It’s not often that the worlds of professional sports and equity compensation intersect. True, I have a Google alert set up for “stock options” that sometimes returns articles about how the stock of football players impacts their career options (as in “Joe Schmo played really well in the last game; his stock is really rising”), but that’s not what I’m referring to. I’m talking about domestic mobility. While we are struggling with how compensation is taxed when employees travel from one state to another, this is an issue that professional sports has been dealing with for a long time now.
Here are a few concepts discussed in the articles that are applicable to equity compensation:
1. If the employee is a resident in a state that has income tax, 100% of the employee’s compensation, including any gains on stock options or awards, is generally taxable in that state. This is true even if the compensation is also taxable in another state.
2. Generally, compensation earned for work performed in another state (that has income tax) is also taxed in that state. For example, when your favorite non-Californian athletes play in California, they have to pay California state income tax on the portion of their compensation attributable to those games. In the context of stock compensation, this could apply to employees on assignment in another state, employees in remote locations that regularly travel to headquarters, employees in any location that travel to other states for work, employees that live in one state and commute to another for work, and a host of other situations.
3. The amount of income attributable to the employee’s non-resident state is generally determined by dividing the days worked in that state, referred to as “duty days,” by the total days over which the compensation is earned. In the context of stock compensation, the period over which the compensation is earned is most likely the vesting schedule.
4. Employees may be able to claim a credit in their state of residence for taxes paid in other states. Unlike a tax deduction, which reduces the income subject to tax, a credit is applied to the employee’s ultimate tax liability.
I’ve used the words “generally,” “typically,” and “most likely” a lot in this blog entry. It’s not that I have a fear of commitment, it’s that there are fifty states and they all write their own tax laws. As with anything that is legislated at the state level, the laws can, and do, differ by state.
Everyone else is talking about Brexit (the vote in the UK to leave the EU), why should the NASPP Blog be left out of the conversation? For today’s entry, I discuss what Brexit might mean for your stock plans.
Don’t Panic—Yet
The good news is that the vote is advisory, so it isn’t as if the UK has immediately exited the EU. They are still part of the EU for the short-term. The UK government and the EU have to come to an agreement about how the exit plan will work and various experts have indicated that this could take two years or more.
How Will Stock Plans Be Impacted?
By now, we are all too familiar with the EU Directives that impact stock compensation. While the Directives are complicated enough, in and of themselves, if the UK leaves the EU, things could get a lot more complicated. The UK will have it’s own rules that may or may not be the same as the rules in the Directives. A recent alert by Baker & McKenzie summaries a number of areas in which stock compensation offered to employees in the UK could be affected.
Securities Laws: The EU Prospectus Directive (including both the filing requirement and exemptions) will no longer apply in the UK. This could turn out to be better or worse than the way things are now: the UK could require companies offering stock compensation to file a prospectus (probably worse), could provide an exemption for stock plans (probably the same as now for many companies, depending on the requirements for exemption), or could recognize prospectuses filed in the EU (or even in countries outside of the EU, such as the United States) (the same or better).
Data Privacy: The EU Data Privacy Directive would also no longer apply in the UK. The EU has proposed new rules for this directive, so right now, we don’t know what the final rules will be for any countries in the EU, much less the UK. But once the UK has left the EU, they can determine their own rules; maybe these rules would be similar to the rules that the EU adopts, maybe not. One bit of good news is that Baker & McKenzie notes that “It would be surprising … if the UK would not consider consent to be a valid ground to collect, process and transfer personal data.” Since that is how most companies comply with the EU Data Privacy Directive for their stock plans, little may change here.
Discrimination: There are a number of EU Directives that prohibit discrimination against specified groups of employees. Those Directives would also no longer apply in the UK, but the UK would be free to adopt its own rules on discrimination. Baker & McKenzie notes that they do not expect to see substantial changes here.
