discussed last week still apply. The only difference is that I think it’s safe to presume that the services performed as an outside director will be substantive (unless the director position is merely ceremonial).
What about an outside director who is hired on as an executive?
The same basic rules still apply, except in reverse. For options and awards that fully vested while the individual was an outside director, you would not need to withhold taxes and you would report the income on Form 1099-MISC, even if the option/award is settled after the individual’s hire date.
For options and awards granted prior to the individual’s hire date but that vest afterwards, you’d use the same income allocation method that I described last week. As I noted, there are several reasonable approaches to this allocation; make sure the approach you use is consistent with what you would do for an employee changing to consultant status.
What about a situation where we hire one of our consultants?
This often doesn’t come up in that situation, because a lot of companies don’t grant options or awards to consultants. But if the consultant had been granted an option or award, this would be handled in the same manner as an outside director that is hired (see the prior question).
What if several years have elapsed since the individual was an employee?
Still the same; the rules don’t change regardless of how much time has elapsed since the individual was an employee. The IRS doesn’t care how long it takes you to pay former employees; if the payment is for services they performed as employees, it is subject to withholding and has to be reported on a Form W-2.
So even if several years have elapsed since the change in status, you still have to assess how much of the option/award payout is attributable to services performed as an employee and withhold/report appropriately.
What if the individual is subject to tax outside the United States?
This is a question for your global stock plan advisors. The tax laws outside the United States that apply to non-employees can be very different than the laws that apply in the United States. Moreover, they can vary from country to country. Hopefully the change in status doesn’t also involve a change in tax jurisdiction; that situation is complexity squared.
Finally, When In Doubt
If you aren’t sure of the correct treatment, the conservative approach (in the United States—I really can’t address the non-US tax considerations) is probably going to be to treat the income as compensation for services performed as an employee (in other words, to withhold taxes and report it on Form W-2).
What is the US tax reg cite for all of this?
My understanding is that none of this is actually specified in the tax regs—not even the basic rules I reviewed last week. This is a practice that has developed over time based on what seems like a reasonable approach.
For today’s blog entry, I discuss how stock plan transactions are taxed when they occur after the award holder has changed employment status (either from employee to non-employee or vice versa). This is a question that I am asked quite frequently; often enough that I’d like to have a handy blog entry that I can point to that explains the answer.
The basic rule here is that the treatment is tied to the services that were performed to earn the compensation paid under the award. If the vesting in the award is attributable to services performed as an employee, the income paid under it is subject to withholding and reportable on Form W-2. Likewise, if vesting is attributable to services performed as a non-employee, the income is not subject to withholding and is reportable on Form 1099-MISC.
Where an award continues vesting after a change in status, the income recognized upon settlement (exercise of NQSOs or vest/payout of restricted stock/RSUs) is allocated based on the portion of the vesting period that elapsed prior to the change in status.
For example, say that an employee is granted an award of RSUs that vests in one year. After nine months, the employee changes to consultant status. The award is paid out at a value of $10,000 on the vest date. Because the change in status occurred after three-fourths of the vesting period had elapsed, 75% of the income, or $7,500, is subject to tax withholding and is reportable on the employee’s Form W-2. The remaining $2,500 of income is not subject to withholding and is reportable on Form 1099-MISC.
What if the award is fully vested at the time of the change in status?
In this case, the tax treatment doesn’t change; it is based on the award holder’s status when the award vested. For example, say an employee fully vests in a award and then later terminates and becomes a consultant. Because the award fully vested while the individual was an employee, the award was earned entirely for services performed as an employee and all of the income realized upon settlement (exercise of NQSOs or vest/payout of restricted stock/RSUs) is subject to withholding and is reportable on Form W-2.
This is true no matter how long (days, months, years) elapse before the settlement. Under Treas. Reg. §31.3401(a)-1(a)(5), payments for services performed while an employee are considered wages (and are subject to withholding, etc.) regardless of whether or not the employment relationship exists at the time the payments are made.
What is the precise formula used to allocate the income?
There isn’t a precise formula for this. We asked Stephen Tackney, Deputy Associate Chief Counsel of the IRS, about this at the NASPP Conference a couple of years ago. He thought that any reasonable method would be acceptable, provided the company applies it consistently.
The example I used above is straight-forward; awards with incremental vesting are trickier. For example, say an employee is granted an NQSO that vests in three annual installments. 15 months later, the employee changes to consultant status.
The first vesting tranche is easy: that tranche fully vested while the individual was an employee, so when those shares are exercised, the entire gain is subject to withholding and reportable on Form W-2.
