stock compensation, deferred compensation and state income
TRANSCRIPT
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Stock Compensation, Deferred Compensation and State
Income Taxes
WEDNESDAY, DECEMBER 11, 2019, 1:00-2:50 pm Eastern
FOR LIVE PROGRAM ONLY
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December 11, 2019
Stock Compensation, Deferred Compensation and State Income Taxes
Joseph S. Pancamo, CPA, Region Leader, Global
Employer Services
BDO US
Marlene Zobayan, Partner
Rutlen Associates
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
Stock Compensation, Deferred Compensation and State Income TaxesCOMPLIANCE WITH CORPORATE AND EMPLOYER
FILINGS
Joe Pancamo – BDO USA, LLP
Marlene Zobayan – Rutlen Associates LLC
DisclaimerThis presentation contains general information only and the respective speakers and represented firms are not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. The respective speakers and firms shall not be responsible for any loss sustained by any person who relies on this presentation.
This presentation focuses only on the payroll tax aspects related to employees, other compliance areas including other areas of tax, securities law, labor law, data privacy etc. are not addressed.
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Agenda1. Background On Stock Compensation And Its Taxation
2. How The Use Of Stock Compensation Can Trigger Nexus
3. Administrative Challenges And Practical Solutions
4. Questions And Answers
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Background On StockCompensation And Its TaxationS T O C K O P T I O N S
R E S T R I C T E D S T O C K A W A R D S
R E S T R I C T E D S T O C K U N I T S
E M P L O Y E E S T O C K P U R C H A S E P L A N
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Nonqualified Stock Options –Tax BasicsAt exercise: the difference between the exercise price and the fair market value (FMV) of the shares is taxed as compensation
The company must:◦ Withhold Federal, state, FICA, Medicare, local taxes as appropriate
◦ Report the income on Form W-2 for the year of exercise◦ Box 12 Code V
At sale: ◦ Increase in the FMV on stock held after exercise is taxed as a capital gain
◦ Decrease in the FMV on stock held after exercise is taxed as a capital loss
The broker must◦ Report the proceeds from sale of shares on Form 1099-B
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Incentive Stock Options – Tax BasicsAt exercise:
◦ No income tax consequences to the employee
◦ However, the difference between the fair market value at exercise and exercise price is a preference item for Alternative Minimum Taxable (AMT) unless the subsequent sale of stock is in the same tax year as the ISO exercise. AMT is payable by the employee and not subject to tax withholding by the employer
At sale: ◦ The sale is a “Qualified Disposition” and the income is taxed as a capital gain
when the employee sells the shares under both these conditions:◦ > 2 years from the date of the option grant
◦ > 1 year from the date of exercise
◦ The sale is a “Disqualifying Disposition” when it does not meet the definition of a "Qualified Disposition" and the gain is taxed at income tax rates, up to 37% in 2018
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ISO TimelineExample 1
Exercise after 1 year
DisqualifyingDisposition
Incentive Stock Options11
Qualifying Disposition
Grant Exercise
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ISO TimelineExample 1
Exercise after 2 years
GrantExercise
DisqualifyingDisposition
Incentive Stock Options
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Incentive Stock OptionsRemember:
Company must report exercise on form 3921
Company must report on W-2 for disqualifying disposition only
Ohio requires withholding on disqualifying dispositions
Pennsylvania does not recognize the qualifying nature of ISOs and ESPP
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Stock Options – Tax Summary
NSOs ISOs
Subject to income tax at exercise Yes No
Preference item for alternativeminimum tax at exercise
No Yes
Subject to income tax at sale No Yes – if disqualifying disposition
Subject to capital gains at sale Yes Yes
Corporate tax deduction for company
Yes*Yes* - if disqualifyingNo - if holding period respected
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*Subject to 162(m) rules
Restricted Stock Awards (RSAs) – Tax BasicsAt grant: if the employee makes a s83b election, the fair market value (FMV) of the shares is taxed as compensation
◦ Must be made within 30 days of grant
◦ Irrevocable election even if the employee later forfeits the shares
At vest/release: if no s 83b election is made, the fair market value (FMV) of the shares is taxed as compensation income
At sale: ◦ Increase in the FMV on stock held after taxing point is taxed as a capital gain
◦ Decrease in the FMV on stock held after taxing point is taxed as a capital loss
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Restricted Stock Units (RSUs) –Tax BasicsAt vest: the fair market value (FMV) of the shares is taxed as compensation income for social security and Medicare purposes
