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© 2013 Equity Administration Solutions, Inc. All rights reserved. 1 September 26, 2014 The Treatment of Equity Awards Upon Termination
© 2013 Equity Administration Solutions, Inc. All rights reserved. 2 Today’s Discussion Death Beneficiary designations, exercise periods, accounting and tax issues Leaves of Absence Types of leave, best practices, tax consequences, ESPP considerations Divorce Tax issues, asset distributions Terminations Global plan issues, tax considerations
© 2013 Equity Administration Solutions, Inc. All rights reserved. 3 Today’s Discussion Retirement 409A, Tax issues, 162(m) Overall Process and System Considerations Best Practices
© 2013 Equity Administration Solutions, Inc. All rights reserved. 4 Death Beneficiary Issues Problems with beneficiary designation forms Enforceability outside the US Employees failing to update their beneficiary designation Overriding state law Community property law, simultaneous death rule, killer statute Specifying beneficiaries in the plan document Requires interpretation by plan administrator Does “children” include adopted children and step children? Meaning of “spouse” after U.S. v. Windsor Considerations Automatic transfer to the estate State in plan document that upon death options would be exercisable by representative of the estate
© 2013 Equity Administration Solutions, Inc. All rights reserved. 5 Exercise Period After Death Considerations Allow time for probate process 12-month exercise period after death is most common 51% of companies according to 2010 NASPP domestic survey Consider Section 409A limit when extending exercise period Extending in-the-money option beyond original term or 10 years after grant date may cause Section 409A to apply to option Modification If change in terms, then Type I modification Calculate incremental expense for outstanding shares
© 2013 Equity Administration Solutions, Inc. All rights reserved. 6 Vesting Acceleration Performance awards Common provision for vesting upon death Pro rata vesting based on portion of period completed Payout at the end of performance period based on actual performance 28% of companies according to 2010 NASPP survey Payout upon death based on an assumed performance level, or 16% of companies according to 2010 NASPP survey Modification If change in terms, then Type III (Improbable to Probable) Calculate change in value for the accelerated shares only
© 2013 Equity Administration Solutions, Inc. All rights reserved. 7 Accounting Treatment Vesting or forfeiture upon death Impact on expense and estimated forfeiture Forfeiture upon death Reverse expense Cancellation at end of performance period Nonattainment of performance condition – reverse expense Nonattainment of market condition – expense is not reversed Accelerated or pro rata vesting upon death Vesting per original grant terms – fair value is not remeasured Vesting due to modification – Type III
© 2013 Equity Administration Solutions, Inc. All rights reserved. 8 Tax Consequences NQSO Exercise By Estate Estate recognizes ordinary income equal to spread at exercise Report gain on estate’s Form 1099-MISC (Box 3, not 7) Tax withholding and reporting Not required if exercise occurs after the year of employee’s death If exercised in the year of employee’s death, only FICA is withheld Apply FICA wage cap using employee’s wages Report FICA/FUTA wages on employee's Form W-2
© 2013 Equity Administration Solutions, Inc. All rights reserved. 9 Tax Consequences Transfer of ISO or ISO shares to estate Transfer of option to estate Does not disqualify ISO. Holding periods no longer applicable. No tax withholding or reporting by company at exercise by estate Gain upon sale by estate is capital gain Stepped up basis = exercise price + fair value of ISO at employee’s death Transfer of ISO shares to estate Holding periods no longer applicable Gain upon sale by estate is capital gain Stepped up basis = exercise price + FMV of shares at employee’s death
© 2013 Equity Administration Solutions, Inc. All rights reserved. 10 Tax Consequences Transfer of ESPP shares upon death Transfer of ESPP shares upon death is a qualifying disposition Ordinary income Lesser of discount at grant or spread at employee’s death Reported on employee’s final Form W-2 Basis in shares for sale by estate is FMV of shares at employee’ death Right to participate in ESPP ends upon death Unused contributions are refunded to estate
© 2013 Equity Administration Solutions, Inc. All rights reserved. 11 Leaves of Absence Types of Leave Protected vs. Discretionary Leaves Paid vs. Unpaid Leaves Effects on Equity Compensation Vesting Continued vesting, suspension, or cancellation Grace period Exercisability and Share Release Continued Participation in ESPP
© 2013 Equity Administration Solutions, Inc. All rights reserved. 12 Leaves of Absence for Global Plans Differences globally Protected leaves Claims of indirect discrimination Paid vs. unpaid leaves Definition of disability Best Practices If feasible, allow vesting to continue More than 85% of companies (2010 NASPP domestic survey) If suspend vesting, specify in grant agreement Maintain equity-related LOA policy at US parent level
© 2013 Equity Administration Solutions, Inc. All rights reserved. 13 U.S. Tax Consequences ISO Extended leaves No impact if employee has guaranteed right to return to work No impact on ISO if leave is not longer than 3 months If both of the above do not apply Termination due to disability Plan may allow exercise up to one year after disability termination
