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).
– Barbara
Tags: fair market value, FICA, FMV, Form 1099-B, restricted stock, Restricted Stock Award, Restricted Stock Unit, retirement, Retirement Eligibility, sell-to-cover, share withholding, tax withholding
Barring some sort of unforeseen obstacle, T+2 settlement is scheduled to go into effect on September 5 of this year. (That’s the Tuesday after Labor Day—what better way to cap a holiday weekend than with a major change in the US securities markets? I guess they didn’t want to wait until December 26).
On Tuesday, I blogged about why the securities industry is moving to T+2 (“Progress Towards T+2“). For today’s blog entry, I have a list of six things you need to think about with respect to T+2.
1. Be prepared to shorten processing time for any stock plan transactions that involve open market sales. This includes same-day-sale and sell-to-cover transactions. The broker will need to receive the shares and know the funds to be transferred to the company to cover the cost of the transaction and tax withholding in time to settle by T+2. That means you’ll have one less day to process the transaction.
2. Other types of transactions may be affected as well. Cash and net exercises and share withholding don’t involve open market transactions and, thus, theoretically aren’t subject to the mandated settlement period. But, in recent years, many companies have begun allowing employees to conduct these transactions using the automated, self-service tools provided by their brokers. Some (many? all?) brokers may subject these transactions to the same two-day settlement period simply because that is how their systems will be designed to work.
3. Watch out for complicated transactions. It may be no sweat to calculate the tax withholding for US employees and get that information over to your brokers in 24 hours. But for non-US employees, where you may have to contact local payroll (possibly in a time zone that is half a day off from yours) for the appropriate tax rate, this might not be so easy. And then there are your mobile employees. Withholding at the maximum tax rate and refunding the excess through local payroll might be the only way to manage this process.
4. Beware the IRS deposit deadline for same-day sales. Where the company’s cumulative deposit liability to the IRS exceeds $100,000, the deposit needs to be made within one business day. But for same-day sale exercises, an IRS field directive considers the deposit timely if made within one day of the settlement date. If settlement occurs on T+2, that means the deposit now needs to be made by T+3.
5. Talk to your brokers. Contact your brokers to find out what they are doing to prepare for T+2 and what testing opportunities will be available to you. Think about what you’ll need from your brokers and communicate this to them. Don’t wait for your brokers to contact you; get out in front of this.
6. Don’t forget about employee communications. Your brokers are going to be communicating this change to your participants. Make sure you know what they will be communicating and when, so you aren’t caught off guard. And review your own educational materials for any mention of the settlement period.
Some of the panelists in the NASPP Conference session on this encouraged the use of the term “settlement period” without explaining how long this period is, so that if/when the period is reduced to T+1, you don’t have to change it again. I hate that idea. It makes a confusing concept even more confusing for employees. And it could be decades before we move to T+1 (moving from T+3 to T+2 took 20 years). By then, you’ll probably have been promoted (or retired) and updating the educational materials will be someone else’s problem.
– Barbara
Tags: NASDAQ, NYSE, same-day sale, SEC, sell-to-cover, settlement, T+2
Companies that grant stock options know that there are a few core challenges that have maintained their existence throughout the life span of these types of equity arrangements. Among them: how to handle the impending expiration of an in-the-money, unexercised grant.
Does it Really Happen?
Stock plan education site, myStockOptions.com, cites the issue of expiring options as one of the “top mishaps with stock options that can cost you money”. This issue of lost dollars creates a conundrum for many companies – if the option expires, there is risk for a disgruntled employee who may decide to litigate. Even if litigation doesn’t happen, many employees who find themselves in that situation often beg for reinstatement of the option, which is not without cost to the company (in the form of additional compensation expense that would need to be incurred for the reinstated option, which would be treated like a new grant in-the-money grant for accounting purposes). These scenarios usually motivate employers to prevent the options from expiring.
Preventing Expiration
While the issue of expiring options remains relatively unchanged – as long as there are stock options, there will be concern around the impending expiration of in-the-money grants – the approaches to handling this situation continue to evolve. The most common practices include outreach programs to remind optionees that their grant is about to expire. This communication can be performed by the company, or, via a third party service provider. Although these programs seem to reduce the number of expired grants, there are no guarantees that a grant will be exercised – the action still falls squarely upon the participant.
New Ideas
In recent years, a new approach has emerged as a practical solution to this age old problem: the auto-exercise. The essence of the auto-exercise is that an in-the-money, otherwise unexercised stock option will automatically be exercised at or shortly before the close of the market on the date of expiration. The “type” of exercise that will be executed is usually determined by the company in conjunction with the service provider who will perform the exercise, in compliance with the company’s plan terms. I don’t have any formal survey data on which auto exercise types are most popular, but I’d say net issuance and sell-to-cover are on my radar as the most logical methods, with an edge to net issuance.
This is not a new concept – auto exercise has been used for publicly traded options for years. However, in adopting this approach for internal stock plans, there are considerations – some of which were recently highlighted in a Fidelity memo titled “Safeguarding Your Employees’ Stock Option Grants“, available on the NASPP web site. This particular article heavily advocates the use of net issuance in these situations; I’ll recap some of the concepts (with my own flavor added) from that angle:
- Cash Flow: Companies need to carefully consider their cash flow when determining which auto exercise method to use. Withholding of shares (net exercise) to cover the exercise costs means that the company will need to remit the tax payment, from its own coffers, to the IRS.
- Plan Provisions: Again, regardless of which exact method is chosen, it’s important to ensure the chosen method is permissible under the plan terms. If there is no provision, it may be necessary to secure a plan amendment.
- Treatment of Existing Options: When implementing an auto exercise program, a determination must be made as to whether this applies to all grants (existing and new) or only on a forward basis (new grants). Addition of this type of feature to an existing grant is considered a Type 1 modification for accounting purposes, but would be no incremental expense.
- Threshold for Automatic Exercise: A determination needs to be made as to how far the options need to be “in-the-money” in order for the auto exercise to execute. Usually a threshold to net one share would be the minimum amount, since most plans and service providers wouldn’t permit a fractional share issuance in these scenarios.
What if the Employee Doesn’t Want Auto-Exercise?
Lastly, there’s the scenario of an employee who actually didn’t want to exercise their in-the-money options and complains that the company has now created a taxable event on their behalf. While that is a consideration, Fidelity points out that “the result of exercising in-the-money options still provides a net financial benefit to the employees, even after accounting for taxes. Moreover, companies routinely create taxable events by paying out full-value stock awards to employees, so a case can be made that the automatic exercise of in-the-money options should be treated no differently.”
Do YOU Have Auto-Exercise?
I do think this solution is slowly gaining traction. Let’s test that thought – take the quick poll below. I think it’s definitely worth consideration, especially for companies that seem to have a significant number of in-the-money options expire.
-Jennifer
POLL
Tags: auto exercise, expired, expiring options, net issuance, plan amendment, sell-to-cover, stock options