Two recent pronouncements from the IRS provide information on when companies need to deposit tax withholding for stock plan transactions. Here’s what you need to know about them.
The first pronouncement is in the form of a GLAM (Generic Legal Advice Memorandum). GLAMs are a form of internal communication within the IRS. They provide legal advice from the National Office of the Office of Chief Counsel (that’s not a typo, the title has the word “office” in it twice—go figure, it’s the government) to national program executives and managers of the IRS. GLAMs cannot be cited as precedent but they provide helpful insights into the IRS’s positions.
GLAM 2020-004, issued on May 18, advises on when amounts related to NQSOs, stock-settled SARs, and RSUs must be included in income for FIT and FICA purposes and when the company’s withholding obligation arises. There’s nothing particularly surprising in the GLAM, but it does provide some helpful clarifications.
For RSUs, the GLAM clarifies that the taxable event is the date the company initiates the payment to the award holder. Because RSUs are taxed upon constructive receipt, I’ve sometimes encountered confusion as to whether they should be taxed on the payout date or the date the shares are actually deposited in the employee’s brokerage account, which usually occurs a few days after the payout date (e.g., see “What Is the Taxable Event for RSUs?”).
The GLAM takes the position that award shares are transferred, and the employee beneficially owns them, as of the date the company initiates the payment. For RSUs paid out upon vesting, this will generally be the vest date. The fact that it takes a few days for the shares to show up in the employee’s brokerage account doesn’t change when the employee recognizes income for the award or the amount of income recognized.
Thus, the income recognized is equal to the value of the stock on the payment date. The stock may increase or decrease in value by the time the shares arrive in the employee’s brokerage account, but this does not change the amount of income the employee recognizes for FIT purposes (or FICA purposes, in the case of RSUs paid out at vesting). Moreover, income for the award payout is reportable to the employee as of the payment date and the company’s tax withholding obligation accrues at this time.
There is less confusion as to when a taxable event occurs for NQSOs and SARs, but in the event that anyone is confused about this, the GLAM indicates that it is the exercise date, not the date the shares are delivered to the employee’s brokerage account.
The employee recognizes income for both FIT and FICA purposes equal to the spread on the exercise date, regardless of what the stock is worth when the employee takes possession of the shares. The income is reportable to the employee as of the exercise date and the company’s tax withholding obligation also accrues on this date.
On May 26, the IRS published a procedural update to the Internal Revenue Manual. The update directs IRS auditors on how to determine late deposit penalties for NQSO and SSAR exercises and payouts of RSUs. The update serves two purposes:
The update is also an internal IRS document and cannot be relied on as precedent. It is simply a direction to IRS auditors on how to treat certain transactions.
Under US tax regulations, when a company’s cumulative deposit liability to the IRS exceeds $100,000, the deposit must be made by the next business day (referred to as the “one-day deposit rule”). It is common for stock plan transactions to trigger this requirement and complying with it can be administratively burdensome.
For transactions which are financed via an open market sale, such as same-day sales of NQSOs and selling shares to cover the taxes due on RSUs, compliance is virtually impossible. As noted in GLAM 2020-004 (discussed above), the company’s deposit liability accrues as of the exercise or payment day. The funds to make the deposit won’t be available to the company until the sale settles, two days later. Under the one-day deposit rule, the company would be required to deposit the tax withholding with the IRS before it has received the funds to be deposited.
Given this practical obstacle to compliance, in 2003 the IRS issued a field directive instructing auditors to treat the company’s deposit liability as accruing on the settlement date for same-day sale exercises of NQSOs. This provided much needed relief for NQSOs and, back then, few companies were granting restricted stock or units, so no one much worried about them.
Nowadays, however, more companies grant RSUs than do stock options, making the one-day deposit rule once again a challenge. It is a significant obstacle to using sell-to-cover to finance the tax withholding due on RSUs. The procedural update solves this by applying the guidance on NQSO exercises to RSUs: for purposes of the one-day deposit rule, IRS auditors are to treat the company’s deposit liability for RSU transactions as accruing on the settlement date. This gives companies until the day after settlement to make the deposit (but no later than three days after the payout event).
Given the cash-flow concerns many companies are experiencing as a result of COVID-19, the timing of this couldn’t be better. For companies wishing to transition from share withholding to sell-to-cover as a means of conserving cash, one significant obstacle has been removed.
Compliance with the one-day deposit rule is also a challenge in the context of share withholding transactions. Here, however, the availability of funds isn’t a problem, it’s merely an administrative challenge. The IRS has been less sympathetic to the argument that companies need more time to make the deposit in this circumstance.
The procedural update doesn’t seem to differentiate between sell-to-cover and share withholding (or taxes paid in cash, for that matter). It does, however, refer to the settlement date, which isn’t a concept that applies to nonmarket transactions (but the IRS seems to be confused about this). Thus, it isn’t clear to me what the intended treatment is for share withholding transactions. I will be asking the IRS and Treasury Speaks panel at this year’s NASPP Conference to clarify this.