Social Insurance, Too
An alert by EY notes that Brexit may also impact the social insurance obligations of mobile employees, their employers’ compliance obligations, and the benefits mobile employees are entitled to. Currently, the EU governs how social insurance applies when employees move between countries in the EU. Unless the UK comes to an agreement with the EU that the EU rules still apply to employees moving between the UK and other EU countries, individual agreements would have to be put in place between the EU and all the EU countries. Some of these agreements exist, but they haven’t been updated since the EU established its rules. Many have expired or don’t address how mobility works in today’s world. This could get ugly.
What About Companies that Don’t Have Stock Plan Participants in the UK?
For those companies, there shouldn’t be any direct impact to their stock plans (other than the impact of stock price volatility resulting from the economic uncertainty caused by Brexit). But, if you are a US-based company with a multi-national stock plan, chances are that you have stock plan participants in the UK. In the NASPP/PwC Global Equity Incentives Survey, the UK is second only to the US in terms of countries where respondents have employees and offer stock compensation.
More to Come
I’m sure there will be more implications to think about as the UK’s exit looms closer. At this year’s NASPP Conference, our perennially popular session, “Around the World in 60 Minutes: Key International Updates” will most certainly have a lot to say about Brexit, as will the session “Making Sense of Europe.” Be sure to attend one or both of these sessions so you are up-to-date on how your stock plan participants in the UK will be affected.
This past summer, the NASPP and Solium co-sponsored a quick survey on global stock plan administration. We asked companies about the technological challenges they experience when it comes to administering global stock plans, focusing on 12 primary challenges related to tax compliance, financial reporting, and other administrative matters. Close to 70% of respondents indicated that they struggle with four or more of the challenges identified and several noted that they struggle with nine or more of the challenges.
For today’s blog entry, I highlight five things I learned from the survey:
1. There are still a lot of manual processes out there.
Two-thirds of respondents say they spend too much time on manual processes. This is a high-risk proposition: it is difficult to implement adequate controls over processes and calculations performed in a spreadsheet. This seems especially concerning given that the SEC is in the process of adopting rules requiring recovery of compensation for all material misstatements, even if due to inadvertent error (see “SEC Proposes Clawback Rules,” July 7, 2015). One incorrect calculation discovered too late could result in recoupment of bonuses and other incentive compensation paid to executive officers.
2. Tax compliance is a top concern for companies.
This really isn’t a surprise—let’s face it, tax laws outside the United States are a hot mess. Every country does something different. Some countries change their laws every few years (I’m looking at you, Australia and France) and grandfather in old awards. Some countries have different rules for social insurance taxes vs. income taxes. Add in mobile employees and, well, you have a lot of work for tax lawyers.
3. Regulatory compliance is also a challenge.
56% of respondents cite keeping up with regulatory changes as a top challenge and 45% cite regulatory requirements in other countries. Regulatory compliance goes beyond tax laws to include things like securities laws, data privacy (a hot topic these days, see “Data Privacy Upheaval,” December 3, 2015), labor laws, currency restrictions and a host of other issues. It’s hard to stay on top of it all.
4. It’s the participants that suffer.
Ultimately, in the struggle to administer a global stock plan, something has to give and that something is usually the participant. Only 50% of respondents offer a qualified plan in countries where they could; the hurdle of regulatory compliance gets in the way. And 75% of respondents said that they would focus more on employee education if they could just spend less time on basic administration.
5. Expectations are low.
When we asked companies what is on their wish list for their administrative system, I was surprised at how low some items ranked (it was a “check all that apply” question, I thought everyone would want just about everything). For example, despite the fact that 71% of respondents reported tax-compliance for mobile employees as a top challenge, only 64% wanted a system that could calculate tax liabilities for mobile participants. It left us wondering if companies need to dream bigger for their administrative platforms.
Check out the White Paper and Survey
If you haven’t had a chance to read it yet, check out the white paper on the survey results and download the full results from the Solium website.
