1. Equity Compensation and Payroll Reporting Obligations
Merianne White, CPP CEP
Rainier Chapter Meeting
January 21, 2016

2. Overview Equity and Common Equity Instruments Communication Flow
Principle of Constructive Payment
Tax Trigger Terminology
Reporting and Remittance Timing
Penalties for Late Remittance
What You Can Do Now

3. What is Equity? Executive hiring and retention tool
Broad-based grants in tech startups
Potentially substantial supplement to salary
Customary equity instruments:
Stock grants, usually at zero cost
Stock awards (RSA, PSA)
Stock units (RSU, PSU)
Stock options, usually at Market price
Incentive Stock Options (ISO)
Nonqualified Stock Options (NQ/NSO)
See PS Section : Stocks and Stock Options
A grant of equity in company stock has been a common hiring and retention tool, usually for executive and managers since the Civil War.
Around the 1980s, technology startup companies offered an equity stake to recruit talent in lieu of market-based salaries, with a promise of a higher payoff than could occur with company cash.
Equity can be defined as stock grants/awards and stock options. Some companies also offer an Employee Stock Purchase Plan (ESPP), whereby employees can elect post-tax dollars through payroll deduction to buy company stock at a discounted price.

4. Equity Instrument Comparison
RSAs
ISOs
NQSOs
RSUs
Is employee taxed at grant?
No, unless 83(b) election is made; otherwise, ordinary income tax paid when restrictions lapse No
Is employee taxed at vesting?
Yes, unless employee makes 83(b) election
Yes, at time of transfer/vesting
Is employee taxed at exercise?
N/A
Yes
Can tax be deferred until sale?
Yes, if 83(b) election made
Yes, if requirements met
No, unless purchase of unvested shares is permitted
Can alternative minimum tax apply?
No, ordinary income rate
Yes, to spread on exercise if shares not sold in year of exercise; otherwise OI
Is there value if the share price drops below the grant price?
Yes, usually granted at $0.00 cost
Can employees delay exercise after vesting?
No, shares belong to employee when restrictions lapse
Yes, under the terms of option
No, shares belong to employee at time of transfer/vesting

5. Cross-Functional Communication
Who performs the equity administration in your company?
In-house or outsourced to legal firm?
General Counsel/paralegal?
Controller/accountant?
HR?

6. Stock Admin/Equity Application
Information Flow
Payroll
HR/Legal
Broker
Accounts Payable
Stock Admin/Equity Application
Tax deposit & reporting; W-2 creation
Grant, price, vest schedule, expiration; communication b d a
Grant authorization; management reporting c e
a. Communicate new grants, master file info (address, cost center, term dates), provide management reporting
b. YTD withholding file to be updated each pay run for latest goals (social security, CA SDI, Federal w/h premium (39.6%), Medicare Surtax (0.9%)); perhaps via secure site/FTP
c. When Broker communicates trade info, SPA/payroll provides tax withholding; Broker remits option price and tax withholding to Company
d. SPA communicates comp and withholding back to payroll for reporting and remittance
e. SPA communicates comp to A/P for year-end reporting
1099-MISC
Nonemployees, Directors
Trade details; cash disbursement

7. Principle of Constructive Payment
Under the principle of constructive payment, an
employee is considered to have been paid when
the wages have been made available to the
employee without “substantial limitation or restriction.”
See PS Section 6.1: The Principle of Actual or Constructive Payment

8. Tax Trigger Terminology
Vesting
Lapse of “substantial risk of forfeiture”
IRC Section 83(b) tax election
Accelerates tax liability to grant date instead of vesting date; must be filed <30 days from grant date
Deferral of Compensation/Section 409A
Per Plan, Agreement, and/or Notice provision; FICA due at vesting, FITW due at transfer
See PS Section : Stocks and Stock Options
Vesting (ownership) occurs when service or performance requirements are met.
83(b) election is for stock grants where the stockholder wishes to early exercise for tax hedging reasons. If share are not earned (forfeited), there is no refund of taxes paid.
Deferrals (usually RSU & PSU) are permitted within the provisions of the Equity Plan and Grant Agreement. It can allow the deferral of share delivery at vesting. This delays the payout of the award and thus the ordinary Federal income tax, though not the Social Security and Medicare taxes.

9. Tax Remittance Timing
When shares are made available, withholding is due to IRS per semiweekly deposit schedule
One-Day Deposit Rule (>$100,000)
Employee Federal, Social Security, Medicare, Employer Social Security and Medicare
Tax remittance due 1-3 days from triggering exercise/trade date
See PS Section 8.2-1: Payroll Tax Deposit Rules
One-day deposit rule: If an employer’s accumulated employment tax liability reaches $100,000 on any day during a monthly or semiweekly deposit period, the taxes must be deposited by the close of the next banking day per IRC Section (c)(3).

