The NASPP Blog

Monthly Archives: June 2010

June 29, 2010

Say-on-Pay: The Final Countdown

Every week brings us a little closer to mandatory “Say-on-Pay.” Last week (very early Friday morning), Senate and House conferees reached agreement on the finance reform bill. All that remains now is for the House and Senate to vote on the bill and for President Obama to sign it into law–all this is expected to be wrapped up in time for the July 4 holiday. (Is it just me or does it seem like all major regulatory changes happen right before a holiday? It’s a good thing we have holidays or nothing would ever get done in this country.)

The full bill is 2,000 pages long–a little light reading for down-time during your 4th of July picnic. For those of you that want the cliff-notes version, we’ve posted a 23-page excerpt of the sections relating to executive compensation.

A Triennial Requirement (or How Much Control Will Your Shareholders Want)?

The final bill would allow companies to seek shareholder approval to hold a Say-on-Pay vote only once every two or three years, rather than requiring the vote every year. Shareholders would have to be allowed to vote on the frequency of Say-on-Pay votes at least once every six years. This must be a separate resolution from the Say-on-Pay vote.

SCT for Rank-and-File Employees

The final bill requires companies to disclose the median pay of all employees other than the CEO and the ratio of this pay to the CEO’s pay. “Pay” for this purpose is computed based on the requirements for reporting total compensation in column (j) of the Summary Compensation Table. The amount for employees other than the CEO will be disclosed on a aggregate basis (you won’t disclose pay for non-NEOs on an individual basis)–but to get to the aggregate amount, you’ll have to apply the SCT principles to each individual employee. Now would be a good time to check with your administrative service providers to determine if their solution offers a report to assist with this calculation.

A Bill by Any Other Name

The last motion on the bill was to change the name to the “Dodd-Frank Wall Street Reform and Consumer Protection Act.” That’s quite a mouthful, so Broc Romanek, in his June 28 blog on the bill, has a poll on what the shorthand name should be. True to my 80’s roots, my favorite is the “Doddy-Frank Goes to Hollywood Act (Relax, don’t do it…)”

18th Annual NASPP Conference
Scheduled for Sept 20-23, the 18th Annual NASPP Conference is timed perfectly to help our members prepare for mandatory Say-on-Pay. Just announced–we’ve added a special Say-on-Pay track, featuring key advice and real-world strategies from in-the-know practitioners. Register for the Conference today.

NASPP New Member Referral Program
Refer new members to the NASPP and your NASPP Conference registration could be free.  You can save $150 off your registration for each new member you refer, up to the full cost of registration. You’ll also be entered into a raffle for an Apple iPad and the new members you refer save 50% on their membership–it’s a win-win!   

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. 

– Barbara

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June 24, 2010

Final Arrangements

Wow – it’s a light-hearted week here at the NASPP! As a follow-up to my post on tax withholding and reporting, today I’d like to address some steps stock plan administrators can take to prepare for the unfortunate event of an employee death.

Availability of Shares

The first step in preparing for efficient handling of an employee death is to know you plans and grant agreements. You need to know how the death will impact different equity vehicles.

Typically, the post-termination period for exercises is at least 12 months for death. This is because of the time and effort it takes to provide the correct documentation. In addition to knowing the period of time an employee’s estate or beneficiary has to exercise vested options, check to see if your plan or grant policy addresses the situation of a participant who dies within the standard post-termination exercise period.

For restricted stock, confirm whether or not unvested shares will accelerate or continue vesting. If there are any required post-vesting holding requirements associated with your restricted stock grants, check to see if these requirements apply to the estate or beneficiary.

If you have an ESPP, confirm that either your plan document or official policy addresses the issue of how contributions will be handled in the event of a death part-way through an offering period. Most companies do not allow the contributions to stay in the plan, but some do, and it is permitted under Section 423. For purchased shares that transfer to the estate or beneficiary, the statutory holding periods no longer apply.

Required Documentation

Unfortunately, it’s difficult to have a blanket policy on documentation required across all jurisdictions. Some companies use beneficiary designation forms to pass equity compensation on to an employee’s beneficiary. I would submit a word of caution against generic beneficiary forms for equity compensation–see Robyn’s blog entry on this topic for more information. Here are a few types of documentation that your company may determine is necessary in order to permit the estate or beneficiary to exercise:

Death Certificate: This is a pretty standard requirement, which will be needed for all types of inheritance issues.

