Navigating Retirement Provisions and FICA for RSUs
March 22, 2023
According to the NASPP’s Equity Incentives Survey (co-sponsored by Deloitte Tax), around two-thirds of respondents offer some form of partial or full continued or accelerated vesting upon retirement for time-based full value awards.
Although there are many sound reasons for this practice (including that retirees have theoretically fulfilled their service to the company, the wealth created by their awards may be a key source of income for them in retirement, and companies often don’t want potential retirees who have otherwise “checked out” sticking around solely to earn their awards), it creates challenges for tax withholding purposes.
For more information on this topic, check out the NASPP Article “Retirement Provisions for RSUs.”
RSUs are subject to tax for income tax purposes when they are paid out, but for FICA purposes, they are subject to tax when no longer subject to a substantial risk of forfeiture. Under most RSU plans, these two events happen at the same time: when awards vest, any risk of forfeiture lapses and the awards are paid out to the employee.
But, when RSUs provide for continued or accelerated vesting upon retirement, there is little risk of forfeiture once the award holder is eligible to retire. The operative word here is “substantial.” RSUs are subject to FICA once there is no longer a substantial risk of forfeiture; it is not necessary for all risk of forfeiture to have been removed for the awards to be subject to FICA.
A limited risk of forfeiture, due to say, termination for cause, generally is not sufficient to delay taxation for FICA purposes. From a practical standpoint, once an individual is eligible to retire, any termination from that point forward is likely to be treated as a retirement except in the case of very egregious misconduct.
Thus, where RSUs provide for accelerated or continued vesting upon retirement and the award holder is eligible to retire, the awards are generally no longer considered to be subject to a substantial risk of forfeiture and they are subject to tax for FICA purposes.
Where an award holder is already eligible to retire at grant, the RSU is subject to FICA upon grant. Otherwise, if the award holder becomes eligible to retire prior to the vesting date stated in the award, the RSU is subject to FICA at the time retirement eligibility is achieved.
Collecting FICA Taxes
Thus, on any given grant date, a portion of the RSUs granted could be immediately subject to FICA. Moreover, depending on the size of the population that receives the RSU awards, the company could have RSU awards becoming subject to FICA continuously throughout the year. Collecting FICA taxes on RSU awards every time RSUs are granted or employees become eligible to retire could be burdensome; luckily, the IRS provides several rules that can be relied on to delay collection of FICA:
The Rule of Administrative Convenience
This rule allows collection of FICA to be delayed until any subsequent date in the same calendar year. If relying on this rule, the taxable income for FICA purposes is based on the FMV on the date the award is included in income.
For example, if an employee holding an RSU becomes eligible to retire in January and the company relies on this rule to delay collecting FICA on the employee’s award until December, the income for FICA purposes is based on the FMV of the stock in December.
This can be a very handy rule because it allows the company to delay collecting FICA on all RSUs granted to retirement-eligible employees and all RSUs held by employees who become eligible to retire until a date that is late in the year (say, the end of the last payroll period of the year). This allows stock plan administration to do just one calculation of FICA for all retirement-eligible employes, rather calculating FICA in dribs and drabs throughout the year.
It’s also possible that many of the retirement-eligible employees holding RSUs will have maxed out on Social Security by the end of the year and only Medicare will need to be collected on their RSUs. The Medicare rate is low enough that it might be possible to deduct the payment from their final paycheck for the year, rather than trying to collect the payment from employees (although pushing the FICA payment to the end of the year means that more employees will be subject to the higher Medicare rate).
The Lag Method
This rule allows collection of FICA to be delayed up to three months. An advantage of this rule is that the income for FICA purposes is based on the FMV on the date the award becomes subject to FICA, not the date that FICA is collected under the rule.
The primary disadvantage, however, is that interest has to be charged on the FICA payment and paid over to the IRS, so it increases the employee’s tax liability. And because the rule only allows a three-month delay, when RSUs become subject to FICA early in the year, employees are more likely to still be subject to Social Security. But this rule can come in handy when the rule of administrative convenience isn’t that helpful (if, say, an RSU holder becomes eligible to retire on December 31).