At release: the fair market value (FMV) of the shares is taxed as compensation income for income tax purposes
At sale: ◦ Increase in the FMV on stock held after release is taxed as a capital gain
◦ Decrease in the FMV on stock held after release is taxed as a capital loss
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ESPP – Tax BasicsAt purchase:
◦ No income tax consequences to the employee
◦ ESPP is not an Alternative Minimum Taxable (AMT) preference item
At sale: ◦ The sale is a “Qualified Disposition” where the income is taxed partly as
income and partly as a capital gain. The sale will be a Qualified Disposition if the employee sells the shares and meets these two conditions:◦ > 2 years from the offering date
◦ > 1 year from the date of purchase
◦ The amount subject to income tax is the amount of the discount as calculated at the time of offering (or the actual discount if less)
◦ If an employee does NOT hold the stock for the required periods, the disposition is referred to as a “Disqualifying Disposition” and the discount is taxed at income tax rates, up to 37% in 2017
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Employee Stock Purchase PlanThe employee’s purchase price is the lower of
a) 85% of the stock price on the offering date
b) 85% of the stock price on the purchase date
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Example:• Fair market value on first day of offering
period: $15• Fair market value on purchase date: $20• Purchase price: $12.75 (85% of $15)
First day of offering period Purchase date
Discount
$12.75
Other Long-Term Incentives Bonus
Deferred Compensation◦ 409A considerations
◦ Watch for inbound non-U.S. plans
Pension Special rules typically apply
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Types of Stock Compensation – Common Terms to KnowExit Based Plan: Plan where vesting occurs only on company event such as stock/asset sale or IPO.
Vesting: When the employee is entitled to keep the award and exercise their rights without any risk of
forfeiture.
Exercise: When employees fulfills the plan’s requirements to acquire the shares such as payment of the
exercise price and notification in writing.
Participant: Individual or entity who has received awards under the equity plan/scheme.
Plan/scheme: Specific details that govern the operations of awards.
Withholding Clause: Clause in plan/scheme setting out payroll withholding.
Broker/Transfer Agent: Third party who transfers the shares between the company and employees and
often handles plan recordkeeping.
Sell to Cover: Where shares are sold by broker to cover option exercise price and/or payroll taxes.
Withholding Rate: Rate used to determine the tax liability required to be withheld.
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Types of Stock Compensation – International IssuesTaxation outside the U.S. varies widely
◦ Do employer homework before making any promises to make grants!
Examples of common issues◦ Stock options (sometimes) and RSAs (often) can be taxable at grant
◦ Tax withholding may be required
◦ Some countries assess the employer for the taxes if there is a failure to withhold
◦ Employer social taxes can be high and uncapped
◦ ISOs and ESPP do not receive preferential tax treatment outside the U.S.
◦ Employees who move overseas will likely have a trailing tax liability and will owe taxes to the U.S. even if the exercise occurs after they are established elsewhere, even if they are not U.S. citizens
◦ Securities, labor laws and foreign exchange laws should be reviewed
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State Taxation of Stock Compensation
Most states follow U.S. federal taxation of stock compensationo Timing of taxation
o Amount subject to taxation
Exceptions:o Pennsylvania does not provide tax favorable treatment for• Incentive Stock Options (ISOs)
• S423 Employee Stock Purchase Plans
o Ohio requires withholding for disqualifying dispositions of shares from ISOs and ESPPs
o State level tax favorable treatment for stock options that meet certain conditions• Hawaii
• Rhode Island
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State Taxation of Stock CompensationFederal:
◦ 22% on supplemental income paid in the year up to $1,000,000
◦ 37% on supplemental income paid in the year over $1,000,000
State:◦ California – 10.23% (bonuses and stock compensation), 6.6% other supplemental
income
◦ New York – 9.62%
◦ Some states do not have supplemental withholding rate. Employers should withhold at W4 (or state equivalent) withholding rate
State payroll taxes◦ For example, CA SDI, Oregon Transit Tax, etc. usually apply
Local taxes:◦ Varies
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Local and Municipal TaxesDo not forget local taxes such as:
◦ State disability and similar payroll taxes
◦ California, New Jersey, Pennsylvania
◦ Local city and municipality taxes
◦ New York City
◦ Pennsylvania townships and school districts
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In 2019, the Tax Foundation
estimated that there are approx.
4,964 local income taxes in
the U.S.