Will: Also known as the “Last Will and Testament”, a will establishes how all of the assets of the decedent will be distributed and should include equity compensation. Generally, an executor will be named in a will and will be tasked with the process of overseeing the distribution of assets in the will. It is generally too risky for the company to attempt to prove that a will is, in fact, the most recent version and how to interpret its contents.

Court Documentation: All jurisdictions have some official body that establishes the official distribution of assets. These official documents will most likely be required by the broker, life insurance company, and other entities that hold assets which need to be distributed. It would be a massive investment in time and resources to identify which official documentation is applicable to each jurisdiction and asset level, so I don’t recommend attempting to identify this in advance. However, it is a good idea to identify your resources in each country for assistance in this matter, should it come up.

Held Shares

Brokerage firms have their own policies and procedures about transferring held shares to the estate or beneficiary. Although this process is essentially completely separate from your company’s process, it can be confusing and stressful for your employee’s heirs to understand that. Similar to educating employees about taxes on equity compensation, there is a fine line between making the process easier and providing legal advice. It’s good to consider how to handle this situation in advance, particularly for international beneficiaries. An important preparation you can make is to meet with your preferred brokers and identify the steps beneficiaries must take and who at the brokerage to contact in the event of an employee death.

Less than One Week Left!

You have through next Tuesday to take advantage of the NASPP’s New Member Referral Program. You can earn $150 off your NASPP Conference registration and an entry into a raffle for an iPad for each new member you refer to the NASPP–and the new members you refer can save 50% on their NASPP membership for 2010. Don’t let this deadline slip by!


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June 22, 2010

Divorce and Termination

A divorce case involving stock options that has some potential lessons for stock plan administrators recently came to my attention. The case involves grants that were divided in a divorce settlement and then later cancelled due to the employee’s termination.

Divorce is Expensive–Especially If Options Expire Unexercised

Under the terms of the divorce settlement, the employee’s options and SARs were split equally between him and his ex-spouse. The grants were non-transferable, so the employee was required to hold half of the grants in constructive trust for the ex-spouse. Upon exercise of that portion of the grants, the employee would then have to pay over the proceeds to the ex-spouse.

After the settlement was final, the employee terminated his employment and, as a result, the period in which the grants could be exercised was curtailed. The employee did not exercise the grants within that period and the grants were cancelled. The employee’s ex-spouse then claimed that the employee owed her the value of her half of the grants–about $15,000–because, by failing to exercise the options/SARs within the prescribed period, the employee had deprived her of the opportunity to realize this gain.

The employee had been under the impression that he could take the options/SARs with him. I’m sure anyone involved in stock plan administration can read the subtext here: the employee likely asked his (uninformed) best buddy at work what would happen to the grants and never bothered to check his grant agreements, exit paperwork, or even call stock plan administration to ask about the grants. I imagine that it’s even possible that this lack of follow-through was a contributing factor in the divorce in the first place.

The end result is that the court agreed with the ex-wife and the employee now owes her about $15,000.

Lesson 1: Appropriate Cancellation Procedures

In this case, the options/SARs were non-transferable and were all still held by the employee. Thus, when the employee’s termination was entered into the stock plan database, it was likely automatically applied to all of the options/SARS. Where the options are transferable and have been assigned to the ex-spouse in the company’s stock plan database, this procedure might not work quite so efficiently. If you are transferring grants divided in a divorce settlement to an ex-spouse, it is critical that you remember to cancel those grants along with the grants held by the employee when the employee terminates.

Lesson 2: Cancellation Notification

The second lesson here is to make sure that, in the event the employee does terminate, it isn’t your job to notify the ex-spouse that the grants he/she has a right to are subject to cancellation. At the time that you receive notice of the divorce settlement, make sure that any responsibility for providing subsequent notices about any change in the status of the grants (due to termination, change-in-control, repricing, stock split, etc.) falls squarely on the employee’s shoulders and that the employee is aware of it. You have enough to do keeping track of employees; you don’t need to take on their ex-spouses as well.

