The IRS has announced an audit initiative focused on Section 409A compliance. Frankly, I’m a little surprised that they haven’t undertaken this sort of audit initiative sooner–I’ve heard from practitioners that, up until now, Section 409A has rarely been a focus of IRS audits. Given the complexity of this area of the tax code and the fact that every time I have a question about it, my sources never seem to be entirely sure of the answer (and I sometimes get conflicting answers), it seems like 409A could be an untapped wealth of compliance errors for the IRS.
Who Are the Lucky Winners?
Some companies are just lucky. The IRS has picked 50 companies to be the subject of the audits, all of which have already been selected for employment tax audits–I guess the IRS is a believer of “when it rains, it pours.” The good news is that if you haven’t already been selected for an employment tax audit, you won’t be part of the initial 409A audit initiative.
What Is the IRS Looking For?
The audits will focus on deferral elections (both initial deferrals and re-deferrals) and payments (including payments to key employees upon separation of service). It’s pretty rare that we see deferral elections for stock compensation; only 29% of respondents to the NASPP’s 2013 Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting) allow deferrals for time-based RSUs and only 24% allow deferrals for performance awards. Based on this, it seems that the audits will concentrate primarily on more traditional NQDC plans, rather than stock compensation.
This seems like a missed opportunity for the IRS–I’ve always found the application of Section 409A to stock compensation to be particularly confounding and full of traps for the unwary. Moreover, I think this is an area of the tax code that often is overlooked when we are thinking about potential concerns related to stock awards. But perhaps the IRS will expand to stock compensation in the next phase of the audit initiative.
The Next Phase?
I say “next phase” because this could be a precursor to a larger, more intensive audit of Section 409A compliance. In a memo on the initiative, Groom Law Group says “The IRS will assess what further steps, if any, to take after the results of these audits are in.” Now is a good time to get out ahead of this and perform your own self-audit of 409A compliance. In his blog on CompensationStandards.com, Mike Melbinger of Winston & Strawn points out that there is a corrections program available for some operational errors under 409A, but that the corrections program is no longer an alternative once you are the subject of an audit.
It’s that time of the year – holidays, festivities and year-end prep. I’ve often wondered how the two can go hand in hand. In today’s blog I’ll combine the two; let’s see how that works out.
Send Your Holiday Selfies
Let’s get the fun out of the way first. Chapter holiday gatherings are already in full swing, and we want to see your photos. Send me your selfies and group photos – we’ll post them to our Facebook page. Some of them might even make it into a holiday oriented future blog post. The pictures are already coming in – see anyone you know from yesterday’s San Diego chapter holiday event? Hint: Raul Fajardo of Qualcomm and James Tozer of E*TRADE.
Year-End Prep Tips
Moving on to the more serious topic of year-end. It seems like it always creeps up on us – one minute we’re celebrating and the next it’s full throttle into year-end reporting, tax and proxy season. To get ahead of the game, I thought of a few things you can do now, in December, to prepare.
1) Audit non-employees in your recordkeeping system. Non-employees who had stock compensation transactions this year will need a Form 1099-MISC. This is not to be confused with “former” employees, who will still receive a Form W-2. In many organizations preparation of 1099 forms is not handled by Payroll, so you’ll want to make sure you know who your non-employees are (including outside directors) and have that list ready come January for whomever is going to prepare the forms.
2) Attend our webcast next week (Thursday, 12/12) on Annual Tax Reporting. This will feature essential information on 6039 reporting, special reporting requirements, non-employee reporting and other detailed tax reporting instructions. This is a prime opportunity to get the lay of the land heading into tax season.
3) Revisit deferred tax withholdings (e.g. FICA on retirement eligible RSUs). If you’ve delayed collection of FICA taxes until year-end, for example (based on the IRS’s Rule of Administrative Convenience, allowing deferral of collection of some taxes until calendar year-end), you’ll want to revisit those scenarios now to determine whether any tax withholding is required before year-end. In relying on the Rule of Administrative Convenience, the idea is that taxes like social security will have reached their annual maximum withholding for many employees by now, eliminating the need to collect any additional social security – meaning none would need to be collected for the award. However, if an employee has not reached the maximum and collection of such taxes were deferred under the rule, then you’ll need to make sure you adequately withhold by 12/31.
