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Equity Compensation Trends in a Challenging Economic Landscape

During the first quarter of each year, employers begin the annual process of establishing incentive compensation for their management teams, both in the form of cash and equity awards. Typically, the equity awards will contain a mix of time and performance-based vesting conditions. While trends vary by industry, this year one pattern has remained true among all industries – employers are trying to balance the challenge of satisfying shareholders in a volatile stock market while retaining key employees in a tightening labor market. Some ways employers are attempting to meet this challenge include:  Continuing to favor RSUs over stock options. Since options typically use an exercise price equal to the fair market value of the company’s stock on the date of grant, options can be less incentivizing in a volatile market (where they can easily become out of the money). RSUs provide the employee with the full value of the… Continue Reading

Upcoming Deadlines: Annual Reporting and IRS Filings for ISO Exercises and ESPP Stock Transfers

Employers sponsoring equity incentive plans or tax-qualified employee stock purchase plans (“ESPP”) must fulfill certain year-end information reporting requirements under Section 6039 of the Code with respect to company stock that is either (i) issued to current or former employees upon exercise of an incentive stock option (“ISO”), or (ii) transferred under an ESPP.  The two IRS forms used to satisfy those requirements are: Form 3921, which is required when an individual exercises an ISO. Form 3922, which is required when an individual acquires stock under an ESPP when either the purchase price of the shares (i) was less than the stock’s fair market value on the date of grant, or (ii) was not fixed or determinable on the date of grant. For ISO exercises and ESPP transfers occurring in the 2021 calendar year, employers should file Copy A of the applicable forms with the IRS no later than February… Continue Reading

Equity Awards Granted to U.S. Participants by Non-U.S. Entities Can Lead to Unintended Consequences

Because of the various benefits, securities, and tax laws that apply to equity awards, what may be permissible (and even commonplace) in one jurisdiction, may be problematic in another. Accordingly, whenever an issuer desires to issue equity awards to service providers (e.g., employees or contractors) in a different jurisdiction, the issuer should engage benefits, securities, and tax counsel in all relevant jurisdictions early in the process to avoid any unanticipated issues that could negatively impact the value or purpose of the awards. For example, a common issue occurs when the issuer is an entity outside of the United States, but equity awards will also be made to service providers in the United States. Under U.S. tax law, there are specific requirements for determining the exercise price of stock options and stock appreciation rights (under Section 409A of the U.S. Internal Revenue Code (?Ç£Section 409A?Ç¥)) that require the exercise price to… Continue Reading

Ordinary Employee Benefits Issues That Can Cause Extraordinary Problems in M&A Deals

Employee benefits rarely drive corporate transactions, but if the benefits of a target company are not reviewed carefully, they can sometimes derail the transaction.  Even some of the most routine facets of benefit plan administration can result in significant potential financial exposure (e.g., additional employer contributions, taxes, penalties, and fees as well as fees associated with the preparation and filing of IRS and DOL correction program applications) that could negatively affect the overall value of the target company. By identifying issues early in the transaction, the seller can prevent costly purchase price reductions and identify issues that need correction, while the buyer can avoid overpaying for a target and ensure that representation and warranty insurance will be available to cover potential claims. Some of those routine compliance issues include, but are not limited to, the following: Failing to timely file an annual Form 5500.  The DOL can assess a penalty… Continue Reading

Keep It Simple: FASB Issues Proposed Standard to Simplify Accounting for Private Company Stock Options

Many privately-held companies use an independent valuation expert to value their common stock for purposes of establishing the exercise price for options granted to their employees, consultants, and outside directors. If this valuation is performed in accordance with Treasury Regulation ?º 1.409A-1(b)(5)(iv)(B)(2), then the valuation is given a presumption of reasonableness under the Internal Revenue Code, making it easier for the granting company to prove to third parties (including the IRS) that the value used was the underlying stock’s fair market value. However, even if a company used such a valuation to establish the exercise price, the company would not be able to use that valuation for purposes of accounting for the stock option awards under Financial Accounting Standards Board (?Ç£FASB?Ç¥) Accounting Topic 718. Instead, for accounting purposes, private companies would typically use an option-pricing model that required the company to provide various inputs, including the fair value of the… Continue Reading

IRS Issues Memorandum Providing Guidance on Income Inclusion, FICA, and Income Tax Withholding for Stock-Settled Equity Awards