Lesson 3: Stay Out of It

I think this case is a good argument for not allowing transfer of options and awards upon divorce. By not permitting the transfer and requiring the employee to exercise the options/SARs on behalf of the ex-spouse, the company effectively distanced itself from all of the proceedings related to the grants. This also helped to clarify that the employee was responsible for alerting the ex-spouse to the fact that the options/SARs were going to cancel as a result of his termination. Where the company has transferred grants to an ex-spouse and is in communication with the ex-spouse about them, the lines may get a little blurry.

See the NASPP webcast archive, “Death and Divorce: The Lighter Side of Equity Compensation” for more tips on administering stock compensation through divorce.

18th Annual NASPP Conference
Don’t miss the 18th Annual NASPP Conference from Sept 20-23 in Chicago. This year’s program is phenomenal–we’ve planned over 40 sessions on critical and timely topics.  Register for the Conference today.

NASPP New Member Referral Program
Refer new members to the NASPP and your NASPP Conference registration could be free.  You can save $150 off your registration for each new member you refer, up to the full cost of registration. You’ll also be entered into a raffle for an Apple iPad–get started on your referrals today to make sure you are included in the June raffle.  And the new members you refer save 50% on their membership–it’s a win-win!   

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. 

– Barbara

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June 17, 2010

Top Three Say on Pay Action Items for Stock Plan Managers

Say on pay is inevitable, but it’s difficult for stock plan managers to know exactly what that means to them. Because it’s practically unheard of for the equity compensation team to be on the decision-making side of executive compensation, it may feel easy to dismiss say on pay as an issue that can be overlooked.

However, availing yourself as a knowledgeable resource within your company elevates you as a subject matter expert. Being a part of the conversation when it comes to new policies or grant practices always helps ensure that the solutions coming down your pipeline are both effective and manageable. In that spirit, these are my top three action items for stock plan managers to prepare for say on pay:

  1. Know what shareholders; hot buttons are for share-based compensation, including what features and provisions are likely to be unacceptable and those that increase the likelihood of acceptance. Take a good look at your company’s executive equity compensation to see how outstanding grants rate. Here are a few:
  2. Pay for Performance – A significant majority of the bad press generated over executive compensation focuses on the disparity between executive compensation pay-outs and the relative success of the company during the same period. Pay for performance is more than simply slapping a performance condition on a grant, especially if the performance measures are not adequate to inspire long-term success. This year, we have a fantastic pre-conference program dedicated to performance awards, the Practical Guide to Performance-Based Awards. If you’re looking for ways to beef up your knowledge on performance awards, this is the program for you!

    Dividend Payments – Shareholders generally don’t want to see executive compensation that pays out dividends or DERs on unvested shares. This follows right in line with pay for performance; shareholders don’t want to see that an executive will be eligible for dividends on unearned shares.

    Long-term Focus – One of the hottest buttons for shareholders is whether or not executive compensation has a long-term focus. For equity compensation, this includes issues like minimum vesting periods (e.g.; at least 3 years, but preferably 5 years) and holding requirements. Increasing the length of time executives must wait before they can cash out their company shares reduces the temptation executives may feel to take excessive risks. Take a close look at your executives’ equity compensation and create a list of features or provisions that demonstrate a long-term focus.

    Double-trigger – When it comes to change in control provisions in your grant agreements, shareholders (and potential acquiring companies) absolutely want to see a double-trigger for acceleration of vesting in the event of a change in control. If you haven’t already, take a close look at your grant agreements to see what your company’s change-in-control provisions look like.

    Clawback Provisions – depending on how the House and Senate reconcile their final versions of their bills, clawback provisions could be required for listed companies. Shareholders generally like to see that clawbacks are not only in place, but also enforceable. Typically, clawback provisions are found in employment contracts, so have a conversation with your legal team to find out what your company’s current practice is and if that will be changing. Remember that clawback provisions can extend beyond fraud situations; they also may be part of other provisions such as non-compete requirements.

  3. Know what your peer companies are doing and how it compares to your company. This is getting easier to do with enhanced proxy disclosure. If your company’s compensation philosophy already identifies peer companies or groups, then the difficult part has already been done for you. Check out the 2010 proxies from those companies and review their executive compensation practices. Also, keep up with the latest news on shareholder advisory votes; particularly keeping your eyes open for any executive compensation that does not garner vote of approval from shareholders.
  4. Coordinate with your legal and compensation teams. First, it’s important to just keep the lines of communication open and be a part of the conversation. More specifically, find out if tackling say on pay (along with increased disclosure requirements) will require you to provide different or additional data and/or analysis. The earlier you know about additional data requirements, especially if they will ultimately be a periodic need, the more time you have to find the most efficient solution to providing that data.

