In May, the IRS released the Office of Chief Counsel Memorandum (the “Memo”) providing detailed guidance on the timing and amount of withholding and deposits for Options, SARs and RSUs. The Memo provides detailed guidance on three situations that became more common and, thus, more important due to the extreme volatility in stock prices during the pandemic, during which the company’s stock price could rise or fall significantly between the date an employee exercised a stock option or become vested in an RSU and the date the shares actually were delivered to him or her and tax withholding applied.
In situation 1, an employee delivered to the grantor corporation written notice of his exercise of stock options and made full payment of the exercise price. However, the stock plan provided that the employee has no interest in the stock until issuance of the stock certificates, which were not issued for several days, during which time the company’s stock price had increased. The IRS concluded that when the employee exercised the stock option, the transfer of shares of stock occurred for purposes of Code § 83 and the employee recognized ordinary income on that date, based on the market price on that date, not on the later date when stock certificates were delivered. FICA taxes and federal income tax withholding due is based on the price on the date of exercise.
In situation 2, an employee acquired beneficial ownership in the underlying shares of stock upon exercise of a Stock-Settled Stock Appreciation Right (“SARs”). Again, the IRS concluded that the amount of federal income and FICA taxes would be determined based on the market price of the stock on the date of exercise, despite an increase in the price of the stock by the time of the actual delivery of shares.
In situation 3, an employee vested in Restricted Stock Units (“RSUs”) and the company initiated payment and delivery of the number of shares of stock vested under the RSU. The shares were not delivered to the employee’s brokerage account until four days later. By the time the shares actually were delivered to her account, the stock price had declined. Once more, the IRS concluded that the fair market value of the underlying stock was includible in the employee’s gross income as compensation when the stock is considered transferred for purposes of Code § 83, which occurred when the company initiated payment under the RSU.
In summary, for better or worse, the employee’s taxable income (and the company’s withholding obligation) is determined based on the market price on the date a stock option is exercised or the company initiates the transfer process, not on the later date when stock certificates are actually received in the employee’s brokerage account.
-Mike Melbinger, CompensationStandards.com June 15, 2020