We recently posted the executive summary to the NASPP and PwC 2015 Global Equity Incentives Survey and, later today, we will be presenting highlights of the results in our webcast, “Top Trends in Equity Plans for International Employees.” For today’s blog entry, I highlight five findings that I think are significant:
Globalization Continues: Back when we did the 2012 survey, 20% of respondents said they expected to increase global participation in their stock plan and this trend held steady in 2015, with 19% again expecting to increase participation. In addition 77% of respondents said they expect global participation to remain the same. That leaves only a very small percentage of companies that expect to pull back their global stock plans.
Compliance Reviews Are More Routine: The percentage of respondents who said they conduct annual compliance reviews of their global stock plans increased to 43%, up from 34% in 2012. At the same time, respondents conducting only sporadic reviews dropped to 40%, down from 45%. It can be risky to wait until you hear about a regulatory change to conduct a compliance review; annual reviews help ensure that you know when the laws impacting your global stock plan have changed.
UK Takes the Lead in Challenging Tax Compliance: We asked respondents to indicate which countries they found to be challenging in terms of tax compliance. The UK was first, with 46% of the votes, up from 36% (third place) in 2012. China, however, is hanging in there at second place with 42% of the votes (China was in first place in 2012). France dropped to third place, with 26% of the votes (down from second place and 38% of the votes in 2012).
Mobility Compliance Up: The percentage of respondents tracking mobile employees continues to increase: 87% of respondents track formal assignees (up from 80% in 2012), 62% of respondents track mobile employees who aren’t part of an assignee program (up from 60% in 2012), and a surprising 27% track business travelers (up from 18% in 2012). But the tools for tracking mobile employees still leave something to be desired: 36% of respondents track this in an Excel spreadsheet, up from 29% in 2012. About another third (32%) outsource tracking to a consultant or TPA. The final third use a hodge podge of methods.
Participant Understanding Looks Like a Mountain Rather Than a Bell Curve: Only 34% of respondents felt that their global participants understand a good deal or completely understand their stock plan benefits. That leaves a two-thirds majority for whom participant understanding is at best, somewhat or partial. Global stock plans are a very expensive employee benefit, both in terms of the P&L and administrative cost. It seems a little crazy to invest resources like this in a plan and not also invest in the education to make sure participants understand it.
Be sure to tune in to the webcast later today to learn more highlights from the survey.
NASPP: What is the most critical thing NASPP Conference attendees need to know about equity awards held by globally mobile employees?
Stuart: Tax authorities across the globe are becoming more and more sophisticated when it comes to understanding the most common equity vehicles available to globally mobile employees. Significant negative outcomes can occur, including financial statement impact, if the right process is not put in place.
NASPP: What common mistake do companies make and how can they avoid it?
Stuart: A common mistake organizations make when dealing with equity provided to expatriate employees is to forget about the employee once they have come off of assignment. Post-repatriation equity income should be reviewed for any host country tax implications.
NASPP: What is the silver lining to all of this?
Stuart: The equity process for expatriates is manageable and surprises can be avoided.
NASPP: Tell us three things people don’t know about you.
Stuart:
I once appeared on the show “Candid Camera” doing hopscotch on a sidewalk in downtown San Jose. I received $25 for that appearance.
I scuba dived in Tahiti, following a divemaster who was towing 1/2 of a marlin while sharks attacked it.
I played trombone for the UCLA Marching Band and was lucky enough to march in two Rose Bowl Parades and play at the follow on Rose Bowl games.
As my readers know, because we’ve covered this topic ad nauseam here in the NASPP Blog (e.g., see entries on December 13, 2012, December 6, 2012, August 10, 2010, and May 6, 2010) when employees holding stock awards travel from state to state, it may be necessary to allocate the taxable income they recognize upon settlement of their awards to the various states where they provided services during the life of the awards. This can apply not only to employees that relocate or that live in one state and work in another, but also to employees on assignment and even business travelers. Many states require employees that work as little as one day in the state to pay income tax in that state. To further complicate matters, the formulas used to allocate the income can vary from state to state.