The NASPP Conference’s Say on Pay Track
Hot off the presses! This week, we announced the “Say on Pay” track that we’ve added to our 18th Annual NASPP Conference. Don’t get left behind on decisions your company may be making in light of say on pay, join us for these essential sessions!


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June 15, 2010

Local Chapter Involvement

Dallas, San Diego, Denver and Boston…what do all of these cities have in common? They are all homes to local chapters of the NASPP. Local chapters, found in 30 cities throughout the country, are a great resource for NASPP members, or persons interested in NASPP membership, who reside in the same geographic area. Local chapter’s vary in size, have meetings several times per year, and are organized by member volunteers.

Involvement with your local chapter is a wonderful supplement to your national membership, enabling you to build relationships and contacts with other industry professionals at a local level and in a more intimate setting. You can share work experiences or enlist the help of your peers in troubleshooting problems and receive immediate feedback or solutions. The network you develop at a local level is also one you can tap into when tasked with projects that involve comparing how other local companies handle their policies or procedures. In addition, through presentations by local speakers, you can stay abreast of current events impacting both the industry and the local market.

Your involvement with your local chapter doesn’t have to be just participatory; it can extend beyond that to a leadership role by volunteering to serve as a chapter board member. You don’t need to be an expert in all things equity compensation to serve on your local board; you just need to be motivated, willing to help promote your chapter and plan meetings. The leadership skills and contacts you develop as a board member are priceless!

What are you waiting for? Maximize your NASPP membership by also becoming a member of your local chapter. You don’t have to be a member of the NASPP to attend your local chapter meetings (although you must be an NASPP member to serve on the chapter board). But we’re pretty sure that you’ll want to become an NASPP member once you attend a local chapter meeting and find out what you’re missing.

To find a local chapter near you and receive its meeting announcements, click here. Speaking of local events, don’t miss Silicon Valley’s Annual All-Day Conference this Thursday and a special half-day meeting in San Diego next Tuesday, June 22nd. I’ll be at both events and hope to see you there.

Upcoming Webcast Reminder

It’s not too late to complete our quick survey and submit your questions for our June 29th webcast, “Ask the Experts: Estimating, Applying and Reconciling Forfeiture Rates.” Complete our survey and get your questions in now before the June 22nd deadline!    


June 10, 2010

The Other “D”

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.


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.


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.

18th Annual NASPP Conference

Our Conference this year is going to be phenomenal! If you are looking to learn all there is to know about Section 6039, don’t miss the double session “IRS Cost-Basis Reporting: Are Your Stock Plans Ready? AND Section 6039 Reporting: Prepare Now Before It’s Too Late” at our 18th Annual Conference in September.

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.

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June 8, 2010

Draft Forms 3921 and 3922

Preview of Forms 3921 and 3922
The IRS has released drafts of Forms 3921 and 3922 and related instructions to the NASPP, for us to share with our members. These forms are drafts only and could be subject to change. The rumor I’ve heard is that the final forms won’t be available until August, but I have not confirmed this with anyone at the IRS.

I haven’t heard anything as to when the electronic file specifications in Publication 1220 will be updated to reflect the final 6039 regs. But, for the past two years, the IRS has posted a new edition of Publication 1220 in July, so hopefully we’ll see another update in the next couple of months.

The IRS has provided the draft forms to the NASPP as a courtesy, in light of the short period between when the final forms will be available and the filing deadline. The IRS requests that the drafts be kept within our industry community.

I also have no information as to when the guidelines on substitute forms in Publication 1179 will be updated for the Section 6039 statements.  I took a look at Publication 1179 recently and it is completely unclear as to which guidelines should apply to the 6039 statements.  But the good news is that an IRS representative has indicated to us that generally any statement within reason that includes all of the required information will likely be acceptable.

NASPP alert announcing the draft forms
Draft Instructions to the forms
Draft Form 3921
Draft Form 3922

I owe a big thank you to Kaye Thomas of Fairmark Press and author of “Consider Your Options” for coming through with a contact at the IRS that was able to send me the draft forms.

