How Companies Manage Tax Compliance for Equity Programs

The outlook on tax compliance for equity awards is strong. The NASPP and Fidelity went deep with our tax reporting and policies survey as part of our Equity Compensation Outlook in August of 2022, and I’m here to help with some surprising insights. The survey covers a wide range of compliance-related topics, from how companies manage tax deposits and source tax rates to how they educate employees on taxation of equity awards and fulfill with reporting requirements.

Let’s start with some good news.

We aren’t quite in the penalty-free zone, but we aren’t far.  Just 12% of companies have been subject to penalties for late deposits of US taxes relating to stock plan transactions within the past year.  Since the penalties on late deposits add up quickly—up to 15% of the deposit amount—this is not an area where anyone should slack off.  There is a slight tick up in this area for technology companies compared to non-technology (13% vs 10%).  Given the heavy use of equity in the technology sector, this isn’t a huge surprise to me—after all, with equity grants to a larger population, it is likely that these companies are triggering next day deposits situations more frequently, in addition to the mountains of distributions they may be processing!

How is everyone so good?!?

Overall, compliance with US federal tax deposit requirements appears to be strong. Very few companies report making late deposits, and most are able to deposit tax withholding accurately and on time, even when subject to the next-day deposit rule. This isn’t just luck. It is the result of planning and preparation.

Nearly half (47%) always perform a special payroll transmission to deposit tax withholding for equity awards and another 37% perform a special payroll transmission when necessary.  When it comes to compliance with the next-day deposit rule, nearly half (48% for full value awards, 46% for stock options) can remit the correct tax within one day of the transaction, with 36% (full value awards) and 46% (stock options) remitting within one day of settlement.

For full value awards, a quarter of companies remit an estimate, most commonly calculated 2-3 days before the transaction (36% of respondents), with a plan to true up later.  Remitting taxes based on an estimate is much less common for stock options (only 4% of respondents). This may be because most option exercises involve an open-market sale, which forces the company to settle the transaction in two days and there is clear and well-established relief from the IRS that provides that taxes deposited within one day of settlement will be considered timely. Although similar relief exists for RSUs, it is more recent and the application of this relief to non-market transactions isn’t as clear. 

Let’s go team!

It’s clear that tax reporting and compliance is a team effort. Stock plan administration works closely with internal stakeholders to make the magic happen.

• In-house payroll—Payroll pops up over and over with respect to tax:
  • Payroll is the most common source of state withholding rates (40% of respondents) and even more common for city and country withholding (56%).
  • Nearly half (48%) count on payroll for withholding state tax on ESPP where applicable.
  • Global tax reports are most often completed by local payroll teams (42%), followed by stock plan administration (26%).
  • Payroll also pops up, though to a lesser extent, for Form 1099-NEC (7%) and 1099-MISC (12%) filings.
• Accounts Payable—AP is the star player in the completion of Forms 1099
  • 60% of companies report AP owns the Form 1099-NEC; Just 21% reported it is handled by stock plan administration.
  • 54% of companies report AP owns the Form 1099-MISC; Just 20% reported it is handled by stock plan administration.

Did someone say retirement?

If all this tax talk has you thinking about retirement, I’m here to help. And, I’m not offering advice on fishing, birdwatching or other retirement activities… I’m talking retirement eligibility. Long famed for its headache-inducing tax compliance, managing tax withholding on awards with retirement eligibility isn’t easy!

By far, the rule of administrative convenience is the choice for collecting FICA payments (66% of respondents). Just 18% count on the lag method, and 15% are collecting immediately. For those using the rule of administrative convenience, over half (52%) use the same date for everyone, another third (31%) use one date for most, and a second date to sweep up employees who become eligible to retire later in the year. Just 15% are ambitiously using several dates throughout the year.

Need more help on managing retirement provisions? Check out the NASPP’s excellent article “ Retirement Provisions for RSUs.” 

Disappointing Disposition Data

I have long been a huge advocate for permanent transfer restrictions for shares acquired through ISO or Section 423 plans. I’ve been known to wax poetic about the fact that transfer restrictions are a gift—yes, a gift!—to plan sponsors. And most companies are receiving that gift.  Over half (60%) of companies report that most or all ISO and ESPP dispositions are reported by their broker, making disposition surveys unnecessary.

But, for the 40% out there that aren’t relying on their designated broker for disposition reports, a quick refresher. To meet reporting obligations, companies need to know when the shares are sold: for ISO shares, through the disqualifying disposition period; for 423 shares, forever. And, absent a transfer restriction, that is darn near impossible. 

When employees transfer the shares out of their captive broker account, the way to find out if the shares are sold is, well, to ask employees.  By sending a survey—for ISO shares through the DD period. For 423 shares… Every. Single. Year.  Yes, for ESPPs, companies have a reporting obligation when the shares are sold, whether in a disqualifying or qualifying disposition and whether the individual is still an employee of your company or has moved on.

As you can imagine, getting employees (and former employees) to return those surveys can be a challenge. How much of a challenge?  I’m glad you asked!  Because now we know.  A full 44% of companies relying on surveys report that less than 25% of surveys are returned. (Another 9% report that less than half are returned!) That is an abysmal rate of return.

And, even more painful, for shares that are sold in a disqualifying disposition that isn’t reported back to the company on a survey, the company misses out of the tax deduction. Ouch—that hurts! Transfer restrictions allow companies to maximize their tax deduction (by capturing all the tax deductions) and minimize their administrative headache (by getting out of the survey business). That sounds like a win-win to me, and now with our handy data on the response rate, I hope companies can build a business case to add transfer restrictions.

P.S.—It’s even worse. In addition to the unfulfilling work of sending out surveys, in the rare cases when those surveys are returned, if they are returned late, nearly a third of respondents are issuing corrected W-2s for any late return, and another 44% are issuing Form W-2c if the late report happens within a certain time period.  Don’t get me wrong. Issuing a W-2c is the correct way to handle this, but a transfer restriction could avoid this all together, since all share sales will be reported by the captive broker and you don’t have to ask employees to respond to your survey.

Speaking of W-2c’s…  

As companies continue to grapple with remote work and associated increased employee mobility, just 18% of companies are issuing corrected Forms W-2 (Form W-2c) for employees who fail to report state-to-state moves in a timely manner.  Another quarter of companies issue Form W-2c for some, but not all, cases. That leaves more than half of companies not addressing these late reported state-to-state moves.

Tax Education

Communication and education is a recurrent theme for stock compensation, so not surprising that tax education rears its head here. 

Overwhelmingly, companies count on their broker/third party administrators for tax education materials, both for US employees (75%) and non-US employees (70%). A sizable population is also supplementing with materials developed in-house for both US employees (69%) and non-US employees (63%).

After that, there is a pretty sharp decline in those reporting that materials are developed by another third party or consultant, use of videos, and annual tax presentations.  Only 8% of companies let their employees go it alone (i.e., do not provide any tax education).

Now what?

There are a lot of great tax findings in this survey.  If I’ve piqued your interest, and you didn’t have a chance to complete the survey, but are salivating to see the full results, don’t fret.  While the initial results are in, but it's not too late to participate and compare your practices vs others.

Since getting info on tax withholding and policies shouldn’t be taxing, we’ve got a webinar coming your way!  Barbara Baksa, the NASPP’s #1 tax fan, and I will be joined by Sandi Antonini of Avery Dennison on October 5. Hope to see you there!

_{Source: NASPP and Fidelity Investments Tax Policy Research, August 2022
The NASPP and Fidelity Investments are not affiliated.}

_{Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
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