With some states (most notably NY and CA, but there are others as well) implementing audit initiatives and actively pursuing enforcement in this area, this issue has moved to the forefront in terms of things that keep stock plan administrators awake at night.
Relief?
Given the complexity of the acronym, it’s hard to believe the Mobile Workforce State Income Tax Simplification Act (MWSITSA? mew-sit-sa? really?) is about simplification but there it is, the word “simplification,” right there in the title. The Act would accomplish this by prohibiting states from taxing non-residents that work in the state for less than 30 days during the calendar year. Moreover, the determination of whether or not the company has to withhold taxes could be based on employees’ expectations of how many days they’ll work in states other than their state of residence (in the absence of fraud, collusion to evade taxes, or some sort of daily attendance tracking system).
A memo from PwC in the NASPP’s State Taxes Portal provides a great summary of the Act (the memo refers to an earlier version of the bill but I believe it is substantially the same as the current version.)
Not So Much?
This would be a big help in terms of business travelers, but there would still be employees on temporary assignment and employees that relocate to contend with. And, even with business travelers, I can imagine plenty of situations where this bill wouldn’t help (e.g., a salesman with an out-of-state territory or a regional division head that spends a lot of time traveling to headquarters in another state). And the bill doesn’t seem to do anything about standardizing the formula for allocating income among jurisdictions.
My impression is that, so far, most companies’ compliance efforts have focused on relocations and assignments and that no one has been doing much in terms of compliance for business travelers anyway. But at least if the Act became law, you could cross business travelers off your list of long-term projects–well, as least some of them.
Which brings us to the $10 million question–will the Act get passed. I think there’s a good chance that legislation of this sort will be enacted some time during, say, my lifetime (note that I expect that I’ve got at least three or four decades ahead of me). But I’m not holding out a lot of hope for the short term. The good news is that a version of this bill was introduced into the House last year and passed. Unfortunately it stalled out in the Senate and now we’re in a new session of Congress so it has to start all over again. Govtrack.us gives it a 40% chance of making it out of committee but only a 6% prognosis of actually being enacted. At least there’s hope for our grandchildren…
Speaking Proposals: NASPP Conference speaking proposals are due a week from Friday, by March 1. With the Conference in September, we are on a tight schedule this year and cannot make any exceptions to this deadline, no matter how dire the circumstances. If you feel the flu coming on, plan accordingly.
Early-Bird Registration: For those of you that are not hoping to speak at the Conference, the deadline for early-bird registration ends on Friday, March 8. This deadline also will not be extended. Don’t pay more than you have to for the Conference; register by March 8.
Quick Survey on Globally Mobile Employees Take our quick survey on globally mobile employees. With just eight questions, we’re serious about the “quick” part–you can complete the survey in less than five minutes!
We Have a Winner! Congratulations to Elizabeth Dodge of Stock & Option Solutions! Elizabeth won our raffle for the free registration to the CEP Symposium.
Here’s your NASPP “To Do List” for the week:
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.
Today we feature another guest blog entry, this time from Marlene Zobayan of Rutlen Associates, who will present on the panel “The Buck Stops Here (Unless, of Course, It Stops Somewhere Else)” at the 19th Annual NASPP Conference in November. The panel will use a case-study approach to define an effective strategy for addressing the taxation of globally mobile employees. Marlene’s co-panelists are Jim McBride of AST Equity Plan Solutions, Kate Forsyth of Deloitte, and Kimberly Kovacs of OptionEase.
The Buck Stops Here (Unless, of Course, It Stops Somewhere Else) by Marlene Zobayan, Rutlen Associates
These days, no discussion on the taxation of equity compensation seems complete without addressing the topic of mobile employees. For any one company, the numbers of mobile employees are usually small compared to the entire workforce, yet the administrative work caused by this small group of employees far exceed those of the fixed population.
