The Financial Accounting Standards Board (FASB) has issued updated accounting standards designed to simplify accounting for stock-based awards. Among other changes, the updated standards permit employers to withhold stock for tax purposes upon settlement of stock-based awards—such as stock options and RSUs—at up to the maximum individual statutory tax rate without triggering adverse accounting consequences.

The new standards will apply to public companies for fiscal years beginning on or after December 15, 2016. A company can apply the new standards sooner, but if it does so, it must adopt all of the new standards, not just some of them.

Current Standards for Stock-Based Award Tax Withholding

Employers that issue stock-based awards may withhold stock otherwise issuable upon the exercise or settlement of an award to meet tax withholding obligations. The current standards act to limit the amount of stock employers can withhold.

• When stock can be withheld only at a rate at or below the minimum statutory rate, stock-based awards can be classified as equity awards under the accounting rules. This results in more favorable accounting treatment as compared to stock-based awards classified as liability awards.
• When stock can be withheld at a rate above the minimum statutory rate, stock-based awards must be classified as liability awards. This results in less favorable accounting treatment.

Equity awards receive more favorable accounting treatment because under accounting rules, equity awards are subject to measurement of accounting expense at grant, while liability awards are subject to accounting expense remeasurement each reporting period (a type of variable accounting).

Thus, under the current standards, the minimum statutory rate serves as a threshold for adverse accounting treatment and a practical limitation for stock withholding upon stock-based award settlements.

This is an undesirable limitation for many employers because the difference between the statutory minimum federal withholding rate of 25 percent and the maximum individual tax rate of 39.6 percent results in tax withholding that is likely to understate the employee's tax liability.

New Standards for Stock-Based Award Tax Withholding

The new standards increase the threshold for triggering liability classification to the maximum individual statutory tax rate. This change provides employers with the flexibility to assist employees by withholding stock in connection with the settlement of a stock-based award at a level that is less likely to understate the employee's tax liability.

We anticipate that this increased threshold for liability treatment will be a welcome change to some employers that withhold stock in connection with the settlement of stock-based awards.

Adoption of New Standards

For public companies, the updated standards are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. For all other companies, the updated standards are effective for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. Early adoption is permitted, but requires the company to adopt all of the updated standards, which includes other revisions involving:

• Cash Flow Classification for Stock-for-Tax Netting
• Accounting for Equity Award Forfeitures
• Accounting for Excess Tax Benefits and Deficiencies Arising Out of Equity Awards
• Determination of Expected Terms for Equity Awards with Service-Based Conditions (for private companies)

The new standards do not require employers to withhold at the maximum statutory rate. Some employers may not want to allow the increased withholding because it will increase the employer's cash remittances to the taxing authorities.

Additionally, the tax withholding standards continue to permit share withholding only for individuals for whom the employer has a statutory obligation to withhold taxes.

Employers are encouraged to contact their accounting advisors to discuss the updated standards and their implementation.

Action Items

• Discuss the updated standards with accounting advisors to assess implementation and cost.
• Discuss the administrative processes for implementing the updated standards with stock administration and payroll departments.
• Review existing equity plan and award agreements to determine what changes (if any) are needed to implement the updated standards and the process required to make the changes (including whether shareholder approval of any plan amendment may be required).

If you would like assistance with reviewing or amending your existing equity arrangements or have any other questions regarding this alert, please contact any member of the employee benefits and compensation practice at Wilson Sonsini.