There’s some room for interpretation with respect to the second and third tranches, however. One approach is to treat each tranche as a separate award (this is akin to the accelerated attribution method under ASC 718). Under this approach, the second tranche is considered to vest over a 24-month period. The employee changed status 15 months into that 24-month period, so 62.5% (15 months divided by 24 months) of that tranche is attributable to services performed as an employee. If this tranche is exercised at a gain of $10,000, $6,250 is subject to withholding and reported on Form W-2. The remaining $3,750 is reported on Form 1099-MISC and is not subject to withholding. The same process applies to the third tranche, except that this tranche vests over a 36-month period, so only 41.7% of this tranche is attributable to services performed as an employee.
This is probably the most conservative approach; it is used in other areas of the tax regulation (e.g., mobile employees) and is also used in the accounting literature applicable to stock compensation. But it isn’t the only reasonable approach (just as there are other reasonable approaches when recording expense for awards under ASC 718) and it isn’t very practical for awards with monthly or quarterly vesting. It might also be reasonable to view each tranche as starting to vest only after the prior tranche has finished vesting. In this approach, each tranche in my example covers only 12 months of service. Again, the first tranche would be fully attributable to service as an employee. Only 25% of the second tranche would be attributable to services as an employee (three months divided by 12 months). And the third tranche would be fully attributable to services performed as a consultant.
These are just two approaches, there might be other approaches that are reasonable as well. Whatever approach you decide to use, be consistent about it (for both employees going to consultant status as well as consultants changing to employee status).
Read “Employment Status Changes, Part II” to learn about additional considerations and complexities relating to changes in employment status.
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.
Is your calendar full for January yet? As we head into the new year, now is a good time to touch base with other departments that you work with throughout the year to review procedures and plan for the coming year. In today’s blog, I discuss a few of the groups you might want to meet with. Looks like it’s going to be a busy month…
Payroll
Schedule a meeting with payroll to kick off the start of the year. A few items for the meeting agenda include reviewing W-2 reporting procedures for various stock plan transactions (see our “Form W-2 Reporting Checklist” and “W-2 and 1099 Reporting for Equity Compensation – FAQs“); reviewing tax rate and limit changes for the upcoming year; and reviewing current procedures–what’s working and what isn’t working.
Accounts Payable
Forms 1099-MISC are typically prepared by accounts payable. If you grant equity to outside directors and other non-employees, it’s a good idea to meet with this group to ensure that any of their taxable stock plan transactions for the year will be reported appropriately. Ditto for any taxable transactions that occurred after the death of an employee or subsequent to the transfer of options/awards pursuant to divorce.
Accounting/Finance
For calendar year-end companies that haven’t done so since last year, now is a good time to review your valuation assumptions (volatility, dividend yield, interest rates, and expected life) for stock option grants. It’s also a good time to revisit the expected forfeiture rate applied to options and awards. Set up a meeting with accounting/finance to have a conversation about this. If you’ve had unusual transactions that occurred during the year (acceleration of vesting, changes in employee status, option exchange programs, other option/award modifications), it’s a good idea to review how these transactions are accounted for as well. You don’t want any surprises when your auditors review your financial reports.
Legal/Finance
You’ve probably already done this if your company has a calendar year-end, but if you haven’t, you’ll want to schedule a meeting with the folks responsible for preparing your company’s Form 10-K and proxy solicitation statements to ascertain what your contributions will need to be. Reviewing last year’s statements to remind yourself of the information included relating to stock compensation can be a good preparatory step for this meeting. It’s also a good idea to review the number of shares available in your stock plans, expected share usage for the next two years, and plan expiration dates, so you’ll know if a shareholder proposal relating to your stock plans is necessary.
HR
Review your current grant guidelines with HR to determine if any tweaking is necessary and to find out if HR has planned any changes to your equity programs for the next year.
Brokers
With cost-basis reporting going into effect for the first time with 2011 Forms 1099-B, you’ll want to meet with your brokers to find out what will be reported as the cost basis for stock issued under your stock plans and what information they will be providing your employees about the new reporting procedures. See my November 30, 2010 bog, “Four Questions to Ask Your Brokers.”
Section 6039 Service
If you plan to use an outside provider to prepare and/or file Section 6039 returns with the IRS and provide statements to employees, don’t wait any longer to get the conversations with your provider started. The deadline for employee statements is January 31!
International Advisors
If you offer stock compensation to non-US employees, it’s a good time to check in with your external advisors for international compliance to find out if any local requirements have changed and if there are any year-end reporting requirements you need to comply with outside of the United States. Where US employees have relocated to other countries, or foreign nationals have moved into the United States, also review the US tax reporting requirements with respect to these folks (even for foreign nationals that moved back out of the US by the end of the year).
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.