The 10th Annual New England NASPP Regional Conference co-hosted by the Boston and Connecticut NASPP Chapters July 11 th, 2018
Agenda 1. General Introduction to Tax Law Related to Equity Compensation 2. Tax Withholding & Reporting 3. Timing of Corporate Tax Deductions Related to Equity Compensation 4. Overview of Common Equity Awards 5. Changes to IRC 162(m) 6. Appendix: Additional IRC 83 and IRC 409A Session Title 2
1. General Introduction to Tax Law Related to Equity Compensation Session Title 3
Introduction to Tax Law Body of Tax Law Internal Revenue Code ( Code or IRC ) o Like any other federal legislation, passed by Congress and signed by President. o Highest authority in the hierarchy. Example, Code Section 162(m)(4)(A). Court cases Treasury Regulations o Interprets the Code. Example, 1.162-27, 31-3121(v)(2)-1. IRS interpretative materials o Revenue Ruling and Revenue Procedures (example Rev. Rul. 2002-1, Rev. Proc. 2003-68). Can be relied on as sub-regulatory authority. o Private Letter Rulings (PLR), Field Service Advisory (FSA), Chief Counsel Advice (CCA), and etc. Can t be relied on by taxpayers, but helpful as guidance. 4
Introduction to Tax Law Key Code Sites Related to Equity Compensation IRC 83 o Section 83(a) provides that an employee has income equal to the FMV of stock (property) transferred on the later of the transfer date or the vesting date. o Employee can make 83(b) election to accelerate income tax to grant date despite vesting schedule. o IRC 83(h) provides a special rule related to the timing of tax deductions for restricted property (the in which and with which rule) (more later). IRC 162(m) o Compensation paid to an employee is generally deductible by the employer, for federal income tax purposes, under IRC 162. o For publicly held corporations, IRC 162(m) limits this deduction to $1M of compensation paid to a covered employee during the company s fiscal year. o 13601 of H.R.1, signed into law by President Trump on December 22, 2017, made key amendments to IRC 162(m) (more later). 5
Introduction to Tax Law Key Code Sites Related to Equity Compensation IRC 409A o IRC 409A regulates the tax treatment of deferred compensation arrangements provided to employees and certain independent contractors (e.g., outside directors). o Types of compensation that could be subject to IRC 409A include, but is not limited to certain stock-based compensation, including options, deferred stock awards and RSUs, and phantom share plans. Pretty much any equity award other than restricted stock is potentially subject to Section 409A. o If the requirements of Section 409A are not observed, penalties are triggered for the employee (which the employer can reimburse) coupled with an immediate tax charge on the income that was not successfully deferred. 6
2. Tax Withholding & Reporting Session Title 3
Tax Withholding & Reporting Federal Income Tax Regular wage withholding applies to salary payments. Supplemental wage withholding applies to all other wages. o Equity awards are generally considered supplemental wages. Withholding rate on up to $1 million of supplemental wages paid in any year is employer s choice of 22% flat rate or the employee's normal wage withholding rate based on the Form W-4 elections. o Change to the rules that altered the accounting impact if withholding was higher than minimum required. Withholding rate on supplemental wages over $1 million is 37% flat rate. o Must be 37%, no higher or lower permitted. Form W-4 is disregarded. Income tax withholding on equity awards generally must occur when the awards are subject to income tax. 8
Tax Withholding & Reporting FICA Taxes FICA Taxes include Social Security and Medicare taxes. o Additional 0.9% employee-only Medicare tax must be withheld from an employee's wages over $200,000. The actual tax only applies to taxpayers filing as individuals on wages over $200,000, and taxpayers filing joint on wages over $250,000. Therefore, there may be unneeded withholding. Employee cannot opt out of withholding. Employees will make any adjustments on Form 1040. FICA generally withheld when compensation is paid. HOWEVER, deferred compensation is subject to "special timing rule." o FICA applies at later of when the services are provided or vesting occurs. o Therefore, may be timing difference between timing of Income and FICA tax withholding. o Potential issue if FICA taxes are due before shares are released to the employee. 9
Tax Withholding & Reporting US Payroll: W-2 Box 1: the reportable federal income Box 2: federal income tax withholding Box 3: FICA OASDI (Social Security) reportable income Box 5: FICA Medicare reportable income Box 4: FICA OASDI (Social Security) withholding Box 6: FICA Medicare withholding Box 16: State reportable income Box 17: state income tax withholding Session Title 10