The difficulties fall into three categories:
There is the administration burden of identifying and tracking who the mobile employees are.
Then there is calculating the correct taxes to apply. Of course, jurisdictions differ widely on what they determine to be their taxable portion resulting in a complicated tax calculation for each set of facts.
Finally there is the difficulty of getting the payroll and administration systems to administer what has been calculated, especially where the amount of income being taxed does not sum to 100%.
For the more advanced company, the impact of mobile employees carries through to the corporate tax deductions, which impacts deferred tax assets and ultimately the accounting expense of the equity compensation.
Although the technologies supporting these categories have come a long way, often manual intervention is still required to make sure the systems properly handle mobile employees.
To demonstrate these issues, the panel will focus on three specific examples of mobile employees who all receive similar equity grants. The examples follow common real-life mobility patterns, if there is such a thing. The audience will see how a mobile employee’s circumstances impact the taxation, employer withholding and reporting compliance, accounting, expense allocation and corporate deduction based on the countries involved and the type of mobility, e.g., whether someone is a temporary assignee, permanent transfer or a business traveler.
What happens when an employee moves to another state while holding an equity award (e.g., stock option, restricted stock, restricted stock unit, etc.)? In many cases both states, (the state the employee moved from and the state the employee moved to) will tax all or part of the income related to the award.
Historically companies have not tracked employees moving from state to state. Companies have merely reported the equity compensation in the state of residency when the taxable event occurs (e.g., exercise of an option or vest of a restricted stock/restricted stock unit). Rutlen Associates recently conducted a survey of how companies track employee movement and report equity awards for employees that move from state to state. (Approximately 150 companies participated in the survey.) The survey results indicated about 20% of survey respondents meet the withholding and reporting requirements for reporting equity awards for mobile employees. Compliance varies depending on the type of mobile employee. Compliance is higher for employees on temporary assignment and employees permanently transferring to a new state. Compliance for business travelers is significantly lower.
In the Rutlen Associates’ survey the reasons for noncompliance vary:
50% could not allocate the income to more than one state because of limited system functionality and/or manual resources.
38% determined the amounts were insignificant.
35% didn’t know the compliance requirements for each state.
27% didn’t have information about employee movement.
Information about employee location/movement is more readily available for permanent transfers than temporary assignments and business travelers. Frequently the change of address when an employee permanently moves to a new state provides better documentation of employee movement.
Despite the challenges associated with compliance, more companies are reassessing the way they track and report state-to-state moves. Increased attention from the tax authorities in various states is encouraging companies to reevaluate their processes. Many states, especially New York and California, are focusing on enforcement of the withholding and reporting requirements for individuals moving into and out of the state. For example, New York is targeting high-level executives. During a recent audit New York State revenue agents reviewed payroll and expense reports for all executives–even executives with no ties to New York. Any company doing business in New York may be selected for this additional scrutiny. For many companies the potential tax assessment may not be significant, but the administrative cost of complying with the requested documents may be onerous.
Many software vendors are adding functionality in the stock plan database to track the historic location of the employee and employee mobility. Of course, adding functionality to track employee movement is a double-edged sword. The improved functionality makes compliance easier–knowing which employees are moving and the move date is the first step to complying with the reporting and withholding requirements. Once you have information on employee movement, however, the tax authorities are less likely to tolerate noncompliance and more likely to assess penalties for ignoring the compliance requirements.
The moral of this story is that it is an excellent time to reevaluate your handling of the issues surrounding state mobility.
It can take a considerable amount of effort, not to mention legal advice, to correctly report income and withhold taxes on your globally mobile employees. In the spirit of keeping this short, I’m going to talk about some of the issues around double taxation and employee mobility in the context of a U.S. company and a U.S. citizen.
