The Financial Accounting Standards Board (FASB) recently issued an Accounting Standards Update relating to share-based payment transactions (which typically involve equity compensation plans). The new FASB standards deal with a number of issues of great interest to people involved in accounting for equity compensation plans, including accounting for income taxes on vesting or settlement of awards, classification of excess tax benefits on cash flow statements, accounting for forfeitures, and issues relating to nonpublic entities. The FASB did not take action on proposed changes relating to awards with repurchase features.
We will limit this post’s discussion to a general review of the new standards’ relaxation of the current requirement under US Generally Accepted Accounting Principles (GAAP) that, in order to maintain equity classification for a share-based award, partial cash settlement of the award for tax withholding purposes may not exceed the minimum applicable statutory tax rate. A second blog post will follow that will go into further detail on implementation issues. Under US GAAP as currently in effect, withholding at a rate higher than the minimum applicable statutory tax rate causes the associated award to be subject to liability classification (i.e., subject to variable accounting), as opposed to the more favorable equity classification. The new standard permits equity classification for partial cash settlement of a share-based award for tax withholding up to the maximum statutory tax rate in the applicable jurisdictions. Although withholding typically is mandatory in most jurisdictions, the new standard appears to provide companies with greater flexibility, for financial accounting purposes, to address the preferences of the award recipients with regard to the amount to be withheld.
For example, under current US GAAP, as a general matter, the federal income tax rate for stock withholding without triggering liability classification for supplemental wages below $1 million could not exceed the supplemental wage withholding rate of 25%; under the new standard, the tax withholding through a properly completed Form W-4 could be an amount up to the maximum applicable marginal federal and state income tax rate in an employee’s jurisdiction. Stated differently, an employee should not request additional amounts of withholding on line 6 of Form W-4 that would increase the employee’s withholding to rates higher than the highest marginal tax rate—which for affected US employees will be a federal income tax rate of 39.6%, plus the applicable state rate.