Advanced (and Unusual) Tax Considerations
October 24, 2013
Taxation can be taxing
Some Unique Equity Tax and Regulatory Considerations
Cathy Goonetilleke – Senior Manager, Ernst & Young
William Murphy – Principal, Ernst & Young
Presenters
 William P. Murphy, Principal – Human Capital
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Ernst & Young LLP, Cleveland, OH
216-583-2869
[email protected]
 Cathy Goonetilleke, Senior Manager – Human
Capital
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Ernst & Young LLP, Los Angeles, CA
213-977-7758
[email protected]
Discussion agenda
 Current tax environment in the US
 Hot topics
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FICA-related issues
Mobile employees
Deduction timing
Legislative/Regulatory Developments
 Questions
Current tax environment in the US
 Complex legislation: 409A, 162(m), etc.
 Gray/challenging areas:
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FICA and social taxes
Business travelers and assignees
 Enforcement: IRS and state audits
FICA TAXATION OF EQUITY
FICA - Background
 Generally, FICA/Medicare (hereinafter “FICA”)
taxation occurs at the time of payment,
consistent with general federal income tax rules
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e.g. Stock Option exercise is generally the date for
both federal income and employment taxation
 FICA rules provide several alternatives for taking
into account wages for FICA purposes, as well
as a special timing rule for “Nonqualified
Deferred Compensation”
FICA: Nonqualified deferred compensation
 Non-qualified deferred compensation plans are
subject to the “special timing” rule under IRC §
3121(v)(2)
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FICA taxation occurs at the later of when the services
are performed or when the employee vests in the
NQDC
Specific application varies based on whether you
have an “account balance plan” (e.g. any equity
awards treated as NQDC) or a non-account balance
plan
FICA – Alternatives for Withholding
 Generally there are two alternative methods for
withholding FICA wages where the amount is not
reasonably calculable
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Lag Method – calculate the value at any time within a 3 month
period after the vesting date based on the original value plus
“interest” at the AFR rate
Estimation Method – estimate the value on the vesting date as
long as “trued up” within 3 months
 In addition, taxpayers may rely on the “rule of
administrative convenience” for non-cash wages
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Recognize as FICA wages at any time during the year as long as
consistently applied
Can this apply to equity awards?
FICA: Restricted stock, Stock Options and
SARs
 Restricted Stock, stock options and SARs do not
constitute deferred compensation for purposes
of IRC § 3121(v)(2)
 FICA taxes must be withheld either when the
restricted stock when it vests (or when granted if
Section 83(b) election was made), or at exercise
of the stock option or SAR
FICA: Phantom stock, RSUs
 Grants of phantom stock are considered deferred
compensation for IRC § 3121(v)(2), and RSUs MAY
be deferred compensation for FICA purposes.
 Normally, RSUs are designed to be paid within 2 ½
months of the vesting date and to NOT be NQDC for
409A (and thus FICA) purposes
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Exceptions – where there is a Retirement vesting feature
Where there are deferral opportunities
FICA: Short-term deferral and § 3121(v)(2)
 Restricted stock units (RSU’s) and performance
awards are exempt from IRC § 409A if payment
is made no later than the 15th day of the third
month following the taxable year.
 The regulations for IRC § 3121(v)(2) contain a
similar exemption.
 Therefore, many plans that are structured to
avoid IRC § 409A will also be exempt from IRC §
3121(v)(2).
MOBILE EMPLOYEES
Mobile employees
 Minimum statutory withholding
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Requirement under US GAAP to secure equity (not
liability) accounting treatment
Applies where shares are net-settled
Challenging for mobile and international participants
• Equalized assignments
– Hypothetical tax rates
– “Lessor of” treatment
• Other countries without flat withholding rate
Mobile employees
 Trailing tax liabilities
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Potential requirement to allocate income for withholding
purposes
• General rule
• Tax treaties
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Withholding requirements by status:
• US citizens: certain exemptions
• Permanent residents/green card holders: no exemption
• Nonresidents: on source income only
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Reporting obligation
• US citizens and permanent residents: full gain
• Nonresidents: on source income only
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Risk assessment
• State versus federal level
• Audit activity and enforcement
Mobile employees
Example
 US expatriate on assignment in the UK
 Spent 50% of time in both US and UK
 Agreement calls for hypothetical tax withholding on
equity awards
 Rates on RSU vesting:
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Hypothetical: 39.6% (US federal)
Blended actual rate of 35%
• US: 50% at 25%
• UK: 50% at 45%
 Application of hypothetical rate results in
overwitholding
DEDUCTION TIMING TRANSACTIONS
Deduction Timing – Background
 Any time there is a transaction, it is extremely
important to understand the structure of the deal
and the types of equity awards outstanding, and
how they are treated either pursuant to the
plans/agreements or under the merger agreement:
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Is it a stock or asset deal?