Well, there you have it. Festivity and planning tips all in one blog. The holiday season is off to a great start. I’m looking forward to seeing everyone’s photos, and I’m wishing you a smooth sailing process as you kick off year-end as well.
It’s a holiday week so I thought I’d do something a little lighter for today’s blog entry. Over the nearly 20 years that I’ve worked in this industry, I have asked a lot of questions about stock compensation. I’ve also found the answers to a lot of them, but there are still a few questions that remain a mystery to me. For today’s entry, I present some of my unanswered questions.
IFRS 2?
The international financial reporting standard for stock compensation is IFRS 2. Two? Is this really the second standard that the IASB drafted? Seriously? Of all the possible areas of discrepancy in worldwide accounting, stock-based compensation was the second most important area they could think of? And, if so, what the heck was so important that it beat us out for the number 1 spot?
Why Two and a Half Months?
What is magical about two and a half months after the end of the calendar year for the IRS? Would anyone care if the deadline were just two months (i.e., the end of the second month)? Because in terms of explaining both the provisions of 409A and the FICA short-term deferral rule, this would be a heck of a lot easier to say.
Forms 1 & 2?
Whatever happened to Forms 1 and 2? I must remember to ask Alan Dye about this. Wouldn’t it have made more sense to call Forms 3, 4, and 5 something like “Forms 16A, 16B, and 16C”? Or maybe 16H (“H” for holdings), 16NE (“NE” for non-exempt transactions), and 16E (“E” for exempt transactions)? The form for Rule 144 is called “Form 144,” why not use the same naming system for Section 16 forms?
When Is 30 Days After June 30?
Why does Form G-4 (filed by companies that have issued loans for the purchase of their own stock in excess of the Federal Reserve Board thresholds) have to be filed within 30 days following June 30? Wouldn’t that always be by July 30? Why couldn’t the Federal Reserve Board just say, “file this form by July 30”? Does the Federal Reserve Board have a different calendar than I do?
How Does the IRS Determine What Constitutes “News”?
Why does the IRS send out an email announcing inflation adjustments for the carbon dioxide (CO2) sequestration credit under §45Q but doesn’t send an email announcing proposed rule changes under Section 83?
How Many EDGAR Passwords Does It Take to Change a Lightbulb?
Why the heck does it take four–count ’em, that’s 4–codes to change my EDGAR password? That’s two more codes than I have to enter to change the password on any of my financial accounts. And it’s useless as a form of security because I can’t remember any of them, so I have them all written down in the same document–if someone manages to get one of them, he/she probably has them all. Heck, I bet most companies have a single document where they store all of these codes for all of their insiders–all in one handy place for anyone who wants to sabotage their insiders’ Section 16 filings. This is a perfect example of why lawyers shouldn’t be allowed to develop computer systems.
What Is a Borker, Anyway?
Does anyone else consistently mistype the word “broker” as “borker”? It seems so inappropriate but also kind of appropriate at the same time. “Consluting” for “consulting” is another typo I make with some regularity. Thankfully, both errors are caught easily with spellcheck.
Just a few thoughts to ponder and perhaps discuss with your family as you enjoy Thanksgiving dinner. Enjoy your holiday!
For today’s “Meet the Speaker” interview, we feature an interview with Rive Rutke of Deloitte Tax, who will lead the session “Equity & Employment Tax: A Marriage Made in Heaven.” Here is what Rive had to say:
NASPP: What are a few key areas your panel will address with respect to stock compensation and employment taxes?
Rive: Our panel will discuss some of the U.S. and global issues relating to audit exposure pertaining to equity compensation compliance. We will also highlight the challenges of managing global withholding obligations related to ASC Topic 718–and provide insight into how three issuer companies manage global withholding rates, in light of ASC 718.
NASPP: What common mistake do companies make and how can they avoid it?
Rive: A common mistake companies make is not adhering to the rules regarding the timing of payroll deposits–both in the US and globally. We are prepared to review some of these rules during our session so that common mishaps can be avoided.
NASPP: What is the silver lining to your employment taxes?
Rive: The silver lining is that once issuer companies are aware of the rules and regulations, positive action steps can be taken which can increase compliance and reduce risk.
NASPP: Tell us three things people don’t know about you.
In today’s blog, I provide an update on the status of FICA taxes as we head into next year and include a note from Alan Dye on the impact of Hurricane Sandy on EDGAR filings.
FICA Tax Increases for 2013 The Social Security Administration announced in a press release on October 16 that the annual wage base for Social Security tax is increasing to $113,700 in 2013 (up from $110,100 in 2012).
In addition, the current 2% rate cut for the employee portion of FICA is due to expire at the end of this year. If Congress doesn’t take action before the end of the year, the withholding rate for Social Security will return to 6.2% next January. If I managed to do the math correctly (something you should never take for granted), that will bring the maximum Social Security tax payment for 2013 up to $7,049.40. This is up from $4,624.20 this year, an increase of over 50%.
For the first time since I’ve started working in stock compensation, the Medicare tax is also increasing, at least for those in the top income tax brackets. As noted in my August 7 blog, “The Supreme Court and Stock Compensation,” wages in excess of $200,000 per year ($250,000 for married taxpayers that file jointly, $125,000 for married taxpayers that file separately) are subject to an additional .9% Medicare tax. Companies will apply the higher rate to any wages in excess of $200,000, regardless of the employee’s filing status and the rest will be sorted out when employees file their tax returns.
The additional Medicare tax applies only to employees; the company’s matching payment is not increased.
There are already a couple of threads started on administering the new Medicare tax in the NASPP Discussion Forum, see topics 7186 and 7354.
Highly Compensated Employees The wage threshold for which employees are considered highly compensated for purposes of Section 423 qualified ESPPs will remain at $115,000 for 2013.
Hurricane Sandy and EDGAR Filings Alan Dye notes in his blog on Section16.net that Hurricane Sandy is preventing folks on the East coast from submitting Section 16 filings and that the SEC was quick to offer relief. From Alan’s blog yesterday:
With Hurricane Sandy bearing down on DC and much of the Northeast, some filers and filing agents are having trouble getting to their offices to make Section 16(a) filings that are due today. The staff is taking an accommodating position for purposes of Section 16(a) and Item 405, saying that “For those affected by the hurricane — filers (or their lawyers/agents) along the East Coast — we won’t object if the filings that are due today are filed tomorrow (assuming that tomorrow is a day on which people can go to work). For filers not affected by the hurricane, then today is a regular business day and filings due today have to be filed today. So, this is effectively a no action position for only those filers (or their lawyers/agents) affected by the hurricane.”
Presumably filers not affected by the hurricane have no need for relief and will file on time. Filers scrambling to find a filing agent, though, now have some breathing room and can file tomorrow (assuming tomorrow is a normal business day). Thanks to the staff for getting on top of this issue quickly.
Hurricane Sandy and Option Exercises We also had a couple of threads started in the NASPP Discussion Forum on how employees that are up against the contractual expiration of their in-the-money stock options can exercise despite the market’s unexpected closure due to Hurricane Sandy. Here is a quick list of the alternatives:
pay cash for the exercise
net exercise
stock-for-stock or pyramid exercise
margin loan to be closed out when the market reopens and the stock acquired up exercise can be sold
loan from the company (if the optionee is not an officer or director) to be repaid as soon as the market opens and the stock can be sold
See NASPP Discussion Forum topics 7361 and 7362 for more information.
The IRS has been busy on projects related to stock compensation lately (see “Dividends and Section 162(m),” July 10, 2012, and “Section 83 Update,” June 12, 2012). Their latest project is a sample Section 83(b) filing, something Stephen Tackney and Thomas Scholz, both of the IRS, had alluded to being in the works at last year’s NASPP Conference.
Rev. Proc 2012-29 provides a sample Section 83(b) election, along with examples clarifying the tax treatment that applies when the election is filed. See the NASPP alert “IRS Issues Sample 83(b) Election Form” for more information.