Deposit RulesIn general the Federal tax deposit rules for stock compensation follows the company’s regular deposit schedule; BUT if the cumulative Federal tax deposit for all employees exceeds $100,000, the amounts withheld must be deposited with the IRS by the next business day
Federal tax deposit generally includes:
Some states have similar rules; e.g.◦ California: Next day deposit required if subject to the Federal next day
deposit plus $500 in California PIT
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• Federal income tax withheld• Social security withheld• Medicare tax withheld
• Employer’s portion of social security • Employer’s portion of Medicare
Deposit Timing For Stock CompensationTax event date requiring Federal deposit:
◦ Incentive stock options: none
◦ Non-qualifying stock options: settlement (if no later than the third business day after exercise)◦ 2003 IRS Field Directive*
◦ For this purpose business day = day stock exchange is open
◦ RSAs: vest date unless s83b election made
◦ RSUs: release date
◦ Employee stock purchase plan: none
*Assertion of the Penalty for Failure to Deposit Employment Taxes Field Directive March 14, 2003
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How The Use Of Stock Compensation Can Trigger Nexus
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Employee WithholdingExplanation of How Employer Nexus is Triggered
- Employment Mobility
- Permanent Establishment
- General Activity and Time
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Employee WithholdingExamples
Activity in Location◦ Management
◦ Sales
◦ Operations
Time in Location
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Employee WithholdingTelecommuting Issues and Challengeso Formal policies increase awareness
o Nexus triggered (impact on other taxes)
o Potential double-taxation
o Key point: Before implementing a telecommuting policy, understand the tax profile and its impact on employees and the company.
o Evaluate an employee’s “work state” location.
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Implications and Issues Related to Corporate Income Apportionment
Payroll Factors: General Rules◦ Uniform Division of Income for Tax Purposes (“UDITPA”) § 13
◦ The payroll factor is a fraction, the numerator of which is the total amount paid in a state and the denominator is the total amount paid everywhere during the tax period.
◦ Compensation includes wages, salaries, and other compensation (i.e. equity awards, bonuses) paid for services to the taxpayer.
◦ Payroll “paid” should be determined by the normal accounting methods of the business so that if the taxpayer “accrues” such matters the payroll should be treated as “paid” for purpose of UDITPA § 13.
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Implications and Issues Related to Corporate Income Apportionment
Alternative Methods or Discretionary Adjustments
◦ Uniform Division of Income for Tax Purposes (“UDITPA”) § 18◦ If the apportionment provisions of the Act do not fairly represent the extent of the Taxpayer’s business
activities within the state, the taxpayer may petition for or the [tax administrator] may require, in respect to all or any part of taxpayer’s business activity, if reasonable:
◦ Separate Accounting
◦ The exclusion of any one or more of the factors
◦ The inclusion of one or more additional factors which will fairly represent the taxpayer’s business activity in the state, or
◦ The employment of any other method to effectuate allocation and apportionment of the taxpayer’s income
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Corporate Income, Franchise, and Sales Tax Exposures“Doing Business” vs. “Transacting Business”
◦ “Doing Business” – J.C Snavely & Sons, Inc. v. Wheeler◦ A corporation is essentially doing business in any state where it “transacts some substantial part
of its ordinary business”
◦ Four criteria to consider:
◦ Whether the corporation pays state taxes
◦ Whether it maintains property, employees, inventory, bank accounts, etc. in the state
◦ Whether it makes contracts in the state
◦ Whether its management functions in the state are pervasive
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Corporate Income, Franchise, and Sales Tax Exposures“Doing Business” vs. “Transacting Business”
◦ “Transacting Business” - Cal. Corp. Code § 191◦ Entering into repeated and successive transactions of its business in this state, other than
interstate or foreign commerce.
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Corporate Income, Franchise, and Sales Tax ExposuresEmployee Withholding Creates a Paper Trail
◦ Track employees’ location(s) to ensure accurate employer withholding reporting/withholding obligations
◦ Issues under payroll review or audit
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Corporate Income, Franchise, and Sales Tax ExposuresSpecific Examples
- Neighboring States◦ New York / New Jersey
◦ Kansas / Missouri
◦ Locality Tax Requirements
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State Legislation of NoteWayfair: June 21, 2018
- States rights to charge tax on virtual purchases.
Quill Corp. v. North Dakota
- Physical Presence
Voluntary Basis
- Individual Tax Returns
Amazon in 2017
- Agreement to collect
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Sourcing of Income Earned vs. recognized
◦ Earned over time
◦ Recognized at a specific point in time
Extent of taxation and withholding is dependent on residency status◦ In general, states tax:
◦ Residents on worldwide income
◦ State tax credits may be available
◦ Non-residents on sourced income
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U.S. Income Tax Sourcing RulesSince January 1, 2006 Federal sourcing is based on U.S. workdays from grant to vest
Some treaties state otherwise:◦ U.S.: Canada
◦ U.S.: Japan
◦ U.S.: U.K.
