The NASPP Blog

Category Archives: ISOs

November 9, 2017

Tax Reform Update

The impact of the Tax Cuts and Jobs Act on stock compensation continues to be a focus here at the NASPP. My understanding is that the bill is supposed to come out of committee in the House possibly as early as today and that we might also see the Senate version of the bill today.

Here are a few updates based on what we know so far.

ISOs and ESPPs Exempt

The Joint Committee on Taxation (JCT) report on the bill clarifies that ISOs and ESPPs are intended to be exempt from the definition of NQDC. That’s good news for those of you who, like myself, are big fans of qualified ESPPs. It also could mean that I wasn’t completely off base on Monday when I suggested this bill might lead to a resurgence of ISOs.

At-the-Money Options NOT Exempt

I know some folks were holding out hope that the failure to exclude at-the-money options from the definition of NQDC was a drafting error but that doesn’t appear to be the case. The JCT report says:

The proposal applies to all stock options and SARs (and similar arrangements involving noncorporate entities), regardless of how the exercise price compares to the value of the related stock on the date the option or SAR is granted. It is intended that no exceptions are to be provided in regulations or other administrative guidance.

So that seems pretty clear. Sounds like someone was annoyed about the exception included in the 409A regs for at-the-money options.

Performance Conditions Don’t Count

An oddity in the proposed legislation is that vesting tied to performance conditions doesn’t count as a substantial risk for forfeiture. For public companies, I think most performance awards are tied to both a service and a performance condition, so this might not be a significant concern (although it probably will be necessary to make sure the service condition extends through the date that the comp committee certifies performance, otherwise the awards would be taxable before performance has been certified). But it’s going to be a significant problem for private companies that want to make vesting in awards contingent on an IPO or CIC.

Retirement Provisions Will be a Problem

The requirement to tax NQSOs and RSUs upon vest will also put a wrinkle in retirement provisions. As you all know, when grants provide for accelerated or continued vesting upon retirement, there’s no longer a substantial risk of forfeiture once an employee is eligible to retire. Thus, under the tax bill, both NQSOs and RSUs that provide for payment upon retirement would be fully taxable for both FIT and FICA purposes when employees are eligible to retire (and restricted stock paid out at retirement is already fully taxable upon retirement eligibility).

Relief for Private Companies

The bill has been amended to include a provision that would allow employees in private companies to make an election upon exercise of stock options or vesting of RSUs that would defer taxation for five years (in the case of stock options, it’s not entirely clear when the five-year period would start). This is nice, but I’m not sure it’s enough. How many private companies are on a five-year trajectory to IPO or can accurately predict when they are five years out from IPO?

– Barbara


April 27, 2017

Trump’s Tax Reform Plan

The Trump Administration released its long-awaited tax reform proposal yesterday.  The proposal is a long ways away from being final; legislation still has to be introduced into Congress and passed by both the House and the Senate, and the proposal, consisting of a single-page of short bullet points, is lacking in key details. The NY Times refers to it as “less a plan than a wish list” (“White House Proposes Slashing Tax Rates, Significantly Aiding Wealthy,” April 26, Julie Hirschfeld Davis and Alan Rappeport).

Here are six ways the proposal, if finalized, could impact equity compensation.

1. Lower Individual Tax Rates: The proposal would replace the current system of seven individual tax rates ranging from 10% to 39.6% with just three tax rates: 10%, 25%, and 35%. The plan doesn’t indicate the income brackets applicable to each rate, but it will clearly be a significant tax cut for many taxpayers (except those already in the lowest tax bracket).

Lower individual tax rates mean that employees take home a greater percentage of the income from their equity awards (and all other compensation). This will impact tax planning and may change employee behavior with respect to stock holdings and equity awards. Employees may be less inclined to hold stock to qualify for capital gains treatment and tax-qualified awards and deferral programs may be less attractive.

2. New Tax Withholding Rates: It’s not clear yet what would happen to the flat withholding rate that is available for supplemental payments. The rate for employees who have received $1 million or less in supplemental payments  is currently pegged to the third lowest tax rate. But with only three tax rates, this procedure no longer makes sense.

