Tax Questions, Answered

As is often the case at this time of the year, a lot of tax related questions have been popping up in the NASPP Q&A Discussion Forum lately.  For today's blog entry, I try to quickly answer some of the questions I've seen the most frequently.

Former Employees
You have to withhold taxes on option exercises by and award payouts to former employees and report the income for these stock plan transactions on a Form W-2, no matter how long it has been since they were employed by the company.  The only exceptions are:

• ISOs exercised within three months of termination (12 months for termination due to disability). 
• RSAs paid out on or after retirement (because these awards will have already been taxed for both income tax and FICA purposes when the award holders became eligible to retire). Likewise, RSUs paid out on or after retirement that have already been subject to FICA are subject to income tax only.

If the former employees did not receive regular wages from the company in the current year or the prior calendar year, US tax regs require you to withhold at their W-4 rate, not the supplemental rate. In my experience, however, few companies are aware of this and most withhold at the supplemental rate because the W-4 rate is too hard to figure out.

Changes in Employment Status
Where an individual changes status from employee to non-employee (or vice versa) and holds options or awards that continue to vest after the change in status, when the option/award is exercised/paid out, you can apportion the income for the transaction based on years of service under each status.  Withhold taxes on the income attributable to service as an employee (and report this income on Form W-2).  No withholding is necessary for the income attributable to service as a non-employee (and this income is reported on Form 1099-MISC). 

Any reasonable method of allocating the income is acceptable, so long as you are consistent about it.

Excess Withholding
I know it's hard to believe, but if you are withholding at the flat supplemental rate, the IRS doesn't want you to withhold at a higher rate at the request of the employee. They care about this so much, they issued an information letter on it (see my blog entry "What You Need to Know About Excess Tax Withholding").  If employees want you to withhold at a higher rate, you have to withhold at their W-4 rate and they have to submit a new W-4 that specifies the amount of additional withholding they want.

Also, withholding shares to cover excess tax withholding triggers liability treatment for accounting purposes (on the grant in question, at a minimum, and possibly for the entire plan).  Selling shares on the open market to cover excess tax withholding does not have any accounting consequence, however.

ISOs and Form 3921
Same-day sales of ISOs have to be reported on Form 3921 even though this is a disqualifying disposition.  It's still an exercise of an ISO and the tax code says that all ISO exercises have to be reported.

On the other hand, if an ISO is exercised more than three months after termination of employment (12 months for termination due to disability), it's no longer an ISO, it's an NQSO.  The good news is that because it's an NQSO, you don't have to report the exercise on Form 3921. The bad news is that you have to withhold taxes on it and report it on a Form W-2 (and, depending on how much time has elapsed, it might have been easier to report the exercise on Form 3921). 

The article "Figuring Out Section 6039 Filings" in the NASPP's Section 6039 topic area is a great resource as you get ready to file Forms 3921 and 3922.

FICA, RSUs, and Retirement Eligible Employees
This topic could easily be a blog entry in and of itself, but it doesn't have to be because we have an in-depth resource available--see "Retirement Provisions for RSUs."  All your questions about what rules you can rely on to delay collecting FICA for retirement eligible employees, what FMV to use to calculate the FICA income, and strategies for collecting the taxes are covered in this article.