A Quick Review
Section 83(b) elections can be filed by employees when they receive stock that is subject to forfeiture and transferability restrictions. The most common arrangement in which employees would receive stock like this is a restricted stock award. A less common arrangement is an early-exercise stock option, under which employees are allowed and choose to exercise prior to vesting. Normally stock acquired under these arrangements is taxed at vest; filing a Section 83(b) election accelerates the taxable event to the grant/exercise date.
The election has to be made relatively quickly–within 30 days of when the stock is transferred to the employee–and must contain specific details about the transaction for which it is made. There’s not a lot of room for error here–miss the 30-day deadline and you are out of luck.
Incomplete Filings?
I was surprised at last year’s Conference to hear that the IRS was working on a sample 83(b) election. I had assumed most companies assisted employees wishing to make the election, ensuring that their elections are complete. But, given the Rev. Proc, now I’m not so sure.
I don’t know this for a fact, but I have to believe that the IRS issued the sample election because they receive a high number of incomplete filings and this is an effort to mitigate the problem. This is an area where you may want to take action to protect your employees. I think it’s a best practice for companies to provide a form that employees can use to make the election and to review their elections before they file them, just to make sure they’ve completed the form correctly. An incomplete or incorrect filing could be a mess if the error isn’t caught before the 30-day deadline. In a worst case scenario, the entire election could be considered invalid.
Note, however, that I never recommend that companies make the election on behalf of employees. Leave the responsibility for actually submitting the election in employees’ hands so that you don’t bear any responsibility if (or should I say “when”) elections aren’t mailed on time.
I’ll never forget a stock plan administrator telling me about starting a new job and opening a drawer in the prior stock plan administrator’s desk only to find a folder filled with Section 83(b) elections that the company had promised to file on behalf of employees over the past year and that had never been mailed. It was a private company and the elections were for early-exercise options that had been exercised at grant. If they had been filed on time as the company had promised, the employees would not have recognized any compensation income on their options. It still makes me a little sick to my stomach to think about it. Don’t do that! Make the employees mail their own elections.
More at the NASPP Conference
Attend the panel, “The IRS Speaks,” at the 20th Annual NASPP Conference to hear more about this Rev. Proc. as well as other rule-making activity that the IRS has completed this year–and hear what’s on tap for next year.
Two weeks ago, I discussed the Medicare tax rate hike that goes into effect next year (“The Supreme Court and Stock Compenation,” August 7). Today I discuss some additional considerations relating to that tax increase and other possible tax increases for 2013.
A Busier Second Half of the Year
Any time there is a tax rate increase on the horizon, tax advisors get on their soap boxes about accelerating transactions to take advantage of the current lower rates. In our world, that translates to employees possibly exercising their NQSOs this year, rather than waiting until next year or later.
Of course, here we’re only talking about an additional .9% in tax. Generally, tax considerations shouldn’t drive investment decisions and I would think that this is especially the case when we’re taking about such a small increase–on a gain of $1 million, that’s only $9,000 in additional tax. If you think the stock is going to increase in value, I’m not sure it’s worth it to exercise early just to save the $9K. But Jenn Namazi, the other half of the NASPP Blog, tells me that she has heard several advisors (including some very large, well-respected firms) suggesting this investment/tax strategy, so what do I know?
More Sales
In addition to NQSO exercises, you also may find more of your insiders selling stock in the latter half of this year. This is because, in addition to the rate hike I described last week, a completely new Medicare tax also goes into effect next year. This is a 3.8% tax that applies only to “unearned income” in excess of the same $200,000/$250,000 threshold. Unearned income sounds like something bad, like you it is income you don’t deserve, but it really just refers to income you didn’t earn by toiling away for your employer. Primarily, this is income from investments, such as capital gains realized on the sales of stock.
3.8% is a little more significant (actually about four times as significant) than .9% (it amounts to $38,000 on a gain of $1 million). On top of that, if Congress doesn’t take action to extend the Bush-era tax cuts, the long-term capital gains rate is going to increase from 15% to 20%. Consequently, long-term capital gains that would currently be taxed at 15% might be taxed as high as 23.8% next year. That’s the sort of tax rate increase that I expect to be more likely to change investment strategies.