Tax Withholding & Reporting US Payroll: W-2 Common Issues Related to US Payroll and Equity Reporting Most payroll systems are set up to automatically bring the income from box 1 down into boxes 3 and 5. Some are also set up to automatically bring it into box 16 as well. In order to enter different figures in these boxes, they may have to be entered manually and/or set up special earn codes. For a expatriate US citizen, the amount of equity subject to withholding is often not what goes in box 2. US payrolls are generally set up to automatically calculate FICA taxes, but not income taxes. May need a payroll true-up or regularization. Special issues may arise around gross-ups, tax equalization payments, etc. Session Title 11
3. Timing of Corporate Deductions For Equity Awards Session Title 3
Timing of Tax Corporate Tax Deductions Transfer of: Fully Vested Cash Compensation In general, expenses are considered incurred and, therefore, deductible by accrual-method taxpayers (most corporations) if the three-part all-events test is satisfied. Under this test, an item is incurred if: o all events have occurred that determine the fact of the taxpayer's liability for the expense, o the taxpayer's liability can be determined with reasonable accuracy, and o economic performance has occurred with respect to the liability. Code Sec. 461(h)(4), Reg. 1.461-1(a)(2) 13
Timing of Tax Corporate Tax Deductions Transfer of: Unvested (Restricted) Property IRC 83(h) provides that the service recipient receives a deduction in the tax year in which and with which ends the tax year in which the income is included in the employee s income. The in with and with which rule applies where unvested stock is transferred to the employee. The in with and with which rule delays deduction for fiscal year employers. o Example: Company s tax year ends on June 30. On February 1, 2017, Company transfers restricted stock to an employee subject to 1 year vesting schedule. If no 83(b) election is made, employee recognizes income on February 1, 2018. The corporate tax deduction, however, is not taken until 2019 (i.e., the July 1, 2018 June 30, 2019 tax year that contains December 31, 2018). Regulations provide that the income is deemed to be included in the employee's income if proper and timely reporting is done on Form W-2 (or 1099-MISC for an independent contractor). 14
Timing of Tax Corporate Tax Deductions Transfer of: RSUs / Stock Options Section 83 regulations provide a special rule for transfers of vested property. o If property is fully vested on transfer, deduction is taken according to employer s normal method of accounting (no in which and with which rule). o Applies to stock transferred upon the exercise of a nonqualified option or vesting of an RSU. Section 421 disallows an employer deduction for ISO or ESPP share transfers unless stock is disposed of under a disqualifying disposition. o Disqualifying disposition occurs if stock is transferred within the either of the following periods: (i) One year from date the option was exercised or (ii) Two years from the date the option was granted. o For a disqualifying disposition, employee recognizes income and employer receives a deduction o Special rules apply if proceeds are less than FMV at exercise. 15
Timing of Tax Corporate Tax Deductions International Deduction Concerns The US allows companies to take a statutory deduction for compensation paid to their employees. The tax laws of most countries require a local company to recognize an expense related to the compensation to claim the deduction. Most countries require the cost of the equity granted to the employee of a foreign subsidiary to be recharged by the US parent to the local subsidiary in order for the subsidiary to claim a deduction. 16
Timing of Tax Corporate Tax Deductions What is a Recharge Arrangement? Transfer of Cost A strategy that allows a Parent company that operates a global equity plan to charge the cost of equity awards to the foreign employing entities where plan participants are providing services. Local Corp -orate Tax Deduction The charge creates an expense in the local subsidiary accounts that typically entitles the foreign subsidiary to a corporate tax deduction for the compensation expense (subject to local country rules) Tax Free Repatriation of Cash In the US, the payment of the recharge invoice from foreign subsidiary back to US Parent is treated as tax free income to the US Parent under Section 1032 IRC. For other countries the position may be different. Session Title 17