Thank You on Cost-Basis Reporting
I also owe a thank you to Andrew Schwartz at BNY Mellon Shareowner Services, who has taught me just about everything I know on the new cost-basis reporting requirements and was a big help with last week’s blog entry on them. Don’t miss our interview with Andrew on cost-basis reporting in the upcoming issue of The NASPP Advisor.

18th Annual NASPP Conference
Don’t miss the 18th Annual NASPP Conference from Sept 20-23 in Chicago. We just posted this year’s program and it is phenomenal–we’ve planned over 40 sessions on critical and timely topics, like the final Section 6039 regs and cost-basis reporting.  Register for the Conference 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. 

– Barbara

June 3, 2010

Correcting Form 4 Mistakes

Form 4 Errors

Form 4 filings can be complex. Ideally, your company has a process in place that is designed to mitigate the risk of erroneous data ending up on a Form 4. However, if an error is discovered, it may be necessary to amend the original filing with a footnote explaining the reason for the amendment. When filing an amended Form 4, there is no need to restate the original Form 4 in its entirety. Rather, the amended Form 4 can include only the line items that are being updated. Additionally, there is no need to amend inaccurate Form 4 filings resulting from the original error that took place between the original erroneous filing and the amendment. Upon discovery of a filing error, the company will need to determine if it is something that must be disclosed in the proxy statement per the requirements of Item 405 (which requires disclosure of late reports and known failures to file required reports).

This week, I’d like to address a few common errors. Obviously, this blog entry shouldn’t be taken as advice. Only your legal counsel (or the SEC) can confirm the appropriate action that you should take when it comes to specific erroneous data in a Form 4 filing. If you subscribe to or the Romeo and Dye Section 16 Treatise and Reporting Guide, you can find additional common errors in form filings along with fantastic guidance on correct reporting and best practices.

Duplicate Grant

If a grant is inadvertently reported twice, removing the duplicate can be done by filing an amended Form 4 with the correct details of the grant along with a footnote clarifying that the grant was originally reported twice. There is no need to show a “disposition” of the erroneous duplicate.

Incorrect Grant Type

If a Form 4 is filed with an incorrect title of derivative security listed in Column 1 of Table II, the correction can be made by filing an amended Form 4 with the correct grant type in Column 1 and a footnote to explain the discrepancy. This is not the same as an amendment to an existing grant, which is considered the disposition of the original grant and acquisition of a new grant. In the case of an incorrect ISO/NQ split, as long as all the other details on the grants (grant date, exercise price, etc.) are the same, then both the ISO portion of the grant and the NQ portion of the grant can be reported on the same line and a correction to share allocation between the two may not require an amendment.

Incorrect Securities Beneficially Owned

If there was an error in the number of shares reported in Column 5 of Table I or Column 9 of Table II, the amended filing is pretty straight forward as long as the total holdings are not incorrect because of an error in or omission of an actual transaction. An amendment with the correct holdings can be filed with a footnote explaining the correction. Likewise, if holdings are incorrectly reported as directly or indirectly held, the same amendment filing would apply. Even if the issue is simply that direct holdings are reported as indirect (or vice versa), it may be best to file an amended Form 4 to show both line items with the correct number of shares. It’s also important to note that the number of shares reported in Column 9 of Table II should only reflect the total of the same class as the derivative security being reported on that line, not the total number of all derivative securities held by the filer.

Immaterial Details

Some errors may not require an amended Form 4 at all because they are not material enough to warrant an amendment. Of course, you’ll want to work closely with your legal counsel to determine the most appropriate course of action in each case. Examples of some details that most likely would not require an amended filing are using the incorrect title, including an incorrect mailing address, failing to disclose that a transaction took place under a Rule 10b5-1 Plan, or accidentally putting the wrong vesting schedule in a footnote.

Section 16 Updates
At the beginning of each year, Alan Dye partners with the NASPP to provide our members with valuable Section 16 updates. NASPP members can access our archive recordings of Section 16 update webcasts in the NASPP Webcast Archive.

Ask the Experts

Speaking of fantastic NASPP programs, mark your calendar for June 29th at 4:00 EST. We will be airing our Latest “Ask the Experts” webcast, Estimating, Applying and Reconciling Forfeiture Rates! If you have a specific issue you would like to have our experts address, it’s not too late to submit your question to the panel.


