Equity Compensation: Employer Tax Deposits
The IRS recently released a generic legal advice memorandum (GLAM), dated May 18, 2020, that reviews the timing of income inclusion and of tax deposit obligations for a stock-settled option, stock appreciation right (SAR) and restricted stock unit (RSU). The GLAM addresses which date in the process of stock settlement is important for the employment tax deposit rules when the settlement transaction uses a stock transfer agent. Under the general rules, an employer with $100,000 or more to deposit must do so by the next business day. But to simplify this “next day” rule for stock settlement, the IRS has adopted an administrative policy that allows for the tax deposit on stock options to be made within the SEC settlement process window (three days at the time the IRS administrative policy was adopted, now two days). A key point covered in the GLAM is how these deposit rules work in the context of RSUs. For employers, it is important to realize that while, under the facts of the GLAM, the vesting date of the RSUs was determined to be the payment date for valuation and deposit rule time, that result was based on the specific facts of the GLAM. For RSUs, the GLAM stands for the proposition that the payment date is the date the employer initiates settlement of the RSUs in stock. For many RSUs, that will be a different date from the date of vesting. Accordingly, it is important to understand how a specific RSU grant operates and identify the right date for measuring income, as well as timing of the employment tax deposit.
Summary of the GLAM
The three fact patterns presented in the GLAM all involve initiating transfer on one day, December 29, using a transfer agent, with delivery of shares into a participant’s account two days later, December 31. In each case, the fair market value (FMV) of the stock is higher on the first date than the second. The GLAM analyzes each situation and concludes that the day on which the transfer is initiated, i.e., December 29, is the key date. For the option and SAR, this is the date of the exercise. The RSU agreement that is described in the GLAM provides for vesting on December 29 and settlement of the award on the same day as vesting. The GLAM concludes that for the RSU, the “payment” date is the date the employer initiated the transfer of the shares, December 29, because this is the date the number of shares is fixed and determinable. It is also the date as of which the employee bears the risk of price fluctuations and has a right to dividends. Accordingly, the deposit timing requirements are tied to December 29 for all three awards.
Application to RSUs
In the context of RSUs, the GLAM’s conclusion is very narrow. Employers should consider how that applies to different RSU designs. Under the facts in the GLAM, the RSUs are structured to settle on the date of vesting. As a result, the vesting date and the date the employer initiates payment are the same in the example. For many RSUs, however, the date payment is initiated will be different than vesting. Applying the GLAM to these awards, the key date for inclusion and employment tax deposit will be the date settlement is initiated, not vesting (or two days later when the transfer settles). RSUs commonly provide for a payment date that is different from the vesting date. This is the key distinction between a transfer of restricted stock and a RSU. With restricted stock, there is a transfer on day one, and an ability to make a section 83(b) election, but no ability to defer taxation beyond the lapse of the substantial risk of forfeiture – the participant is already in receipt of the stock, so the lapse is the income point. In contrast, a RSU is a contract right – an unfunded, unsecured promise of payment in the future. There is no initial transfer and a section 83(b) election is not permissible, but the timing of income can be deferred beyond vesting (subject, of course, to compliance with section 409A).
The difference between the timing of vesting and timing of settlement of a RSU is one reason employers choose to grant RSUs instead of restricted stock awards. For example, a RSU may provide that settlement will be made within 30 days of vesting, which then allows the employer to coordinate tax inclusion with a payroll cycle. Further delay beyond vesting is also permissible — nonqualified deferred compensation notionally invested in employer stock is the same as a vested RSU with deferral of income. Whatever it may be called, any arrangement under which the compensation is measured by reference to stock and then settled in stock is a version of a “RSU.”
The timing of income for RSUs generally is governed by Internal Revenue Code section 451, which provides for income to a cash-basis taxpayer on actual or constructive receipt. The GLAM discusses section 83 and the employment tax deposit rules, but does not reference section 451 (other than in a brief footnote related to the difference in authority between income tax inclusion and employment tax treatment).
A discussion of section 451 and constructive receipt likely would not have changed the conclusions reached by the GLAM, given the facts set out. Section 83 refers to “transfer” of property, and Treas. Reg. 1.83-e(a)(1) explains that transfer occurs “when the service provider acquires a beneficial ownership” in property, but there is no reason in the Code or tax policy to suggest that a “transfer” is distinct from the more general principles of timing of income inclusion. Under Treas. Reg. 1.451-2, constructive receipt is defined as setting amounts aside for the benefit of the service provider, who can access the funds without substantial limitation. The example given in Treas. Reg. 1. 451-2(a) involves bonus stock and the difference between crediting the stock on corporate books and making it available, clearly illustrating that section 451 is applicable to arrangements that settle in stock and cash. Under the logic of the GLAM, constructive receipt occurs when settlement is initiated.
Whatever the reason section 451 was not addressed, however, the omission should not be read as a suggestion that the general principles of section 451 are not relevant when compensation is paid in stock rather than cash. Rather, the GLAM is best read as saying that for income tax purposes, the date of transfer of stock, which is the same as the date of actual or constructive receipt, is when the settlement process commences, not when it ends. Other than for a grant with the exact same design as the one outlined in the GLAM, for an RSU, the vesting date is not relevant for income tax timing.