Companies impose trading blackouts prior to the public release of information that could influence trading decisions on company stock as a safeguard to avoid questionable trading in advance of significant corporate developments. Typically, these trading blackouts will regularly occur in advance of quarterly financial disclosures, but may also be imposed in advance of potential corporate transactions.
There are several situations where the blackout period could be problematic for both the company and employees–other than the obvious inconvenience of having to wait for an open trading window. One of these issues is what to do about restricted stock vests. When a restricted stock unit or award vests, taxes are due on the income from that vest. If trading is absolutely prohibited during the blackout, the issue of how to cover the taxes due becomes a problem. There are, however, a few solutions to consider.
First, you can try to ensure that no vesting ever takes place in a blackout. This means not only timing your vesting, but ensuring the vesting is never modified by a leave of absence or change in status. This also doesn’t help if you have an unscheduled trading blackout. However, this strategy is still a good idea in general even if your company is employing other approaches because it will reduce the number of instances where restricted stock is vesting in a blackout period.
Second, you can require employees to remit shares back to the company to cover the tax obligation, either for every vest or only for vests that take place in a blackout period. It is easier to get your legal counsel and auditors to be comfortable with a required share withholding because there is no market transaction. There are, of course, considerations for this tax remittance such as calculating minimum statutory tax rates and the availability of cash that may make this an undesirable choice for your company.
Third, you can disallow any choice in the tax withholding method. You may or may not want to also have Rule 10b5-1 language built into your grant agreements to help secure an affirmative defense against allegations of insider trading. If you allow a choice it is conceivable that this could be manipulated, particularly if the company permits a choice between paying cash for the taxes and another method. For example, if a person knows that the company stock will fall as a result of an upcoming announcement and happens to have restricted stock vesting, she could choose to sell or trade shares for taxes instead of pay cash knowing that this would be the best price she’ll get for the shares for a while. More likely, however, is that an employee would make that decision based on personal circumstances like an unexpected expense. If an employee changed from paying cash to selling shares and then the stock happened to fall drastically after financial disclosures, there would be a risk of the appearance of making that decision based on inside information. By removing the choice, you help to eliminate the appearance of insider trading.
You may also have a combination of these methods, such as having a default tax payment method, but not permit any change inside a blackout period. This may work for your non-insiders, but may require special attention for your Section 16 insiders. If this isn’t enough for your legal team or auditor, consider requiring Section 16 insiders to include the restricted stock vests as part of a Rule 10b5-1 trading plan.
Also, whatever your approach is, don’t forget to check the verbiage in your insider trading policy. If you will be permitting remitting selling shares to cover taxes in a blackout period, it’s best if your insider trading policy clearly indicates this exception.
Don’t miss our Ask the Experts: Restricted Stock and Unit Awards webcast on May 26th for all your restricted stock questions. In fact, it’s not too late to submit a question for our experts to address!
When it comes to compliance on your globally mobile employees, one of the most challenging aspects of achieving or maintaining compliance on tax withholding and reporting for your globally mobile employees is keeping pace with changes to applicable legislation and standards. Today, I highlight the top three recent changes that might impact your global mobility compliance.
France
Effective April 1, 2011, withholding on nonresident income from French-qualified awards will be required by employers. Fortunately, this is only applicable to the French-sourced portion of the income, but it is a change from the current withholding requirements. Like other tax withholding issues in France, there is always the thread of jail time or individual financial penalties for failure to comply. You can find more information about this legislation in the Pricewaterhouse Coopers article, Recent Legislative Updates.
China
As noted in this Ernst & Young alert, China will begin requiring employers to make of social security insurance contributions for all employees, including foreigners working in the PRC in July of 2011. Associated with this requirement is a host of administration concerns including actually enrolling nonresident employees with the appropriate social insurance agency, completing monthly contribution reporting, and issuing applicable termination certificates. To put some teeth in the requirement, there will also be a greater liability for noncompliance including fines of up to 300% of the missed payments.