The rate might stay at 25% or, with only three individual tax rates, the IRS might dispense with the supplemental flat rate altogether and simply require that companies withhold at the rate applicable to the individual. This could have the added benefit of resolving the question of whether to allow stock plan participants to request excess withholding on their transactions.

3. Lower Capital Gains Rate. The plan calls for elimination of the additional 3.8% Medicare tax imposed on investments that is used to fund Obamacare. This will increase the profit employees keep from their stock sales.

4. No More AMT. If you’ve been putting off learning about the AMT, maybe now you won’t have to. The plan would eliminate the AMT altogether (there aren’t any details, but I assume taxpayers would still be able to use AMT credits saved up from prior years). This would be a welcome relief for any companies that grant ISOs.

5. Elimination of the Estate Tax. With elimination of the estate tax, the strategy of gifting options to family members or trusts for estate-planning purposes would no longer be necessary.

6. Lower Corporate Tax Rate. The plan calls for the corporate tax rate to be reduced from 35% to 15%. A lower corporate tax will reduce corporate tax deductions for stock compensation, which will mitigate the impact of the FASB’s recent decision to require all tax effects for stock awards to be recorded in the P&L.

– Barbara

Tags: , , ,

April 20, 2017

When Is a Benefit Not a Benefit?

Riddle me this: when is a benefit not a benefit? The answer: when that benefit results in a change to the terms and conditions of an ISO. Making changes to ISO can have the unfortunate effect of disqualifying the options from ISO treatment, which might make the optionees less than enthusiastic about the new “benefit.”

The Uber Case

This was highlighted in a recent class-action lawsuit brought by an Uber employee (McElrath v. Uber Technologies). McElrath, an employee of Uber and the plaintiff in the suit, was promised an ISO that vested over four years in his offer letter.  But, when the ISO was granted, the vesting schedule was shortened to just six months. This caused a much greater portion of the ISO to exceed the $100,000 limitation. The plaintiff contends that Uber changed the vesting schedule to ensure a corporate tax deduction for the option.

There could be any number of legitimate reasons for Uber to grant the options with a shorter vesting schedule than stated in the offer letter.  Additionally, shorter vesting periods certainly offer benefits to employees. I suspect that many companies consider acceleration of vesting to be a change they can make without an award holder’s consent. But this illustrates that, when it comes to ISOs, it is important to consider the tax consequences to the optionee before making any changes.

Modifications, Too

The Uber case doesn’t involve a modification, just a discrepancy between what was granted and what was promised in the offer letter. But this concept also applies any time an ISO is modified. Any change that confers additional benefits on the optionee (other than acceleration of exercisability and conversion of the option in the event of a change-in-control) is consider to be the cancellation of the existing ISO and the grant of a new option. If the new option doesn’t meet all of the ISO requirements (option price at least equal to the current FMV, granted to an employee, $100,000 limitation, etc.), the option is disqualified from ISO treatment.

And, while acceleration of exercisability (which most practitioners interpret to mean vesting) doesn’t result in a new grant, there is still the pesky $100,000 limitation to worry about.  In many cases, acceleration of exercisability will cause an ISO to exceed this limitation.

Where a modification disqualifies all or a portion of an option from ISO treatment, it is important to consider whether it is necessary for the optionee to consent to the modification. Most option agreements stipulate that any changes that adversely impact the optionee cannot be executed without the optionee’s consent. Keep this in mind the next time your compensation committee has a bright idea about making existing ISOs better.

– Barbara

Tags: , ,

January 11, 2017

Form 3922 Gets an Upgrade

Here we are again at the start of another season of Section 6039 filings. Nothing much has changed with respect to Section 6039 filings in recent years, so imagine my surprise when I learned that the IRS had updated Form 3922.

Form 3922 Grows Up

As it turns out, the only update to the form is that it has been turned into a fill-in form. If you are planning on submitting paper filings, this allows the form to be filled in using Adobe Acrobat, so you don’t have to scare up a typewriter or practice your handwriting. I haven’t owned a typewriter since college and even I can’t read my handwriting, so I am a big fan of fill-in forms.

Unfortunately, this is just about the least helpful improvement to the forms that the IRS could make. Form 3922 is for ESPP transactions. ESPPs tend to be offered by publicly held companies with well over 250 employees.  Chance are, if a company has to file Form 3922, the company has more than 250 returns to file (less than 250 ESPP participants is probably a pretty dismal participation rate for most ESPP sponsors) and the returns have to be filed electronically. The fill-in feature doesn’t impact the electronic filing procedures; it is only helpful for paper filings.