Timing of Tax Corporate Tax Deductions Structure of a Chargeback US Parent 5. Repatriation of earnings 3. Invoicing of equity award costs 1. Equity Awards Foreign Sub 4. Corporate tax deduction 2. Stock Employees Benefits Corporate tax benefit for foreign subsidiaries. Tax-free repatriation of foreign earnings. Session Title 18
Timing of Tax Corporate Tax Deductions Implementation Considerations Resistance by local entities Limitation on amount of deduction Exposure for past noncompliance Corporate tax deduction permitted? Increased local withholding and reporting Potential increase in local payroll taxes Treasury shares required Session Title 19
Timing of Tax Corporate Tax Deductions Operational Considerations Determination of plans to include Identification of grant date, vesting date, and exercise price Identification of awards granted to cross-border employees/us expatriates/aliens Deciding in which countries to chargeback costs Local tax deduction value Repatriation benefits Treasury share requirements Deduction taken under cash or accrual basis Personnel to administer chargeback agreement Cash flow in same-day sale (cashless exercise) or an exercise Communication with transfer agent/plan administrator to verify ability to identify foreign vests/exercises timely Impact under US GAAP/IFR Communication with joint Tax, HR, finance audience to establish conceptual buy-in Communication with local works council, where appropriate Session Title 20
Timing of Tax Corporate Tax Deductions Typical Recharge Process 1) Broker withholds taxes based on tax rates provided by PwC 2) Broker pays tax dollars to US Parent 3) US Parent books cash received from broker as partial settlement of recharge 4) Company invoices local subsidiaries for the full spread in most jurisdictions 5) Subsidiaries pay US Parent full spread less tax dollars Session Title 21
Timing of Tax Corporate Tax Deductions Typical Recharge Process (continued) 6) Subsidiaries secure a tax deduction for full spread 7) Company secures tax free US repatriation for full spread 8) Subsidiaries remit tax dollars from own cash to local tax authorities 9) Subsidiaries complete local employer reporting 10) Maximum Corporate Tax Efficiencies Session Title 22
Timing of Tax Corporate Tax Deductions Implementation Steps 1. Drafting of chargeback agreements Review by US internal counsel to verify legality Review by PwC-Foreign offices to ensure eligibility for local tax deduction, and VAT and withholding tax implications 2. Establishment of internal procedures to identify the equity transactions on a periodic basis Establish the compensation amount eligible for chargeback Communicate this amount to foreign affiliates via periodic invoices Process these invoices through intercompany accounting Consider expatriate situations (determine which company should be charged for the equity gain) 3. Education of local administrators Provide local administrators with instructions which communicate the appropriate internal procedures Identify outside consultant (PwC) to provide local technical advice, and coordinate consulting through US to ensure quality/consistency Session Title 23
Timing of Tax Corporate Tax Deductions Implementation Steps (continued) 4. Education of local employees Use of these agreements increases the need to emphasize the participant s tax obligations. Consideration of level of current communications with foreign participants 5. Financial accounting entries Educate US and foreign financial accounting personnel on the appropriate accounting entries needed to record the chargeback while ensuring neutrality from a profit/loss perspective 6. Ongoing Maintenance Based upon the procedures established, compensation amounts will be periodically invoiced to US Parent s foreign affiliates Perform periodic legal updates to verify continuing legal compliance Session Title 24
4. Overview of Common Equity Awards Session Title 3
Overview of Common Equity Awards Overview of the types of equity awards covered today: Award Type Abbreviation Tax Point (U.S.) Stock Option SO Exercise or Sale Stock Appreciation Rights SAR Exercise Restricted Stock RS Grant/Vesting Restricted Stock Unit RSU Vesting Employee Stock Purchase Plan ESPP Purchase 26
Overview of Common Equity Awards Stock Options (SOs) Definition When an employee is granted the right or option to acquire stock at a fixed price. Grant Date Vesting Date Exercise Date Employee receives award Price to acquire shares is set on grant date The date on which restrictions are lifted Employee may exercise after this date The date on which employee exercises right to purchase Generally, considered the taxable moment Session Title 27
Overview of Common Equity Awards Incentive Stock Options (ISOs) Region Employer Deduction Employee Income Tax Employment Tax Reporting Withholding Section 83(b) Election Subject to section 409A US No, for QDs (held more than two years from grant, one year from exercise) Yes, for DDs No, for QDs. Capital gains instead Yes, for DDs, on spread at time of DD (or gain at sale if lower) Spread at exercise must be included in AMT taxable income (unless shares sold in same year as exercise) None at exercise or at sale of stock Yes, Form 3921 is due upon transfer of stock purchased via exercise No (Notice 2001-72) No No Global ISO designation completely irrelevant for employees who are not US taxpayers Session Title 28
Overview of Common Equity Awards Non Qualified Stock Options (NQSOs) Region US Global Employer Deduction Yes, on the spread when the employee recognizes income Depends on country; usually need a recharge and even if recharge, may not get a deduction Employee Income Tax Yes, at exercise Depends on country; in most countries at exercise. Outliers: Belgium and previously Australia Employment Tax Reporting Withholding Yes, at exercise Depends on country; in some countries not subject to social taxes Yes - the spread, on Form W-2 Depends on country Yes, at exercise (have "T+3" to withhold under 3/14/03 Field Directive - only applies to NQSOs) Or next day deposit rules if over $100k Depends on country Section 83(b) Election No N/A Subject to section 409A Yes unless meets an exemption (usually exempt as grants made at FMV) N/A Session Title 29
Overview of Common Equity Awards Stock Appreciation Rights (SARs) Definition When an employee is granted the right to acquire stock or cash based on the appreciation in value of a fixed number of shares. Grant Date Vesting Date Exercise Date Employee receives award Price to acquire shares is set on grant date The date on which restrictions are lifted Employee may exercise after this date The date on which employee exercises right Typically considered the taxable moment Appreciation in value can be provided in shares or cash Session Title 30
Overview of Common Equity Awards Tax Implications of SARs Region US Global Employer Deduction Yes, on the spread when the employee recognizes income Depends on country; usually need a recharge and even if recharge, may not get a deduction Employee Income Tax Yes, at exercise In most countries, taxed at exercise Employment Tax Reporting Withholding Yes, at exercise Yes - the spread, on Form W-2 Depends on country; social taxes not due in some countries Depends on country Yes, at exercise Depends on country Section 83(b) Election No N/A Subject to section 409A Yes, unless meets an exemption N/A Session Title 31
Overview of Common Equity Awards Restricted Stock (RS) Definition An award of stock that is not fully transferable until certain conditions have been met. Grant Date Vesting Date Employee receives award Employees receive RS at a nominal or no cost If employee receives ownership rights (i.e., dividends, right to vote) at grant, taxation may arise at grant in several countries The date on which restrictions are lifted and employee becomes entitles to receives shares Restrictions may be time or performance-based Commonly the point of taxation (unless employee was entitled to ownership rights ) Session Title 32
Overview of Common Equity Awards Tax Implications of Restricted Stock Region Employer Deduction Employee Income Tax Employment Tax Reporting Withholding Section 83(b) Election Subject to section 409A US When employee recognizes income, assuming company does proper and timely reporting At vesting or sooner, if 83(b) election is made Capital gains treatment applies to subsequent sale. Holding period begins when income is recognized Yes, at vesting even if an 83(b) election is made. Yes, difference between FMV at grant and tax point, less amount paid, on Form W-2 Yes, both income and employment taxes Yes No Global Depends on country; usually need a recharge and even if recharge, may not get a deduction Depends on country, but in a lot of countries, tax is due at grant (not advisable to grant RS outside of US) Depends on country Depends on country Depends on country N/A N/A Session Title 33
Overview of Common Equity Awards Restricted Stock Units (RSUs) Definition An unit representing stock that is not transferred to the employee until certain conditions have been met. Grant Date Vesting Date Employee receives award Typically employee receives RSUs at no cost Given the employee is granted a unit of stock, no ownership rights will arise The date on which restrictions are lifted and employee is entitled to receive shares Typically the point of taxation Session Title 34
Overview of Common Equity Awards Tax Implications of RSUs Region Employer Deduction Employee Income Tax Employment Tax Reporting Withholding Section 83(b) Election Subject to section 409A US When employee recognizes income When shares are transferred Capital gains treatment applies to subsequent sale. Holding period begins when income is recognized Yes, at vesting even if shares are not transferred until later Yes, value of shares at transfer, on Form W-2 Yes, both income and employment taxes No No, if RSU is structured to transfer at vest Yes, if RSU is structured to transfer at later date Global Depends on country; usually need a recharge and even if recharge, may not get a deduction In most countries, taxed at vesting Depends on country Depends on country Depends on country N/A N/A Session Title 35
Overview of Common Equity Awards Employee Stock Purchase Plan (ESPP) Definition Employee is allowed to purchase company stock at fixed intervals throughout the year, generally at a discount. Grant Date Vesting Date Employee enrolls in the plan prior to the start of the offer period Employee indicates the amount to purchase in shares prior to offer date The date at the end of the offer period on which shares are purchased Shares are generally purchased at a discount Taxation occurs on the purchase date on the discount Session Title 36
Overview of Common Equity Awards Tax Implications of ESPPs Region Employer Deduction Employee Income Tax Employment Tax Reporting Withholding Section 83(b) Election Subject to section 409A US No for QD, same as ISO Yes for DD Yes, for both QD and DD None at exercise or at sale of stock until ruling is finalized Yes - box 1 of W-2 a. discount portion of stock acquired upon dispositi on None No No, if qualified b. spread upon DD Form 3922 at first transfer Global Depends on country; usually need a recharge and even if recharge, may not get a deduction In most countries, taxed at purchase Depends on country Depends on country Depends on country N/A N/A Session Title 37
5. Changes to IRC 162(m) Session Title 3
Changes to IRC 162(m) IRC 162(m) Generally Compensation paid to an employee is generally deductible by the employer, for federal income tax purposes, under IRC 162. For publicly held corporations, IRC 162(m) limits this deduction to $1M of compensation paid to a covered employee during the company s fiscal year. 13601 of H.R.1, signed into law by President Trump on December 22, 2017, made key amendments to IRC 162(m). o Expanded the group of companies covered by IRC 162(m) o Expanded the definition of covered employee. o Extended the term for which an individual is considered a covered employee. o Repeals the exception for performance-based compensation. 39
Changes to IRC 162(m) Expanded Definition of Publically Held Corporations Prior to H.R. 1, publicly held corporations were limited to publicly listed companies that were required to register their common stock under 12 of the Securities and Exchange Act of 1934 (the Act ). o Generally limited to companies required to file an SEC proxy statement. Under H.R. 1 13601(c), the definition is expanded to also include companies the are required to file reports under 15(d) of the Act. o Companies that issue public debt or American Depository Receipts ( ADRs ) are now subject to IRC 162(m). 40
Changes to IRC 162(m) Expanded Definition of Covered Employee Prior to H.R. 1, covered employees were limited to: o The chief executive officer (CEO) (or an employee acting in that capacity) of the corporation. o The three highest compensated officers (excluding the CEO and the principal/chief financial officer (PFO/CFO)). Under H.R. 1 13601(b), the definition is expanded to include: o CEO, CFO and 3 other highest-compensated officers. 41
Changes to IRC 162(m) Expanded Definition of Covered Employee Prior to H.R. 1, covered employees were determined as of the last day of a company s fiscal year. o IRC 162(m) would generally not apply to compensation paid to an individual who was not a covered employee as of such date. Under H.R. 1 13601(b), the definition is expanded to include: o An individual who was a CEO or CFO at any point during the fiscal year. o Any individual who was a covered employee of the corporation for any taxable year beginning after December 31, 2016. o Covered employee status now permanent for years beginning after December 31, 2016. Payments to a retired covered employee may be limited. Also includes beneficiaries after the death of a covered employee. 42
Changes to IRC 162(m) Repeal of Performance-Based Compensation Exception Prior to H.R. 1, if certain requirements were met, performance-based compensation was exempt from the IRC 162(m) deduction limitation. o Requirements included: Paid solely on account of attainment of performance goals. Goals determined by compensation committee. Terms disclosed to shareholders. Terms approved by shareholder before payment is made. Compensation committee certifies the goals have been satisfied. Under H.R. 1 13601(a), this exception has been eliminated. 43
Changes to IRC 162(m) Transition Relief may be Available The amendments apply to taxable years beginning after December 31, 2017. (H.R. 1 13601(e)(1)). Amendments do not apply to compensation paid: o Pursuant to a written binding contract that was in effect as of November 2, 2017, and o The contract was not modified in any material respect on or after this date. (H.R. 1 13601(e)(2)). 44
Changes to IRC 162(m) Additional Questions & Issues: Definition of Publically Held Corporation Does IRC 162(m) now apply to partnerships? o E.g., a Master Limited Partnerships required to file a registration statement and meet other SEC reporting requirements. Will IRC 162(m) still apply if a public company becomes private? o Does it still have covered employees? Can companies that had become public continue to rely on the IPO transition relief under Reg. 1.162-27(f)? Does the IPO transition relief still apply to companies that become public going forward? 45
Changes to IRC 162(m) Additional Questions & Issues: Covered Employees For tax years beginning after December 31, 2017, are covered employees for taxable years beginning after December 31, 2016 determined under the old or new rules? o Do covered employees for 2017 need to be reassessed for 2018? Will certain companies that do not file proxy statements or complete a compensation table now need to identify their covered employees? Who are the covered employees of a merged company? o Do the covered employees of a public predecessor entity retain their status? o Do the covered employees of a private predecessor entity need to be determined? 46
Changes to IRC 162(m) Additional Questions & Issues: Transition Relief How is the existence of a binding contract determined? o Does state law control? o Can a binding contract exist if plan allows for negative discretion? o Can a binding contract exist if a grant is still subject to performance requirements as of November 2, 2017? What is a material modification? o Does the use of discretion cause a material modification? Does transition relief apply to CFO compensation? 47
Changes to IRC 162(m) Additional Questions & Issues: Transition Relief Stock options: o If outstanding but unexercised as of November 2, 2017, is there a position that the grant documents and plan constitute a binding contract? o If approved by Compensation Committee prior to November 2, 2017, but not granted, are there circumstances under which there could be a binding contract? 48
Changes to IRC 162(m) 49
APPENDIX: Additional IRC 83 and IRC 409A Session Title 3
Additional IRC 83 and IRC 409A Introduction to IRC Section 83 What type of compensation is taxed under Section 83? Only Property, i.e.: Real or Personal Property, not o Money. o Unfunded unsecured promise to pay money or property in the future. o Beneficial interest in assets (including money) that are transferred or set aside from claims of creditors of the transferor, i.e., in a trust or escrow. Example: A share of stock but not a stock unit or option (that is not publicly traded) When is property taxed under Section 83? When the property is transferable OR No longer subject to a substantial risk of forfeiture. o If property is not subject to a risk of forfeiture, it can still be taxed even if you cannot sell it. 51
Additional IRC 83 and IRC 409A Introduction to IRC 83 Amount of income taxed is the excess of the fair market value of the property at the time of transfer over the amount paid by the employee for the property What is a transfer? o A transfer of property occurs when an employee receives the benefits and risks of holding the property. Bears the risk of decline in value What is a substantial risk of forfeiture? o Depending on facts and circumstances, generally a service condition or a condition related to the purpose of the transfer. o Look at both the likelihood that the forfeiture event will occur and the likelihood that the forfeiture will be enforced. o Generally transfer (sale) restrictions do not create a substantial risk of forfeiture. o Even a transfer restriction that provides for forfeiture or other penalties if the restriction is violated does NOT create a substantial risk of forfeiture. 52