United Kingdom
Thankfully, there is some relatively good news from the United Kingdom. Included in the new budget is the potential for some relief for mobile employees. Although not in the form of a tax break or even easier withholding processes, the UK Treasury has finally determined that it is time for a statutory definition of residence. Currently, residency in the UK is particularly ambiguous and based mostly on interpretations of case law and HMRC practice because the essential concepts of residence, ordinarily residence, and domicile are not clearly defined in UK tax law. As Deloitte highlighted in this alert from March of last year, the landmark case of Robert Ganes-Cooper created confusion for individuals and companies after it was determined that Mr. Ganes-Cooper was a tax resident. (You can also check out both Mr. Ganes-Cooper’s version of the facts and the HMRC’s statement on the case.) Although Mr. Ganes-Cooper satisfied the requirements outlined in the IR20 (The IR20 was replaced by HMRC6 in 2009), he didn’t actually leave the UK for tax purposes, which means he is still a resident and that the IR20 is not applicable.
This isn’t the first time that there has been a call for a clear definition regarding residency. In fact, both the IR20 and subsequent HRMC6 were intended to provide a clear test. The Treasury is hoping to create a new residency test in 2011 and will begin a consultation process on the subject in June of 2011. I am curious to see what ambiguity can be cleared up by the new test once it is available.
Honestly, I anticipated that the Bush-era tax cuts would lapse at the end of this year–and I know I’m not the only one. It’s is unusual for Congress to be this active this late in the year. But, yesterday the Senate did approve the tax plan which includes an extension of those tax cuts for two more years. The bill is up for a vote in the Senate today and is expected to pass. (See this article from Reuters.)
So, if your company has been grappling with what, if anything, should be done in anticipation of tax increases, you’ve just been given a couple more years to sort through the issue. If you are wondering what in the world this has to do with your stock plans, since employers can just use a flat rate for withholding on equity compensation, then you must have missed our July webcast, How Upcoming Tax Rate Changes Impact Your Stock Plans. Don’t worry; the full webcast and transcript are still available!
Where this bill could really hit home is this: In addition to the extension of the individual tax rates, the bill includes a one-year decrease in payroll taxes. Specifically, the 6.2% Social Security tax paid by employees would be reduced to 4.2%. Employers would not be given the same tax holiday; employer “matching” stays at 6.2%. The bill doesn’t appear to impact the changes to the Medicare portion of payroll taxes, which are set to increase from 1.45% to 2.35% for wages above the threshold amount starting in 2013. (For more information on the implications of the Health Care and Education Reconciliation Act of 2010, check out that great webcast I mentioned above.)
If this bill does pass, there are a few things you will want to be sure and prepare for. Obviously, you’ll need to make sure to update the Social Security tax rate in your stock plan administration database. Additionally, it will be a good idea to sit down briefly with your payroll department to confirm that there won’t be any glitches exchanging Social Security withholding and year-to-date levels after the payroll system is updated.
On the communication front, this isn’t really the kind of issue that warrants a whole campaign. It’s not confusing and lower taxes are always well received. It is, however, a great reminder of the value of a good disclaimer. Your educational materials, particularly those pertaining to taxes on equity compensation, should have a disclaimer that includes verbiage indicating that the information in the materials may not reflect current regulatory developments. This bill would mean a pretty straight-forward decrease in tax withholding, but the next development may not be so simple. Having a quality disclaimer helps protect the company in case there is a delay in updating your educational materials or if employees are inadvertently referring to outdated printed material. If you’re feeling ambitious, a handy little asterisk notation on any examples you have available to employees noting the one-year reduction in the Social Security withholding rate would be fantastic.
Finally, and maybe only after the dust settles from the changes that 2010 has brought us, take a look at what 2013 might look like for your employees, particularly those making over $200,000 annually, and decide if there are any changes your company may want to implement in anticipation of the tax rates increasing.