Of course, there’s no tax withholding on long-term capital gains and this applies to the new Medicare supplement as well. There’s also no matching company payment, so the company doesn’t have any reporting or withholding obligations with respect to this tax.
But, where the sellers are executives, the sales could have other impacts to the company. At a minimum, the sales have to be reported for Section 16 purposes. And where executives have Rule 10b5-1 plans set up, you might find a flurry of changes to increase sales under these plans, which most companies would need to review/approve.
Shareholder optics are also a consideration; having several executives (or all executives) suddenly appear to be dumping company stock around year-end may not be the best thing for the company’s stock price. Your investor relations group may want to get out in front of this one.
April 9th was a picture perfect day at Lincoln Financial Field in Philadelphia. Not only is it the home field for an NFL football team, but it was the location for the Philadelphia chapter’s half day event as well.
I was fortunate to be one of the 75 people in attendance that day. The agenda included two great stock compensation educational sessions, lunch overlooking Lincoln Financial Field, and a behind-the-scenes tour of the stadium. For today’s blog, I share some photos that captured the essence of the day. (Click on thumbnail to see larger image.) Kudos to the chapter board and meeting sponsors who came together to create something unforgettable.
Picture Perfect
The setting for the chapter meeting was Lincoln Financial Field, home to the Philadelphia Eagles.
Chapter board member Scott McCloskey of Lincoln National Corporation and Chapter President Terry Adamson of Aon Hewitt take in the view while preparing to kick off the day’s events.
Emily Cervino of the Certified Equity Professional Institute, Liz Stoudt of Aon Hewitt, and Mike Palermo of E*TRADE lead attendees through an informative session on the current landscape of offering an Employee Stock Purchase Plan.
Bill Dunn of PwC talks about election year tax volatility.
The newest addition to the Philadelphia chapter board, Andrea Kagan of QlikTech, takes time to network.
Session attendees listen intently.
Lunch, sponsored by E*TRADE, is held in the press box. Attendees network while enjoying the amazing view.
Did I mention that there was an incredible view from the press box?
After lunch, attendees were treated to a behind the scenes tour of the stadium, which included a tour of the locker room. I’ve never seen so many cell phone cameras fly out at once!
This is where many players meet the press after their games.
It was a day filled with education, great networking, and fun for all who participated.
It’s April already, and in spite of the sneezing and wheezing of spring allergies in full force all around me, I couldn’t help but notice that we’re less than two weeks away from tax filing deadline day. April 17th is just around the corner. (Yes, if you’re late in starting your tax return, it is due on April 17th this year; April 15th falls on a Sunday and April 16th is a holiday in Washington, D.C., so that gives filers until April 17th to file their returns.) I’ve been wondering how stock plan administrators are faring this tax season. With the new Schedule D, 1099-B cost-basis reporting, and additional new IRS forms, I’ve felt certain there would be volumes of employee questions.
Do People Really Procrastinate?
There is an abundance of statistics on taxpayer filing habits; many land near a 40% figure as the number of taxpayers who file their tax returns during the last two weeks before the deadline. When I worked on the issuer side of the industry, I recall planning for those first two weeks in April to be filled with last minute participant questions. So I ask: are the questions pouring in this year? If so, I offer some last minute survival strategies for making it through one of our more complex tax seasons (from an equity compensation perspective, of course!) in recent years.
Have Resources Available to Answer the Phone/Email
Even if you’re sure you’re not going to pass out tax advice; even if you’re certain that the broker can answer all of their 1099-B questions, if you had significant transaction activity resultant from your stock plans in 2011, expect that a fair number of those participants have not yet filed their tax returns and they will emerge at the last minute. There’s an expression that I’ve heard often: “Failure to Plan on Your Part Does Not Constitute an Emergency on My Part.” Well, yes, that’s a fair argument. Yet in reality, we know participants are going to have questions. Rather than taking a stand against procrastination, sometimes it’s better to just accept that these things are going to happen and plan accordingly. Look at your volume of activity during 2011, and if it was minimally significant or more, make sure you have a plan in place for someone to answer that participant call. When up against a deadline, nothing is worse than getting voice mail or sending an unanswered email.
