IRS Updates on Timing of Tax Deposits

Two recent pronouncements from the IRS provide information on when companies need to deposit tax withholding for stock plan transactions. Here’s what you need to know about them.

The Glamorous: Timing of Income Inclusion and Withholding Obligation

The first pronouncement is in the form of a GLAM (Generic Legal Advice Memorandum). GLAMs are a form of internal communication within the IRS. They provide legal advice from the National Office of the Office of Chief Counsel (that’s not a typo, the title has the word “office” in it twice—go figure, it’s the government) to national program executives and managers of the IRS. GLAMs cannot be cited as precedent but they provide helpful insights into the IRS’s positions.

GLAM 2020-004 advises on when amounts related to NQSOs, stock-settled SARs, and stock-settled RSUs must be included in income for FIT and FICA purposes and when the company’s withholding obligation arises. There’s nothing particularly surprising in the GLAM, but it does provide some helpful clarifications.

The GLAM and RSUs

For stock-settled RSUs, the GLAM clarifies that the taxable event is the date the company initiates the payment of shares to the award holder. Because RSUs are taxed upon constructive receipt, I’ve sometimes encountered confusion as to whether they should be taxed on the payout date or the date the shares are actually deposited in the employee’s brokerage account, which usually occurs a few days after the payout date (e.g., see “ What Is the Taxable Event for RSUs?”).

The GLAM takes the position that award shares are transferred, and the employee beneficially owns them, as of the date the company initiates the payment. For RSUs paid out upon vesting, this will generally be the vest date. The fact that it takes a few days for the shares to show up in the employee’s brokerage account doesn’t change when the employee recognizes income for the award or the amount of income recognized.

Thus, the income recognized is equal to the value of the stock on the payment date. The stock may increase or decrease in value by the time the shares arrive in the employee’s brokerage account, but this does not change the amount of income the employee recognizes for FIT purposes (or FICA purposes, in the case of RSUs paid out at vesting).  Moreover, income for the award payout is reportable to the employee as of the payment date and the company’s tax withholding obligation accrues at this time.

The GLAM and NQSOs and SARs

There is less confusion as to when a taxable event occurs for NQSOs and stock-settled SARs, but in the event that anyone is confused about this, the GLAM indicates that it is the exercise date, not the date the shares are delivered to the employee’s brokerage account.

The employee recognizes income for both FIT and FICA purposes equal to the spread on the exercise date, regardless of what the stock is worth when the employee takes possession of the shares. The income is reportable to the employee as of the exercise date and the company’s tax withholding obligation also accrues on this date.

The Less Glamorous: IRM Procedural Update

On May 26, the IRS published a procedural update to the Internal Revenue Manual. The update directs IRS auditors on how to determine late deposit penalties for NQSO and stock-settled SAR exercises and payouts of stock-settled RSUs. The update serves two purposes:

• Revises the audit procedures to reflect the SEC’s new two-day settlement period that applies to open market transactions
• Extends relief previously afforded to NQSO exercises to stock-settled SARs and stock-settled RSUs

The update is also an internal IRS document and cannot be relied on as precedent. It is simply a direction to IRS auditors on how to treat certain transactions.

The One-Day Deposit Rule, RSUs, and the Relief

Under US tax regulations, when a company’s cumulative deposit liability to the IRS exceeds $100,000, the deposit must be made by the next business day (referred to as the “one-day deposit rule”). It is common for stock plan transactions to trigger this requirement and complying with it can be administratively burdensome.

For transactions which are financed via an open market sale, such as same-day sales of NQSOs and selling shares to cover the taxes due on RSUs, compliance is virtually impossible. As noted in GLAM 2020-004 (discussed above), the company’s deposit liability accrues as of the exercise or payment day. The funds to make the deposit won’t be available to the company until the sale settles, two days later. Under the one-day deposit rule, the company would be required to deposit the tax withholding with the IRS before it has received the funds to be deposited.

Given this practical obstacle to compliance, in 2003 the IRS issued a field directive instructing auditors to treat the company’s deposit liability as accruing on the settlement date for same-day sale exercises of NQSOs. This provided much needed relief for NQSOs and, back then, few companies were granting restricted stock or units, so no one much worried about them.

Nowadays, however, more companies grant RSUs than do stock options, making the one-day deposit rule once again a challenge. It is a significant obstacle to using sell-to-cover to finance the tax withholding due on RSUs. The procedural update mitigates this challenge by extending the same relief previously afforded to NQSOs to stock-settled RSUs (and to stock-settled SARs).

Here's how the updated guidance applies to NQSOs, SARs, and RSUs:

NQSOs and Stock-Settled SARs: The update to the IRM instructs IRS auditors to treat a company's tax deposit for NQSO and stock-settled SAR exercises as timely under the next-day deposit rule if made within one day of the settlement date, provided settlement occurs no more than two days after the exercise date.

Stock-Settled RSUs: The update to the IRM instructs IRS auditors to treat a company's tax deposit for release of shares under an RSU as timely if made within one day of the settlement date, provided settlement occurs no more than two days after the date payment of the shares underlying the award is initiated.