We are about half-way through the first tax year in which employers have known the income reporting, tax withholding, and valuation requirements for employees in India. Last year (2009/2010) was quite a scramble, with retroactive updates and guidance being provided late into 2009.
Valuations
One issue that companies continue to work with is the calculation of FMV, as a Category 1 Merchant Banker valuation is still required for companies not listed on a recognized exchange (Neither NASDAQ nor NYSE are recognized exchanges.). There were several months where it was unclear whether or not Merchant Banker valuations would be required. If your company reported and withheld based on the market value of your stock during the 2009/2010 tax year, you should have adjusted your reporting at this point.
Frequency
When it comes to Merchant Banker valuations, frequency is still a key consideration (and one that will remain so long as these valuations are required). The regulations state that valuations are only required every 180 days, so it is possible to only value your company’s shares two times a year. However, this may not right for your company, especially if the trading value of the shares has decreased significantly since the most recent valuation.
Double Standard
The difference between the Merchant Banker valuation and the trading value of the stock will remain an ongoing issue regardless of how often your company has a valuation performed. If your stock plan administration software does not permit more than one FMV on a trading date, you may have to provide custom employee communications to accommodate the FMV that was used to calculate income.
Australia
Reporting Obligations
Generally speaking, most options and RSU grants in Australia awarded after July 1, 2009 are taxable at vest. There is no withholding obligation for employers, but there is a reporting obligation of Employee Share Scheme (ESS) statements to both the employee and the Australian Tax Office (ATO). They are not unlike the U.S. Section 6039 information statements in theory; presumably they will help employees better understand how to complete their own tax returns and will help the tax authorities determine if income is being properly reported on tax returns, which they will be auditing (See this alert from Deloitte.)
Valuation
For RSUs, the trading value of the shares at vest may be the FMV for income calculation. However, options are considered an “unlisted right” and might require a valuation method (e.g.; Black Scholes) to determine the market value of the shares on date of the taxable event.
30 Day Rule
One tricky piece of determining the FMV on the taxable date in Australia is the 30 day rule. If an employee sells shares from an RSU vest or option exercise within 30 days of the original taxable event date, then the sale date might be considered the taxable event, provided the company is aware of the sale.
Employees
Individual tax returns for the 2009/2010 tax year are due by October 31, 2010. Employees may still be trying to understand the ESS statements provided to them by the company.
Taking Action
Many companies appear to have moved away from granting options in Australia as a result of the reporting obligations. We completed a Quick Survey on this in September; only 20% of respondents were continuing to grant options in Australia, 38% were not granting options to begin with, and a significant 42% were moving to share grants (like RSUs) or some type of cash compensation.
Restricted stock units and awards carry a unique risk when it comes to grant acceptance. It’s easiest to understand this risk in contrast to stock options. In most countries and situations, the taxable event on a stock option is the exercise. Employees must personally take action in order to exercise a stock option, which gives companies the opportunity to have their undivided attention when it comes to grant acceptance and simply prevent exercise until the grant has been signed. Restricted stock awards and units, on the other hand, are taxed on either the vest date or even at grant (depending on the country and circumstances). For the purpose of simplification, I’m going to focus on RSUs granted in the U.S. that do not have accelerated or continued vesting after retirement.
Policy #1: Time’s Up!
Some companies take a conservative approach to this issue by actually enforcing a grant acceptance requirement with a policy under which employees forfeit their grants if acceptance isn’t completed within a specific timeframe. In this approach, the highest risk is in ensuring adequate communication regarding the timeframe and consequences of not accepting the grants. In addition to including a warning in all communications leading up to the grant, it’s a good idea to also send out reminders to employees as they approach the deadline for acceptance.