Rule of Administration Convenience + the Lag Method
It is permissible to combine the rule of administrative convenience with the lag method. For example, a company might rely on the rule of administrative convenience to delay including the awards in income for FICA purposes until the very end of the year. Then once the amount of income recognized for the awards has been established under this rule, the company might rely on the lag method to further delay collecting the FICA for up to another three months. This might allow the FICA to be collected from bonuses being paid early in the following year, rather than from employees’ regular paychecks.
Where this approach is taken, the value of the shares for FICA purposes is based on the FMV on the date the awards are taken into income under the rule of administrative convenience, not the date the taxes are collected under the lag method. The FICA payment is subject to interest, however, from the date that the award is taken into income under rule of administrative convenience until the taxes are collected under the lag method.
Unfortunately, the FICA payment is based on employees’ year-to-date wages at the time the taxes are collected. Thus, by pushing the payment into the following year, more award holders will have to pay Social Security, as well as Medicare, on the awards. Ultimately, this is only a timing issue for employees (the Social Security payment on their RSU reduces the amount of Social Security that must be paid from their other wages for the year), but it could make withholding the payment from employee paychecks less viable.
The FICA Short-Term Deferral Rule
This rule allows collection of FICA to be delayed until the award is paid out, but it can only be relied on if the award is paid out no later than two and a half months after the end of the calendar year in which the RSU became subject to FICA. Thus, this rule is only helpful if an employee becomes eligible to retire (or an already eligible to retire employee receives an award) and then retires by March 15 of the following year. But in this situation, it’s a handy rule (assuming the award is paid out upon retirement).
Under this rule, the income for FICA purposes is based on the FMV on the date the award is paid out. The award will also be subject to income tax at that point, so the same FMV will be used to calculate income for both FICA and income tax purposes, keeping things nice and simple. And because the award is being paid out at that time and is now subject to income taxes, shares can be used to cover the FICA taxes (as well as the income taxes) without creating any additional tax liability for the employee.
Using Shares to Cover FICA Taxes
Shares can be withheld (or even sold) to cover the FICA taxes, but these shares will then be considered to have been paid out to the employee and, thus, will be subject to income taxes. Additional shares might then be needed to cover the income taxes, and these additional shares will also become subject to income taxes (and then more shares are needed, and so on and so on).
The NASPP article “Retirement Provisions for RSUs” has an example of the calculations involved in using shares to cover the FICA taxes (see the downloads available with the article). Because using shares triggers income taxation, most companies try to withhold the FICA taxes from employees’ paychecks instead.
No Delay Past Payout
In no event, under any of these rules, can collection of FICA be delayed past the date that the award is paid out. For example, say that an employee becomes eligible to retire in January and the company relies on the rule of administrative convenience with the intent of collecting FICA on the employee’s RSUs in December, but the employee retires in March and the award is paid out at that time. FICA (and income taxes) must be collected on the award in March.
What About Restricted Stock?
Restricted stock is subject to both FICA and income taxes when the award is no longer subject to a substantial risk of forfeiture. In addition, all the special rules we’ve discussed that allow collection of FICA to be delayed only apply in a situation where the award is not yet subject to income tax. Thus, these rules can’t be relied on to delay taxation of restricted stock. Where restricted stock awards provide for accelerated or continued vesting upon retirement, both income taxes and FICA must be collected on the awards as soon as the award holder is eligible to retire (or at grant, if the award holder is already eligible to retire when the award is granted). Thus, where it is desirable to grant awards that provide for continued or accelerated vesting upon retirement, the best practice is to issue RSUs, rather than restricted stock awards.
Explaining This All to Employees
We have an excellent sample FAQ to help you explain to retirement-eligible employees how FICA taxes will be collected on their RSUs that provide for accelerated/continued vesting upon retirement.