Anticipate, Anticipate, Anticipate!
We’re nearing the end of tax season, so hopefully you’ve already gained some flavor for what participants are asking about this year. It’s been a complex tax reporting season from a stock plan perspective, so anticipating hot button questions and having a ready response will help both sides: you with managing the inquiries, and participants with getting what they need quickly. One great trick I heard about (and tested myself once upon a time) can be applied to your email inbox. You can come up with a list of the top 10 questions that you think participants will email about, and then prepare an “auto reply” that lists the top 10 questions and answers. When the participant emails in a question, they will automatically receive the auto-reply. In many cases, the participant may find their answer in the auto-reply and won’t have to wait for you to respond individually to their email. I would suggest that you still respond, but knowing that in many cases the employee could potentially get the information even faster via the auto reply can go yards in assisting employees during peak periods. Keep in mind you don’t have to necessarily answer “tax” questions; sometimes the employee is just looking for a next step or other resources. Something as simple as a question/answer that addresses where they can find more information on a particular topic can be helpful.
I wish you all smooth sailing through the last couple weeks of tax season.
Back in November, the IRS proposed additional regulations on cost-basis reporting. These regulations primarily relate to the third phase of implementation of the reporting requirements, which applies to options and debt securities. But there are a few areas in the regulations that are of interest to stock plan professionals.
You Win Some: Sale Proceeds to Be Reported Net of Fees
It will come as a relief to anyone that has reviewed any of my cost-basis reporting flow charts to know that the regulations would require all brokers to deduct the transaction fees from the sale proceeds reported on Form 1099-B. In my humble opinion, this is a requirement that is long overdue. The fees are usually a small amount, sometimes immaterial, but trying to explain how they are included in the tax return when the broker doesn’t deduct them from the sale proceeds (or worse, when you don’t know whether the broker has deducted them) is almost an insurmountable challenge. If the IRS adopts these regulations and requires all brokers to report the sale price net of fees, I’ll be able to reduce my 6039 flow charts from 14 pages down to a mere five pages.
You Lose Some (or The More Things Change, the More They Stay the Same)
Readers of prior NASPP blog entries (see “Four Questions to Ask Your Brokers,” Nov. 30, 2010) know that the current regulations, which have been in effect since January 1, 2011, allow brokers to exclude the compensation component from the reported cost basis until 2013 for shares acquired under stock compensation arrangements. The newly proposed regs not only retain this exclusion but remove the limitation that it is only available until 2013. Thus, it doesn’t look like brokers will be required to report the full basis of shares acquired under stock compensation arrangements for the foreseeable future. I guess the silver lining here is that now you will get more than two years of use out of all those great educational materials you’ve been creating to explain this to your employees.
The regulations state that the IRS is contemplating requiring brokers to indicate whether the shares sold were acquired under a compensatory arrangement on the Form 1099-B (and in transfer statements). Frankly, I’m not really sure this helps much. For most employees, even executives, the only stock of their employer that they own was acquired through compensatory arrangements. When they sell their employer’s stock, I think they probably already know that the stock was acquired through a compensatory arrangement.
The proposed regs also state that the IRS will update the instructions to Schedule D and Form 8949 to clarify that the basis for shares acquired under compensatory arrangements may be incorrect. I have to admit that I’m not confident this is going to help much, especially given how clear the instructions included with Forms 3921 and 3922 are.
I will be hauling my cost-basis reporting soapbox to the February Silicon Valley and Sacramento chapter meetings, where Larry Reynolds of E*TRADE and I will provide a just-in-time overview of cost basis and the new Forms 1099-B. I hope to see you there!
Get in the Game If you haven’t been playing the NASPP Question of the Week Challenge, now is a great time to join the game. A new challenge just started and you have until Feb 3 to answer all the questions posted in January (after that, you only have a week to answer each question). All the cool kids are doing it–sign up today.
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.