Policy #2: It’s Yours Whether You Know it or Not
Some companies default to the philosophy that grants will continue to vest regardless of the grant acceptance status, even if they have a policy that theoretically requires grant acceptance without actually enforcing it. Hopefully, this is a well thought-out policy and not just a head-in-the-sand reaction to the issue of grant acceptance. For example, it could be that the comany’s legal team concluded that allowing shares to vest before the terms and conditions have been accepted poses less risk to the company than cancelling unaccepted grants. Regardless of the reason behind adopting this policy, the best way to make it effective is to make sure that grant documents, communications, and company policy accommodate how tax withholding is executed. The smart approach is to have a default tax withholding method which does not require action by the employee such as share withholding. Another advantage of share withholding over other methods is that, in the event the employee ultimately wants to decline the grant, the odds of being able to “unravel” the vest are much higher.
Policy #3: What?!
The riskiest approach of all is to ignore the issue until it’s too late. Of course, it’s entirely tongue-in-cheek to call this a policy at all. A company might fall into this situation because of poor planning, inadequate documentation, or a sudden increase in the number of RSU recipients. This could lead to a situation where taxes are due, but the company has no way to collect them because there either isn’t a default tax withholding method, or the default isn’t possible without action from the employee. Companies that find themselves in this position must scramble to get grant acceptance and/or collect taxes, possibly delaying the tax remittance or actual delivery of shares. Because it’s likely not possible to consider a late delivery of shares as a delay in constructive receipt of the shares in, delayed tax remittance could result in penalties incurred by the company.
Last month I wrote about divorce and stock plan management, and today I’m going to tackle the other big “d”…death. Although (thankfully) the death of an employee is a relatively unlikely scenario, it’s one that warrants preparation. None of the issues surrounding the death of an employee can be addressed without an underlying consideration for what the decedent’s family will coping with. Not only is the death of a family member an emotional period, there is also a pretty intense amount of paperwork to be completed.
When it comes to handling equity compensation after the death of an employee, there are issues that are straightforward and those that are subject to interpretation and company policy. This week, I’m only going to cover the tax withholding and reporting since the IRS has made this relatively clear.
ISO and ESPP
For both ISOs and 423 ESPP shares transferred to the estate or beneficiary upon the death of an employee, the statutory holding periods for preferential tax treatment no longer apply. When it comes to tax withholding, this means the company is off the hook. However, there remains a reporting obligation both to comply with Section 6039 and to report ordinary income on discounted ESPP. The transfer of ESPP shares is considered a qualifying disposition. The compensation income, which is the lesser of the discount at purchase or the actual gain at the disposition, is reported on the employee’s final Form W-2. For ISOs, because any sale of shares by the estate or beneficiary is treated as a qualified disposition, the company generally has no income reporting or tax withholding obligation.
Section 6039 Considerations
The exercise of an ISO triggers the 6039 reporting obligations regardless of whether the exercise is made by the employee or by the employee’s estate or beneficiary. This means that the company should still furnish an information statement. In addition, for any exercises beginning in 2010, the company must file Form 3921 with the IRS. (Catch up on the latest regarding Forms 3921 and 3922 in Barbara’s post from Tuesday.)
For ESPP, however, the 6039 considerations hinge on how the company issues ESPP shares at purchase as well as the company’s policy regarding the current offering period both come into play. According to the final regulations, if the purchased shares are immediately deposited into the employee’s brokerage account, this is considered the “first transfer of legal title”. Since this is the prevalent practice for ESPP shares, many companies will provide 6039 information statements to employees and file a Form 3022 (for purchase beginning in 2010) to the IRS subsequent to each purchase. In addition, most companies do not permit the estate or beneficiary to purchase shares in the current offering period, refunding accumulated contributions instead.
This means that for most situations involving the death of an employee, the event that triggers 6039 reporting obligations on ESPP shares has already taken place. If, however, the ESPP shares are issued in certificate form or otherwise held in the employee’s name, or if the employee is not automatically withdrawn from the current offering upon death, the company may still have outstanding 6039 reporting obligations when it comes to ESPP shares.