The IRS recently issued Generic Legal Advice Memorandum No. AM 2020-004 (the ?Ç£GLAM?Ç¥) to address when income from nonqualified stock options, stock-settled stock appreciation rights, and stock-settled restricted stock units is (i) includable in an employee?ÇÖs gross income, (ii) subject to FICA taxes, and (iii) subject to federal income tax withholding. In addition, the GLAM provides a discussion of the deposit rules for FICA and income tax withholdings that have been withheld with respect to such equity awards, including the ?Ç£One-Day?Ç¥ rule (or the Next-Day Deposit Rule) that requires employers to deposit employment taxes on the next banking day after $100,000 or more in employment taxes have been accumulated. The GLAM provides a series of illustrative examples and analyses of such issues. The GLAM does not, however, address the impact of an employer?ÇÖs ability to defer employment tax deposits under Section 2302 of the Coronavirus, Aid, Relief and Economic Security… Continue Reading

Evaluating Performance Goals and Incentive Compensation in Light of COVID-19

Boards and compensation committees will be reevaluating their incentive compensation arrangements in light of the COVID-19 pandemic and the resulting market uncertainty. Both long-term and short-term incentive plans can lose motivational and retention value if the performance goals are unachievable or if they do not align with market reality. Companies that have not yet established performance goals for their 2020 equity and bonus awards should carefully consider market conditions and shareholder perception before establishing goals, focusing on motivating their executives with pay for performance that aligns with shareholders?ÇÖ interests, while giving the company flexibility to navigate through uncharted territory. To the extent possible, companies should also consider delaying the issuance of incentive compensation awards until there is more stability in the business and in the financial markets. Companies that have already established goals for their 2020 awards (or that are evaluating the continued effectiveness of performance goals for prior year… Continue Reading

Recent Guidance on Compensation Practices from Glass Lewis in Light of COVID-19

On March 26, 2020, Glass Lewis released its governance report discussing its approach to corporate governance in light of the COVID-19 pandemic. According to the report, Glass Lewis expects all governance issues to be impacted by COVID-19 and will be taking a pragmatic approach to corporate governance and voting on affected proposals, prioritizing disclosure and timing and certainty on such matters, and exercising discretion as appropriate. Glass Lewis states in the report that: “The stark reality is that for many workers, including executives, they should not expect to be worth as much as they were before the crisis, because their free market value as human capital has now changed. There is a heavy burden of proof for boards and executives to justify their compensation levels in a drastically different market for talent . . . Trying to make executives whole at even further expense to shareholders and other employees is… Continue Reading

COVID-19 EMPLOYEE BENEFIT AND EXECUTIVE COMPENSATION QUESTIONS AND ANSWERS

In light of the recent economic developments stemming from the COVID-19 pandemic, many employers are evaluating their employee benefit plans and how employee and employer costs will be impacted. The following summary provides a list of questions we have been receiving from clients over the past week, along with action items to help employers address these issues. Health and Welfare Plans and Fringe Benefits Should benefits coverage continue while an employee is on an unpaid furlough? If so, how would the employee pay the employee?ÇÖs portion of the premium? Could the employee elect to drop coverage due to the reduction in hours of active service? Could the employer pay for coverage for some or all of its furloughed employees? Continued eligibility for benefits will depend on whether the employer treats the furlough as a termination of employment or as an unpaid leave of absence. The terms of the plan, including… Continue Reading

Philippines Bureau of Internal Revenue Clarifies Tax Treatment of Stock Options

According to Revenue Memorandum Circular (RMD) No. 88-2012, the Philippines Bureau of Internal Revenue recently clarified that income or gains derived from an employee?ÇÖs exercise of stock options is subject to income tax as ?Ç£additional compensation,?Ç¥ and employers are required to withhold taxes on such compensation. For managerial or supervisory employees, to the extent any such income or gain qualifies as fringe benefits, it?áis subject to the fringe benefit tax pursuant to Section 33 of the National Internal Revenue Code of 1997, as amended (?Ç£NIRC?Ç¥). Further, if the shares to be issued upon the employee?ÇÖs exercise of the stock option come from unissued stock of the corporation, then the issuance of these shares is also subject to the documentary stamp tax (the ?Ç£DST?Ç¥) pursuant to NIRC Section 174. Finally, the RMC details the tax implications to an employee upon his or her subsequent sale, exchange, or disposal of shares of… Continue Reading

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