Double Taxation
All income made by a U.S. citizen is taxable in the U.S., regardless of where the income was earned. Additionally, the company has the withholding and reporting obligations with regards to income and income tax. This means that a conservative approach to withholding on income from equity compensation for your U.S. employees who are working abroad would be to withhold U.S. income tax on the entire amount. The local tax authority in the country in which your mobile employee resides may also require reporting and withholding on that same income, creating double taxation for the employee. This issue was addressed in 2004 by the Organisation for Economic Co-Operation and Development (OECD) in their paper on the taxation of mobile employees. In this paper, the OECD calls for tax treaties that help alleviate the burden of double taxation by sourcing the income based on where it was earned. Although the paper, and other recommendations by the OECD, is non-binding to any country, it has influenced the way equity compensation income is addressed in tax treaties.
Tax Treaties
Fortunately, many countries have treaties in place that provide a protocol for income tax obligations on income that may be sourced to more than one country. In fact, the U.S. has entered into income tax treaties with over 60 countries. You can find them all on the IRS website HERE. These treaties are typically for the individual and do not necessarily relate to your company’s obligation as an employer to report and/or withhold. They often permit the individual to receive a foreign tax credit on income that was earned outside of the U.S. and is also taxed in the other country. Some employers, at the recommendation or approval of their own tax advisors, apply these tax credits proactively to equity compensation income that was “earned” outside the U.S., using a pro-rata arrangement to allocate income that was earned while the employee was still in the U.S.
Totalization Agreements
Income tax is not the only tax that companies need to consider when dealing with globally mobile employees. Social taxes also apply, and may be handled differently than income tax arrangements. Double taxation is also an issue with social taxes like the U.S. social security tax and Medicare; this is called dual coverage since social taxes are typically designed to cover an individual or their families in retirement, illness, disability, or death. The issue of dual coverage is costly for both your mobile employees and your company, since most countries have an employer-paid portion of social taxes. To address this issue, the U.S. has entered into “Totalization agreements”. These agreements allow the individual and the company to source the entire amount of equity income to one country or the other, per the agreement (you can’t choose which country to contribute social taxes to). You can find all the countries with which the U.S. Social Security Administration (SSA) has Totalization agreements on the SSA site HERE. If your company is planning to rely on a Totalization agreement for some or all of your mobile employees, you will need to ensure that each employee has a certificate of coverage issued from the country in which the employee will be paying social taxes. In the U.S., the certificate of coverage can be requested from the SSA by your company on behalf of the employee.
Multiple Sourcing Periods
What all this means is that if your company decided to proactively apply both the income tax treaties and the Totalization agreements, there may be several ways in which income is allocated. Even though this is advantageous to your mobile employees because they will not need to pay now and true-up their tax obligation when they file their income tax returns, it does mean that you will need to communicate very clearly with your employees and your Payroll department. Essentially, your company will need to report a different amount of income in Box 1 of the W-2 than is in Box 3 and Box 5 (see our Tax Withholding and Reporting portal for more on U.S. tax withholding). Additionally, if you are sourcing the income pro-rata, the sourcing may be applied differently in the U.S. than in the other country. In the U.S., it’s generally accepted that the sourcing is from grant to vest for options, but in some countries it may be grant to exercise.
Key Resources
There are, of course, many additional considerations for tax withholding for your mobile employees. You can find additional resources in the NASPP Global Stock Plans portal, in our Document Library, and on the Discussion Forum (search for the keyword “mobile”). You can also see what other companies are doing by reviewing our 2006 and 2008 International Stock Plan Design and Administration Surveys, co-sponsored by Deloitte. Until the full 2008 survey is available on our site, you can catch the highlights in the archive of our recent webcast, Top Trends in Stock Plans for Overseas Employees.
You should already be registered for our 17th Annual NASPP Conference. If you haven’t, act now – the early bird rates end this Friday. If global mobility is a topic you want to hear more about, be sure to sign up for the workshop “Traveling with Equity” at the Conference!