Dividend Equivalents and Retirement Eligibility

For today's blog entry, I cover yet another challenge in the ongoing saga of awards that provide for accelerated or continued vesting upon retirement.

A recent Chief Counsel Advice memorandum casts doubt on the treatment of dividend equivalents paid on vested but unpaid RSUs.  This comes up when dividend equivalents are paid on RSUs that allow for deferred payout on either a mandatory basis or at the election of the award holder. This arrangement is relatively rare, however, and probably only impacts a few of my readers.  More commonly, however, this is also an issue where dividend equivalents are paid on awards that provide for accelerated or continued vesting upon retirement and the award holder is eligible to retire.

Background

In either of the above situations, the RSU is subject to FICA when no longer subject to a substantial risk of forfeiture. For traditional deferral arrangements, risk of forfeiture lapses when the award vests.  In the case of awards that provide for accelerated or continued vesting upon retirement, the risk of forfeiture substantively lapses when the award holder is eligible to retire.

Any dividend equivalents accrued on the award prior to when the award is subject to FICA will be subject to FICA at the time paid (if they are paid out to award holders at the same time they are paid to shareholders) or when the award is subject to FICA (if they will be paid out with the underlying award). But what about the dividend equivalents paid after the award has been subject to FICA?  Does the company need to collect FICA on those equivalents when they are accrued/paid?

The Non-Duplication Rule

Under, Treas. Reg. §31.3121(v)(2)-1(a)(2)(iii), referred to as the "non-duplication rule," once an RSU has been taken into income for FICA purposes, any future earnings on the underlying stock are not subject to FICA. So the answer to FICA treatment of the dividends depends on whether the dividends paid after this point are considered a form of earnings, akin to appreciation in value in the underlying stock (in which case, they would not be subject to FICA), or additional compensation (in which case, they would still be subject to FICA).

I've spoken with a number of practitioners about this.  Most believe that an argument can be made that the dividend equivalent payments are a form of earnings and, thus, are not subject to FICA.

The CCA

In Chief Counsel Advice 201414018, issued earlier this year, the IRS argued that dividends paid after the award is subject to FICA are still subject to FICA.  The situation the memorandum addresses, however, involved a number of facts not typically characteristic of RSUs that receive dividend equivalents:

• The RSUs were granted by a private company
• The awards were paid out only in cash
• The dividend equivalents were paid out to award holders at the same time dividends were paid to shareholders, rather than with the underlying award

While concerning, the memorandum doesn't necessary dictate a change in practice with respect to the FICA treatment of dividend equivalents, especially if your company is public, your RSUs are paid out in stock, and your dividend equivalents are paid out with the underlying award.  It may, however, be worth reviewing the ruling with your tax advisors to ensure they are comfortable with your procedures (especially if any of the conditions in the memorandum also apply to your RSUs and dividend equivalents).

- Barbara