10. Timely Remittance of Taxes from Equity Transactions
IRS will allow a Trade Date+3 closing of the transaction for broker-assisted option exercises before transaction is deemed closed; see Field Directive dated March 14, 2003
IRS will not allow the same lag time on the taxes due on full value award vesting events (RSAs and RSUs); withholdings are due the next day
So, deposit when withholding accumulates to $100,000, unless…
Restricted Stock/RSU (next day), or;
Broker-assisted option exercise (TD+3)

11. Reporting and Remittance Example

12. Penalty Example

13. Penalties for Late Remittance
If late 5 days or fewer, penalty is 2% of the tax
If late 6 to 15 days, penalty is 5% of the tax
If more than 15 days late, penalty is 10% of the tax
Individuals in the company that are responsible to make these payments can also be found to be liable for the tax
If non-payment is deemed to be intentional, individuals can be held criminally liable

14. Penalty Calculation

15. Penalty Mitigation

16. What You Can Do Now
Work closely to help your equity group to understand the transaction date and the resulting required remittance obligations
Communicate remittance rules; propose mitigation
Review your tax rates annually and periodically to ensure correct withholding
Communicate YTD income and withholdings to your equity administrator or application in a timely manner (e.g., after each pay period)

17. Form Examples

18. Form W-2 for NQSO Reporting
The gain from nonqualified stock option exercise is totaled on the W-2 with other income in the following boxes:
Box 1: Wages, tips, and other compensation
Box 3: Social Security wages (up to the income ceiling)
Box 5: Medicare wages and tips
Box 16: State wages, tips, etc. (if applicable)
Box 18: Local wages, tips, etc. (if applicable)
Box 12 (Code V)
NQs can be granted to employees or non-employees, Directors, consultants. There is no preferential tax treatment; they are taxed and treated like a payroll bonus (i.e., subject to supplemental tax rates and employment taxes).

19. Form W-2 for ISO Disqualifying Disposition Reporting
For an ISO exercise in which you hold the stock (i.e. not a cashless exercise/same-day sale), your Form W-2 does not include the value of the spread. The spread value appears on the W-2 only when you make what is technically called a disqualifying disposition*.
It is reflected on the W-2 as compensation income (without any reduction for fees and commissions) in:
Box 1: Wages, tips, and other compensation
Box 16: State wages (if applicable)
Box 18: Local wages (if applicable)
* When you sell or gift the stock before you have met the required holding periods of one year from exercise and two years from grant, the preferential tax treatment is forfeited.
ISOs have strict eligibility requirements:
Companies may voluntarily report the income from ISO DDs in Box 14 ("Other").

20. Form 3921 for ISO Exercise Reporting
Incentive stock option exercises in a given tax year are reported on IRS Form 3921 and delivered by January 31st the following year (e.g., Forms 1099 & W-2).
The form helps you collect information for reporting sales of ISO shares on your tax return. It also helps in the AMT calculation at exercise. The IRS receives a copy of the form, ensuring that it knows about your ISO exercise and therefore any AMT triggered by the exercise income.
An annual survey is required to report when the ISO is subsequently sold for Corporate Tax purposes.

21. Form W-2 for Restricted Stock Unit Reporting
RSUs result in ordinary income when the grant vests and shares are delivered. Compensation is the fair market value (FMV) of the stock at vesting multiplied by the number of shares vested.
The income is reported on Form W-2, as follows:
Box 1: Wages, tips, and other compensation
Box 3: Social Security wages (up to the income ceiling)
Box 5: Medicare wages and tips
Box 16: State wages (if applicable)
Box 18: Local wages (if applicable)
The amount withheld in connection with your RSUs is included, when appropriate, in Boxes 2, 4, 6, 17, and 19.
Companies may voluntarily report the income from RSUs in Box 14 ("Other").

22. Form W-2 for Performance Stock Unit Reporting
Performance shares result in ordinary income when the grant vests after specified targets are reached and shares are either delivered or paid out. Compensation is the FMV of the stock at vesting (or when vested shares are paid out after targets are reached) multiplied by the number of shares vested.
The income will be reported on Form W-2, in the totals of your other income, as follows:
Box 1: Wages, tips, and other compensation
Box 3: Social Security wages (up to the income ceiling)
Box 5: Medicare wages and tips
Box 16: State wages (if applicable)
Box 18: Local wages (if applicable)
Companies may voluntarily report the income from PSUs in Box 14 ("Other").

23. Form 1099-MISC for Nonemployees
Nonemployees (e.g. Directors, consultants, independent contractors) receive this for to report income/compensation. It is similar in concept to the W-2 for employees. Withholding does not apply when nonemployees exercise NQSOs. The spread at exercise is compensation for services; therefore, self-employment tax, along with state and federal income tax, applies when you file your tax return.
The income is reported on Form 1099-MISC, as follows:
Box 7: Nonemployee compensation

24. Resources
Wright, Alison, et al. The Stock Options Book. 16th ed. Oakland: The National Center for Employee Ownership, 2015 American Payroll Association: E*TRADE Financial Services: MyStockOptions.com: National Association of Stock Plan Professionals: National Center for Employee Ownership: Merianne White: