Yesterday’s blog post outlined the general scope of the Financial Accounting Standards Board’s (FASB’s) new standards on stock withholding to satisfy tax obligations in equity compensation arrangements. Today’s post will address a few comments and caveats about the new standard:
- For public companies, the new standard is effective for annual reporting periods beginning after December 15, 2016, and interim periods within those annual periods; for nonpublic entities, the new standard is effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted in any interim or annual period; if an entity early adopts in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes the interim period.
- Most equity compensation plans have the minimum statutory tax rate withholding requirement “hardwired” into the plan, thus requiring a plan amendment to effect this change.
- Whether such an amendment will require shareholder approval for public companies under NYSE or NASDAQ rules is unclear, however, previous interpretive guidance suggests that shareholder approval may not be required (for example, a NASDAQ staff interpretation that a plan amendment to permit tax withholding generally does not require shareholder approval and NYSE guidance regarding the lack of “formula plan” implications for returning shares subject to tax withholding to the pool of available shares under a plan).
- Company officers and directors subject to section 16 under the Securities Exchange Act would not appear to experience an issue with the adoption of an increased withholding rate for tax purposes. Both Exchange Act regulations and related US Securities and Exchange Commission (SEC) guidance support the view that the provision of a stock withholding right related to the maximum statutory withholding rate would be nonreportable for section 16 purposes, so long as the amount withheld is applied to the tax obligation generated by the underlying transaction. Of course, the actual withholding of shares would continue to be a reportable event (subject to an exemption from the short swing profit provisions of section 16(b) if the share withholding received the requisite board, committee or shareholder approval). Note, however, that the SEC staff has taken the position that if a company retains the discretion to prevent the withholding transaction from being effected, the withholding right would be deemed a reportable derivative security.
- It is not clear that US companies will want to enlarge the withholding rate, given the negative cash flow effect of doing so and the relative ease of the existing rule, but some companies have already expressed an interest in assisting grantees by withholding at a higher rate. Employers with non-US grantees may be even more willing to do so, given the relatively higher applicable rates.
- Applicable IRS rules preclude giving awardees the discretion to name the applicable tax rate. Instead, as a practical matter, the alternatives are to (a) continue to treat the event as a supplemental wage payment subject to the 25% withholding rate (on supplemental wages below $1 million) or (b) apply the withholding rate generated by a grantee’s current Form W-4 filing (and not treat the event as one subject to the flat rate of 25% for supplemental wage payments). Note that a grantee may file a revised Form W-4 claiming a reduced number of exemptions and/or enter a specific dollar amount of increased withholding as a means of boosting the withholding rate toward the 39.6% level, but the IRS process does not generally allow a grantee to specify a percentage rate for federal income tax withholding. Note also that if the effect of the revised Form W-4 filing is to cause the percentage withholding rate to exceed 39.6%, then liability accounting will apply for US Generally Accepted Accounting Principles purposes.