The Financial Accounting Standards Board (FASB) has adopted new accounting standards under ASC Topic 718 for stock-based compensation awards. Among the changes is a rule that will provide companies the flexibility to withhold shares for tax purposes at a higher rate upon an event, such as the exercise of options or the settlement of restricted stock units, without triggering “liability” accounting.
The existing accounting rules have distinguished between stock-based awards that provide for share withholding at no more than the minimum statutory tax rate and those that permit share withholding at a higher rate. An award that caps share withholding at no more than the minimum statutory rate will generally qualify for “equity” accounting, which means that the charge associated with the award is fixed at grant and taken over the vesting life of the award. Awards that permit share withholding at a higher rate are generally subject to liability accounting. Liability accounting is unattractive because it requires a re-measurement of the charge based on fluctuations in value over the life of the award. Consequently, companies have largely tended to limit share withholding to the minimum statutory rate. That may mean that employees who pay taxes at a rate (up to the maximum individual federal rate of 39.6 percent) that is higher than the minimum rate of 25 percent find themselves in an under-withholding situation.
The new rule permits companies to withhold shares at up to the maximum individual statutory tax rate without triggering liability accounting. The new rule may be an attractive way for companies to assist employees in meeting their tax obligations through share withholding, provided that the company can accommodate the increased cash that it must pay to the taxing authorities. Note that the new rule is permissive. Companies are not required to withhold shares at the higher rate.
The new, more flexible rule is effective for public companies for annual periods beginning after December 15, 2016. For private companies, the rule is effective for annual periods beginning after December 15, 2017. Companies may early-adopt the new rule, but they must adopt additional updated standards related to stock-based compensation at the same time. They may not early-adopt the share withholding rule in isolation.
Companies interested in adopting the new share withholding rule should consider the cost of adoption and implementation with their accounting advisers and equity plan administrators. They should also consider whether amendments to stock plans and award agreements are needed, and whether shareholder approval of a plan amendment is required in their case.
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Michael T. Frank
Matthew E. Johnson
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