Will awards vest and be paid out?
When are the amount paid?
Who is the “service recipient” entitled to the deduction?
Any escrow, earn-outs or other factors to consider?
Deduction timing: Example
• On March 30, 2006, a private equity firm acquires 100% of the
outstanding stock of Company M, a public company, through its
new subsidiary, Newco. Newco is the tax survivor of M, and will
continue with M’s tax year-end. (e.g. a stock deal)
• Company M maintains equity compensation agreements that
provides for the grant of NQSOs, restricted stock, and restricted
stock units.
• Pursuant to the provisions of the relevant plans and agreements,
the outstanding equity awards will become fully vested and paid
out upon a CIC.
• Company M is an accrual basis taxpayer with a July 31 year
end. However, M will have a final, short year ending on the date
of the transaction.
Deduction timing: Restricted stock “year
within which” rule
• Compensation is generally deductible under § 83 upon vesting and
when includible in recipient’s income.
• Deduction should be taken in accordance with the “year within which”
rule under Section 1.83-6 (i.e. deduction occurs for the year in which or
within which ends the tax year of the employee).
• Based on our example, when would Company M be entitled to a
deduction?
• Under the “year within which” rule, Company M would be entitled
to the deduction (assuming no § 83(b) elections had been made)
with respect to the vesting/cash out of the restricted stock for its
tax year ending July 31, 2007 (the year which includes 12/31/06).
• The employees would include the value in gross income in their
taxable years ending December 31, 2006.
Deduction timing: RSUs & NQSOs
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Compensation is generally deductible under § 83 for NQSOs exercised and
RSUs vested and includible in recipient’s income.
Deduction should be taken in accordance with the taxpayer’s normal method of
accounting.
Based on our example, when would Company M be entitled to a deduction?
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Assuming there are no §§ 280G or 162(m) issues, Company M is entitled to a
deduction in the amount of the payment for its final, short tax year ending on the date
of the transaction, March 30, 2006.
The employees would include the value in gross income in their taxable years ending
December 31, 2006.
This assumes that the RSUs are not deferred compensation for purposes of
§§409A and 3121(v) – if deferred compensation (e.g. retirement vesting
provision) then deductible under the “year within which” rule described in the
prior slides
Deduction timing: Other key issues
• Generally, the entity that is the employer of the employee exercising the
award will be entitled to a deduction.
• It may be possible to control the timing of the deduction when drafting
the operative documents (i.e., pre-close or post-close deduction).
• There may also be an opportunity to rely on the consolidated tax
regulations for the “next day rule” to shift some deductions to the post
close period.
• This is a complex area that is not always intuitive. Make sure you know
all of the facts in order to get deduction timing correct.
LEGISLATIVE AND REGULATORY
DEVELOPMENTS
Section 162(m) – proposed regulations
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The IRS has issued proposed regulations that would amend Reg. § 1.16227(e)(2) to clarify the requirement that the plan state the maximum number of
shares with respect to which the stock options or stock appreciation rights may
be granted during a specified period applies on an individual employee basis.
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The IRS has issued Prop. Reg. § 1.162-31.
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For taxable years beginning after December 31, 2012, § 162(m)(6) limits
to $500,000 the allowable deduction for remuneration attributable to
services performed by an applicable individual for a covered health
insurance provider.
Section 162(m) – legislative proposal
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Stop Subsidizing Multimillion Dollar Corporate Bonuses Act introduced to
Congress on August 1, 2013. The Bill would make four significant changes to
§162(m):
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Expand the group of individuals subject to the $1 million deduction limit to include all
officers, directors, and employees of a publicly-held corporation;
Eliminate the exception to the deduction for “commission-based” remuneration;
Eliminate the exception to the deduction limit for “performance-based compensation”;
and
Modify the definition of “publicly-held corporation”.
Ending Excessive Corporate Deductions for Stock Options Act introduced to
Congress on July 14, 2011.
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The Act proposes to re-designate §162(q) as “Treatment of Compensation Paid With
Stock Options”, which would require that the tax deduction for stock option
compensation not exceed the stock option compensation reported on the financial
statements
DOMA and equity compensation
 Rev. Rul. 2013-17 and the “Place of Celebration”
Rule
 Securities law implications
 Equity plan term changes and areas for review
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Beneficiary designations
Divorce decrees and transferable options
 Future guidance
Questions?
Contacts
Cathy Goonetilleke
Senior Manager
Ernst & Young
[email protected]
William Murphy Principal
Ernst & Young
[email protected]