Specific grants may require different sourcing◦ E.g., an award granted for a project undertaken in a particular location
State sourcing may differ◦ E.g., Arizona, California
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Sourcing PrinciplesThe general rule is that income is sourced where it is earned or over the “earnings period”
Each state may have a different view of the earnings period particularly for stock compensation
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Earned Paid
Base salary Daily Bi-weekly or semi-monthly or monthly
Bonus Over bonus performance period or related to the achievement of a goal
Quarterly or annually or achievement of target
Commission Related to a sale After sale close
Pension Daily Post retirement
Stock options From grant to vest/exercise Upon exercise
Restricted Stock Units
From grant to vest/release Upon release
Each double tax treaty is different
U.S. has double tax treaties with almost 70 countries
BUT generally an individual is tax exempt if :◦ The employee is present in the host country for 183 days or less,
◦ In the taxable year concerned or rolling 12 month period
◦ The employee compensation is paid by or on behalf of an employer which is not a resident of the host country, and
◦ The compensation is not borne by a Permanent Establishment (PE) or fixed base which the employer has in the host country
◦ Economic employer
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Totalization AgreementsSimilar to double tax treaties but focus is social security
U.S. has totalization agreements with 27 countries
Generally, individual can be covered in “Home Country” for up to 5 years
◦ Requires a document from the social security authorities known as Certificate of Coverage
If “local” employee in new country, income can be subject to social tax in new country only
May mean that income tax and social tax are sourced differently for the same income
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State Sourcing Of Stock CompensationInconsistency in allocation methods; e.g.
◦ Workdays from grant to vest◦ Georgia
◦ New York
◦ Workdays from grant to exercise◦ Arizona
◦ California
◦ Exceptions◦ Illinois - Five-year special rule
◦ North Carolina - location of grant
◦ Ohio - Degree of appreciation method
Most states do not have designated allocation methodology◦ Default to Federal allocation rules?
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There are 41 states in the U.S.
that charge an income tax
plus District of Columbia
New York - Sourcing RulesMove to New York
◦ Granted while a nonresident, taxable while a resident
◦ Taxed on worldwide income
◦ Subject to state tax credits
Move out of York◦ Granted while a resident, taxed while a nonresident
◦ Income taxable to the extent earned in York using grant to vest methodology
Business travel to New York◦ No de minimis for employees
◦ 14 day de minimis for employer compliance
Employment in New York◦ Taxable in New York even if the employee physically works elsewhere except at
the convenience of the employer
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California – Sourcing RulesMove to California
◦ Granted while a nonresident, taxable while a resident
◦ Taxed on worldwide income
◦ Subject to state tax credits
Move out of California◦ Granted while a resident, taxed while a nonresident
◦ Income taxable to the extent earned in California; one reasonable method is time◦ Stock option examples and audit manual use time between date of grant to date of exercise
◦ RSUs – guidance is to use time between date of grant to date of vest
Business travel to California◦ No de minimis
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Administrative Challenges And Practical Solutions
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Examples of StatesCalifornia
New York
Illinois
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Trends in AuditSpecific Examples of States and Audit Practices
Compensation Matching
- Reporting
- Withholding
Sourcing based on employment role
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Trends in AuditPolicy Issues Companies Need to Examine
◦ What companies and their tax staffs can do if employees have cash flow problems or file returns in multiple states.
◦ Tax Equalization
◦ Tax Protection
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Background on HR, Stock Plan, and Relevant Payroll SystemsWhat Tools are Available and Systems Limitations
Software Solutions
- HRIS
- Travel
- Equity Withholding
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Background on HR, Stock Plan, and Relevant Payroll SystemsHow to Make These More Sophisticated
All-inclusive software solution integrations
- Employment Management, Travel, and Tax
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Background on HR, Stock Plan, and Relevant Payroll SystemsHow Tax Specialists Can Help in this Effort
Diagnostic Reviews
Projections and Automation
Accuracy
Timelines
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Challenges with Employee MovementCreating Internal Mechanisms to Track Employee Movements
◦ How Tax Specialists Can Help in this Effort
◦ Implementation of Software Solutions
◦ Travel and Threshold Matrix
◦ Tax Planning
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Challenges with Employee MovementWhat Companies are Doing
◦ The habit of monitoring only executives and the inherent dangers
◦ Situations in which execs move from low-tax to high-tax states
◦ Need for additional controls
◦ Exposure
◦ Paper trail
◦ Employee Satisfaction
◦ Lack of Tax Policies
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Questions?
Joseph S. Pancamo, CPA
Global Employer Services
BDO USA, LLP
312-233-1840
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Marlene Zobayan
Rutlen Associates LLC
650-868-9282