© 2013 Equity Administration Solutions, Inc. All rights reserved. 14 Divorce – Tax Consequences NQSO Transfer of NQSO pursuant to divorce is not a taxable event Ex-spouse recognizes ordinary income upon exercise Report income and FIT withholding on Form 1099-MISC of ex-spouse Box 3, not box 7 Income tax and FICA must be withheld FICA is based on employee’s income, attributed to employee, and reported on employee’s Form W-2 (but paid by ex-spouse) Report FICA/FUTA wages on employee’s Form W-2 Boxes 3 and 5 only, do not report in Box 1
© 2013 Equity Administration Solutions, Inc. All rights reserved. 15 Divorce – Tax Consequences ISO Transfer of Option Transfer of ISO disqualifies the option from ISO treatment PLR , 9/14/07 Community property state – portion of ISO owned by spouse Employee agrees to exercise ex-spouse’s ISO in the future if instructed Neither the division of ISO nor transfer of shares to ex-spouse will disqualify the ISO Transfer of Shares Transfer of ISO shares does not disqualify shares Statutory holding periods still apply Report any ordinary income upon sale on Form 1099-MISC of ex-spouse
© 2013 Equity Administration Solutions, Inc. All rights reserved. 16 Divorce – Tax Consequences Restricted Stock Transfer of RSA pursuant to divorce PLR , 4/23/10 * Non-community property state Divorce decree that employee transfers the shares upon vesting Shares remain in the name of the employee until vest Ex-spouse recognizes ordinary income upon vesting Tax withholding & reporting at vest similar to NQSO exercise
© 2013 Equity Administration Solutions, Inc. All rights reserved. 17 Termination of Employment in General Issues for Global Plans Forfeiture on termination Right to retain and continue to vest in award Termination date (notice period, garden leave) Continued vesting after qualified termination (e.g., retirement) Age discrimination issues Acceleration of taxable event Impact on Severance Pay May need to include value of award Mitigate by separating equity awards and employment relationship
© 2013 Equity Administration Solutions, Inc. All rights reserved. 18 Tax Issues Grant agreements with retirement acceleration provision RSA Income tax and FICA/FUTA at retirement eligible date RSU FICA/FUTA at retirement eligible date FICA withholding FICA reporting: Form W-2, Boxes 3, 5 and 11 Income tax at release date In no event can FICA/FUTA be later than income tax Example: Employee eligible for retirement on 12/1/13. Shares released on 1/15/14. FICA/FUTA using short-term deferral rule would be based on FMV at 1/15/14.
© 2013 Equity Administration Solutions, Inc. All rights reserved. 19 Section 409A RSU with retirement acceleration provision Section 409A not applicable to RSUs if payable upon vesting Common mistakes in design Vesting upon retirement Vesting upon termination for non-compliant “good reason” If Section 409A applies (and for Phantom Stock) Releases/payout must be tied to pre-established dates or a permissible event, including “separation from service”, death and disability One release schedule for each permissible event Erroneous determinations of “separations from service” may result in Section 409A violations Must comply with short-term deferral rule
© 2013 Equity Administration Solutions, Inc. All rights reserved. 20 Tax Issues PSU with retirement acceleration provision FICA/FUTA accelerated at retirement eligible date only if payout is reasonably ascertainable No FICA/FUTA if the award does not guarantee a minimum payout Awards with accelerated/continued vesting on retirement and minimum payouts should be closely examined to minimize unforeseen tax consequences
© 2013 Equity Administration Solutions, Inc. All rights reserved. 21 Termination of Employment in General PSU with retirement acceleration provision Rev. Rul If the plan or an agreement provides for vesting upon retirement, Exemption for performance-based compensation is not available, even if the accelerated vesting is never triggered Best Practice If performance-based RSU vests upon retirement Limit payment to pro rata amount that would otherwise be payable on achievement of performance goals Delay release until end of performance period
© 2013 Equity Administration Solutions, Inc. All rights reserved. 22 Process and System Considerations Data capture Administration – change in employment status date, termination reason, retirement eligible date, breaks in service (rehires), etc. Accounting – accounting dates, post-termination substantive services Processing changes in employment status Effects on administration – vesting, exercise period, eligibility for plan Effects on taxation – withholding, reporting, timing, ISO status Flagging/relabeling administrative data for accounting purposes Vesting – due to modification vs. “qualified termination” trigger Cancellation – due to service condition vs. market condition Effects on accounting – expense acceleration, types of modification Documentation Identify system limitations & document manual processes
© 2013 Equity Administration Solutions, Inc. All rights reserved. 23 Best Practices Update employee data from HR system on periodic basis Reconcile changes of employment status between the systems Perform on monthly basis and before any major stock event Include effective date of change of status in reconciliation Develop and document process Transferring awards upon death & divorce Required documentation; notice to broker; SEC compliance How to handle late notifications of change in status Post-dated transactions report; notice to Finance Action upon discovery of inappropriate releases and exercises Notice to Legal
© 2013 Equity Administration Solutions, Inc. All rights reserved. 24 Q & A Discussion Nicole Dmitruchina, CEP Consultant, Professional Services Equity Administration Solutions, Inc. Compliance with Confidence Vince Alessi, CEP Manager, Private Markets Equity Administration Solutions, Inc. Compliance with Confidence
© 2013 Equity Administration Solutions, Inc. All rights reserved. 25 Thank You! Questions?
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