NQSOs
For NQSOs, the company’s withholding and reporting obligations differ depending on whether the exercise by the estate or beneficiary takes place in the same year as the death of the participant or not. In either case, the company’s obligation to withhold income tax no longer applies. If the exercise takes place in a subsequent year, the company generally has no withholding obligation and reports the income on a Form 1099-MISC issued to the employee’s estate or beneficiary. However, if the exercise takes place in the year of the employee’s death, then the company withholds FICA taxes (but no FIT) on the exercise and reports the income and FICA withholding on the employee’s final Form W-2.
If diving into the latest updates on tax withholding and reporting is on your list, then you won’t want to miss the session, “The IRS and Treasury Speak: Hot Tax Topics and Updates” . In fact, we’ve got all the hottest topics lined up for you this year. If you haven’t already, register today! If you’re already registered, don’t forget to let us know which sessions you’ll be attending.
-Rachel
Your outside directors should be making estimated tax payments to the IRS on compensation they receive from your company in exchange for their services as an outside director. This includes income realized from equity compensation. Sometimes companies are tempted to withhold taxes on outside director stock transaction. At face value, this may appear to be simple common sense–we know that they will owe taxes, why not facilitate a sell-to-cover or withhold shares to cover those tax payments? The truth is that withholding taxes on outside director transactions is something that your company really should not be doing.
Why not withhold shares?
There has recently been a lot of focus on the accounting consequences of withholding shares above the statutory minimum, because this triggers liability accounting under FAS123(R) (see Paragraph 35). Many companies are struggling with this issue when it comes to share withholding on restricted stock in locations where there is no flat statutory tax rate associated with stock transactions. In the case of non-employees, any taxes withheld will be above the statutory minimum. Therefore, if you withhold shares on a transaction made by an outside director, then the entire grant would be classified and accounted for as a liability. Even worse, if you establish a pattern of allowing shares to be withheld above the minimum statutory required tax obligation, then it is possible that you will trigger liability accounting for the entire plan.
Why not withhold FIT?
So, what about facilitating a sale of shares to help the outside director cover taxes due? As attractive as that may sound, this also is a problem for both the company and the outside director. In addition to the general issues surrounding excess tax payments, reporting the income and tax withholding will prove to be a challenge. Payments for services made to non-employees must be reported on a Form 1099-MISC. You can’t properly report that federal tax payment on a 1099-MISC. This is because there is no provision in the tax regulations for withholding taxes on payments made to non-employees. Additionally, if you withhold federal income tax, then the IRS may determine that FICA and FUTA should also have been withheld, which could result in penalties for the company.
Why not withhold FICA?
This is a bad idea all around–bad for the company and bad for the director. The outside director will need to pay both the income taxes and the self-employment taxes on his or her equity compensation from your company. Self-employment tax includes both the FICA payment and what would be the company’s matching payment. If you withhold FICA at the time of the transaction, it won’t exempt the outside director from also having to pay the self-employment tax on that same income. For the company, if FICA is withheld, then the IRS is going to expect to see a matching company payment. Failing to make that matching payment could result in penalties for the company.
Why not just report everything on a W-2?
Reporting payments made to a non-employee on a W-2 goes against Regulation §1.6041-2(a)(2), which specifically states that the W-2 is for reporting payments made to an employee. Additionally, failing to report the income on a Form 1099 puts the company’s tax deduction in jeopardy–the company would need to prove that the outside director had properly reported the income and paid the income taxes and self-employment taxes on it in order to receive the corporate tax deduction.
Ah, but there is an exception.
If your outside director received a stock grant as an employee (before becoming an outside director), then the some or all of the income from a transaction on that grant may be subject to tax withholding and be reported on a W-2.
We have several great resources on the NASPP site to help you deal with your company’s tax withholding and reporting obligations. Our best resource is the NASPP Tax Withholding and Reporting portal. You can also go back and review our annual webcasts on Tax Withholding and Reporting–the 2008 Webcast has fantastic points on dealing with non-employees! Also, don’t forget about the NASPP Discussion Forum. Take advantage of the key word search to find questions other members have submitted; you might find that the answer to your question is already available.