It would have been more helpful if the IRS had made Form 3921 a fill-in form. Given the declining interest in ISOs (only around 10% of respondents to the NASPP/Deloitte Consulting 2016 Domestic Stock Plan Design Survey grant ISOs), companies are more likely to be filing this form on paper.  The IRS notes, however, that it selected Form 3922 to be made into a fill-in form because they receive so few filings of it on paper. I guess the IRS’s goal was to appear helpful but not actually be helpful. Your tax dollars at work.

A Fill-In Form Isn’t As Helpful As You Think, Anyway

As it turns out, having a fill-in form may not be that helpful, anyway. I was thinking you could fill in the form, save it, and then email it to the IRS but it doesn’t seem like this is the case.  No, even if you fill it in using Adobe Acrobat, you still have to print it out and mail it to the IRS. And the requirements for printing the form out still include phrases like “optical character recognition A font,” “non-reflective carbon-based ink,” and “principally bleached chemical wood pulp.” I think this means that you have to print the form on white paper, using black ink that isn’t too shiny, and using the standard fonts in the fill-in form. But I’m not entirely sure.

What About Form 3921?

When I first saw that Form 3922 is now fill-in-able, I assumed, perhaps naively, that a fill-in Form 3921, which would truly be useful, would be available any day. But that was back in September and still no update to Form 3921. Upon reflection, especially given the IRS’s statement about why this honor was bestowed upon Form 3922, I think I may have been overly optimistic.

More Information about Section 6039 Filings

For more information on Section 6039 Filings, check out the NASPP Alert “Reminder: ISO and ESPP Information Returns and Statements.”

Thanks to Diana Woods of Fenwick & West for bringing the updated form to my attention.

– Barbara

Tags: , , , , , ,

March 1, 2016

Tax Holding Periods and Leap Year

Leap year can make things complicated. For example, if you use a daily accrual rate for some purpose related to stock compensation, such as calculating a pro-rata payout, a tax allocation for a mobile employee, or expense accruals, you have to remember to add a day to your calculation once every four years.  Personally, I think it would be easier if we handled leap year the same way we handle the transition from Daylight Saving Time to Standard Time: everyone just set their calendar back 24 hours. Rather than doing this on the last day of February, I think it would be best to do it on the last Sunday in February, so that the “fall back” always occurs on a weekend.

In a slightly belated celebration of Leap Day, I have a few tidbits related to leap years and tax holding periods.

If a holding period for tax purposes spans February 29, this adds an extra day to the holding period.  For example, if a taxpayer buys stock on January 15, 2015, the stock must be held for 365 days, through January 15, 2016 for the sale to qualify for long-term capital gains treatment.  But if stock is purchased a year later, on January 15, 2016, the stock has to be held for 366 days, until January 15, 2017, to qualify for long-term capital gains treatment.  The same concept applies in the case of the statutory ISO and ESPP holding periods–see my blog entry “Leap Year and ISOs,” (June 23, 2009).

Even trickier, if stock is purchased on February 28 of the year prior to a leap year, it still has to be held until March 1 of the following year for the sale to qualify for capital gains treatment.  This is because the IRS treats the holding period as starting on the day after the purchase.  Stock purchased on February 28 in a non-leap year has a holding period that starts on March 1, which means that even with the extra day in February in the year after the purchase, the stock still has to be held until March 1.  See the Fairmark Press article, “Capital Gains and Leap Year,” February 26, 2008.

Ditto if stock is purchased on either February 28 or February 29 of a leap year.  In the case of stock purchased on February 28, the holding period will start on February 29. But there won’t be a February 29 in the following year, so the taxpayer will have to hold the stock until March 1.  And if stock is purchased on February 29, the holding period starts on March 1. Interesting how none of these rules seem to work in the taxpayer’s favor.

The moral of the story: if long-term capital gains treatment is important to you, it’s not a bad idea to give yourself an extra day just to be safe–especially if there’s a leap year involved.

– Barbara



Tags: , , , , , , , , , ,