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June 2, 2010

Cost-Basis Reporting: Complicating an Already Confusing Topic

Cost-Basis Reporting: Helpful Information or Disaster Waiting to Happen?
Cost-basis reporting on Form 1099-B will be required for sales of any equity securities acquired after January 1, 2011. This includes sales of shares acquired under stock option, restricted stock/unit, and other stock plans, as well as shares acquired under ESPPs. But the rules apply slightly differently to shares acquired under these plans than for, say, shares acquired via a run-of-the-mill open-market purchase. The end result is likely to be a lot of confusion, a lot of employee inquiries, and, probably, a lot of overpayment of taxes.

Understanding Cost-Basis for Equity Compensation

For shares acquired through an open-market purchase, the cost basis is simply the amount paid for the shares plus any transaction fees (including fees for the sale transaction, if the broker doesn’t report the sale proceeds net of fees on Form 1099-B). But for shares acquired under a stock compensation program, the cost basis also includes any income reported on the employee’s Form W-2 in connection with either the purchase or the sale of the shares.

Maybe You Should Install a Second Phone Line

The proposed regulations on cost-basis reporting, however, only require brokers, et. al., to report the amount paid for the securities as the cost basis on Form 1099-B. Regulations requiring brokers to report the full cost basis won’t be effective until 2013 at the earliest. For stock compensation, this seems like a huge flaw in the reporting requirements.

If, as a stock plan administrator, you’ve been thinking that you don’t need to worry about these rules because it isn’t your job to issue Forms 1099-B, think again! I can only imagine how confusing this will be for employees–who are already pretty confused about how to report stock compensation on Schedule D. Unless you have some top-notch communications about this, you’ll need to be prepared for a lot of employee confusion and inquiries. And this goes for brokers too–employees are just as likely to look to the broker that issued the Form 1099-B for answers as they are to look to their company’s stock plan administrator.

Now I Understand the Additional Tax Revenue

I suspect that many employees will simply report the Form 1099-B cost basis on their Schedule D, not realizing that this is an understated amount. This will cause employees to pay capital gains tax on the amounts that have already been taxed at ordinary income rates. If the sale is less than a year after the stock was acquired (as in the case of a same-day sale exercise), it is a short-term gain, taxed at the same rate as ordinary income. This doubles the federal income tax paid on the transaction–for employees in the highest tax bracket, it could result in taxes paid of more than 80% of the spread.

I’ve been trying to figure out how cost-basis reporting is going to generate so much additional tax revenue, but now I think I understand.

And, if by some miracle, employees do manage to report the correct tax basis on their tax returns, what happens when the cost basis reported on Schedule D doesn’t match the basis reported on Form 1099-B? Currently, if there is a discrepancy in the sale proceeds reported on Schedule D vs. Form 1099-B, this triggers an automatic IRS notice that there is an error on the return. Will the same type of notice be generated if the reported cost-basis amounts don’t match? If so, how will employees explain the discrepancy to IRS auditors–who probably don’t understand cost-basis for equity compensation any better than they do?

Do You Know What Your Brokers Are Doing?

As I understand it, brokers are permitted to go above and beyond the minimum reporting requirements. If they have the full cost-basis information available and are so inclined, brokers can report the full cost basis (amount paid plus amounts included income) on Form 1099-B. Now would be a good time to ask your brokers a few questions about how they plan to comply:

  • What will they report as the cost basis for shares acquired under various types of stock compensation arrangements? Ask specifically about NQSOs, restricted stock/units, ISOs, and ESPPs if you offer all of these arrangements.
  • What sort of communication materials are your brokers going to provide to employees to help them understand the information reported on Form 1099-B and how will this information be provided? Will they actively distribute information to employees or will employees have to ask for it?

Don’t miss the session “IRS Cost Basis Reporting: Are Your Stock Plans Ready?” at the 18th Annual NASPP Conference for more information on this topic.

Thanks to Andrew Schwartz at BNY Mellon Shareowner Services for providing the background information on how the cost-basis reporting requirements apply to stock compensation.  Be sure to check out Andrew’s interview on cost-basis reporting in the upcoming issue of The NASPP Advisor

18th Annual NASPP Conference
Don’t miss the 18th Annual NASPP Conference from Sept 20-23 in Chicago. We just posted this year’s program and it is phenomenal–we’ve planned over 40 sessions on critical and timely topics, like cost-basis reporting.  Register for the Conference 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. 

– Barbara

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