United States: New FASB Tax Withholding Rules Give Companies (Particularly Multinationals) More Flexibility

Last Updated: June 14 2016
Article by Jason D. Flaherty

Overview

As part of its Simplification Initiative, the FASB recently adopted Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, which impacts how companies (both public and private) account for certain aspects of share-based payments to employees under Accounting Standards Codification (ASC) 718, Compensation Stock Compensation.

Following are some of the key changes:

  • Recognizing income tax effects of awards in the income statement when the awards vest or are settled (i.e., APIC pools will be eliminated);
  • Expanding the exception to liability accounting for net share settlement on restricted stock units (RSUs), thus allowing a company to retain shares to cover the tax withholding obligation in excess of the minimum statutory withholding rate; and
  • Simplifying of the accruing of compensation cost for potential forfeitures.

Further, the new guidance allows privately held companies to make two practical elections:

  • an accounting policy election to apply a practical expedient to estimate the expected term for all awards with performance or service conditions that meet certain conditions; and
  • a one-time accounting policy election to switch from measuring all liability-classified awards at fair value to intrinsic value.

While the changes noted above are meant to simplify the accounting for share-based awards, the change to the minimum statutory withholding requirement has an added benefit to the payroll function within the organization, as well as, to the affected employees. Specifically, by using a single rate (rather than determining individual rates), organizations that have an annual RSU bulk vest may streamline the process of determining the appropriate withholding rate and, therefore, accelerate the time it takes to settle its RSU awards for both local and cross-border employees alike. Further, for employees who historically have had a significant tax balance at year-end as a result of limiting the tax withholding to the minimum statutory rate, the employer will now be able to close the gap by retaining additional shares from the RSUs upon vesting.

Background

Upon exercise of an option or settlement of an RSU, an equity plan may allow employees to "net settle" or use existing shares to satisfy their tax withholding requirement resulting from the exercise or settlement of the equity award. In effect, the company "repurchases" a number of shares, at fair value from the participant, and then uses company cash to satisfy the employee's tax withholding requirements. This method of settling the tax withholding obligation can benefit both the issuing company and the participant - the company issues less shares and thereby minimizes share dilution and the employee preserves cash flow by not writing a check to the company and saves money by not paying broker fees if the employee would otherwise sell shares to cover the taxes.

The FASB noted that although the repurchase of shares upon vesting of an RSU should result in the employer's incurrence of a liability, for pragmatic reasons, the FASB decided to continue the exception for direct or indirect repurchases to meet the employer's minimum statutory withholding requirements. Liability accounting requires a company to remeasure an award at fair value each reporting period until it is settled.

Administratively, this has become very burdensome, particularly for organizations with participants outside the U.S. For countries that apply varying tax withholding rates depending on each employee's particular circumstances rather than a flat supplemental withholding rate, the employer must first determine the minimum withholding requirements on an employee-by-employee basis.

To make things more complex, as employees become increasingly mobile (i.e., working in more than one jurisdiction during the vesting period), the employer would need to consider the withholding requirements in each jurisdiction to determine the appropriate tax rate to be applied. For expatriates on a tax equalization policy, care is needed to ensure that the hypothetical tax applied to the RSU upon vesting does not exceed the actual tax withholding that would apply to the employee.

Additionally, in the U.S., the flat supplemental withholding rate may not be sufficient to cover the ultimate taxes due, in which case the employee will have to pay quarterly taxes, which can be an administrative burden for the employee.

Enter ASU 2016-09

Pursuant to ASU 2016-09, a company will be able to retain enough shares to cover the tax withholding obligation up to the maximum statutory rate in the relevant jurisdiction. It should be noted that a company may need to determine only one maximum rate for all employees in each jurisdiction rather than a separate rate for each employee in the jurisdiction.

This long-awaited change provides room for a company to streamline the process of settling RSU awards for participants around the globe without being overly concerned about triggering liability accounting with respect to the RSU awards.

Further, for employees whose equity income is subject to U.S. federal income tax withholding, in many instances, the current application of ASC 718 has resulted in employees having a significant tax balance upon filing their annual tax return, and in some instances, subject to penalties for not making estimate tax payments throughout the tax year. For example, an employee who is in the 33% or 39.6% tax bracket may owe an additional 8% - 14.6% in federal taxes on the equity award income if the 25% supplemental tax withholding were applied. With the implementation of ASU 2016-09, it may be possible to withhold at a rate that is higher than the flat supplemental withholding rate of 25% - thus closing the gap.

For organizations that have expatriate employees who are tax equalized, the company may also be able to withhold hypothetical tax at a higher rate. By withholding hypothetical tax at the higher rate, a company can avoid the challenge of needing to collect large balances of hypothetical tax from its expatriate employees during the tax equalization process, which may occur more than a year after the RSUs vested.

Next Steps

The new guidance is effective for fiscal years beginning after December 15, 2016 (and interim periods within those years) for public business entities and for fiscal years beginning after December 15, 2017 (and interim periods within fiscal years beginning after December 15, 2018) for all other entities.

If your equity plan permits net share settlement, now is a good time to review the plan document and the award agreements to ensure that your organization has the flexibility to retain a greater amount of shares to cover the tax withholding obligation at the time of the taxable event. Many equity plans explicitly limit the ability to use share withholding in excess of the statutory minimum and, therefore, an amendment to the equity plan may be required to take advantage of the benefits of withholding at a higher rate.

If an amendment is required, you will need to closely review the terms of your equity plan to ensure compliance with the NYSE and NASDAQ rules.

For companies that have been net share settling to date, it is just as important to consider whether making the change to allow withholding in excess of the statutory minimum makes practical sense. Based on your global footprint, Orrick can assist you in analyzing whether such a change makes sense by evaluating the pros and cons of withholding at a higher rate than the minimum statutory withholding rate in each country in which you provide equity to employees.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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