Additional IRC 83 and IRC 409A Introduction to IRC 83 If property is subject to a substantial risk of forfeiture, an employee can elect to pay tax at grant under IRC 83(b). An IRC 83(b) election disregards the substantial risk of forfeiture provision and starts the employee s capital gains holding period (i.e., any increase in value of the property is taxed as a capital gain as opposed to ordinary income). By making this election the employee will be taxed on the FMV of the restricted stock on the grant date and any subsequent appreciation will be taxed as capital gain. The employer will be required to withhold applicable taxes at the grant date (i.e. employee must make arrangement to remit taxes to employer). An IRC 83(b) election does not, however, affect the requirement that the employee satisfy the vesting condition. If the employee fails to satisfy the vesting condition, the award will still be forfeited. An IRC 83(b) election must be filed no later than 30 days after grant; once filed, the election is irrevocable. The election must be filed with the IRS service center where the employee normally files his/her tax return. o It not longer needs to be attached to the employee s tax return for the taxable year in which the election is made. 53
Additional IRC 83 and IRC 409A Introduction to IRC 409A IRC 409A provides specific rules for deferral elections, distributions, and funding mechanisms under nonqualified deferred compensation plans. Individuals in non-compliant plans are subject to tax at the time of vesting (i.e. taxation is not deferred), plus a 20% penalty tax, plus interest at the underpayment rate plus 1% Employer risk relates to withholding (of regular income tax) and reporting obligations. Employers may voluntarily agree to gross-up individuals for their liability. 54
Additional IRC 83 and IRC 409A Introduction to IRC 409A What is deferred compensation? o Defined broadly: a legally binding right to receive compensation that is payable in a later tax year. Examples: Employee earns bonus for 2017 but payment is delayed to 2020. Agreement entered into in 2017 that provides for payment of severance on termination. Agreement to pay $10,000 in two years. A deferred RSU. o 409A doesn t apply if the employee doesn t really have a right to the compensation (i.e. no legally binding right because the employer can unilaterally take it away). Example: fully discretionary annual bonuses. 55
Additional IRC 83 and IRC 409A Introduction to IRC 409A Section 409A rules: All payment dates should be built in at inception generally problematic to add a new payment date after plan has been established. o There can be no discretion to delay or accelerate timing of payment Payment date may only be: o A specified date (see next slide) o Separation from Service (as defined) o Death o Disability (as defined) o Change in Control (as defined) o Unforeseeable Emergency 56
Additional IRC 83 and IRC 409A Introduction to IRC 409A Section 409A rules: Payment date may only be: o A specific date. o A period within a single tax year (or a full calendar year) e.g. February, 2018, or 2018. o No longer than 90 days into the following tax year after a permitted payment event, as long as employee can t control year of payment. Fixed date or schedule may be triggered by event that is a substantial risk of forfeiture. o e.g., payment due on change of control will be paid in three annual installments beginning in the year following the change of control. May use first to occur or last to occur of more than one permitted payment events. Generally, may only have one payment schedule for the same type of payment event. 57
Additional IRC 83 and IRC 409A Introduction to IRC 409A Relevant Exemptions and exceptions: o Short-term deferrals o Stock options and SARs o Certain separation pay o Restricted property under Section 83 o Qualified retirement plans o Nontaxable fringe benefits o Certain foreign plans 58
Additional IRC 83 and IRC 409A Introduction to IRC 409A Stock Options and SARs are not deferred compensation subject to section 409A if: o Exercise price can never be less than the fair market value (FMV) of the underlying stock on the grant date. o Stock right is granted on service recipient stock. o Stock right does not include any deferral feature other than the deferral of income from the grant date until the option exercise date. Watch out for SARs that aren t based on the fair market value of the stock. Restricted Stock are not deferred compensation subject to section 409A. o There is no tax deferral post-vesting. 59
Additional IRC 83 and IRC 409A Introduction to IRC 409A Modification of Stock Rights Modification generally results in a new grant. If the exercise price is carried forward, the new option may be discounted and violate section 409A. Modification is any change in the terms of the stock right that may give the holder: o A direct or indirect reduction in the exercise price of the right, o An additional deferral feature, or o An extension or renewal of the stock right. Changes that would meet requirements under section 424 rules for ISOs are not treated as new grants of rights. Exercise period may be extended to the earlier of when the right would have originally expired or 10 years from original grant. Can extend term of underwater options (treated as new grant). 60