2016-Issue 17 – The Financial Accounting Standards Board (FASB) recently released Accounting Standards Update (ASU) No. 2016-09, which finalizes significant changes aimed at simplifying the accounting for share-based payments. The final rules are effective for annual periods beginning after December 15, 2016, for public companies and after December 15, 2017, for all other entities. Early adoption is permitted, but if a company chooses to early adopt, it must do so for all amendments in ASU 2016-09. A prior edition of Tax Advisor Weekly explored the proposed rules in detail. This edition discusses changes and clarifications in the final rules as well as key items that companies should consider before the final rules become effective.
Changes to Proposed Rules
- Accounting for income taxes: The final rules, consistent with the proposed rules, eliminate the APIC pool concept requiring that all excess and deficient tax benefits run through the income statement. However, the final rules clarify that the impact on a company’s effective tax rate from share-based payment tax deductions will be treated as a discrete item, which means companies will exclude them in the determination of their estimated effective tax rate.
- Statutory withholding requirements: Consistent with the proposed rules, ASU 2016-09 broadens the ability for companies to cash settle a portion of an award for tax withholding purposes as long as that withholding is for no more than the maximum statutory tax rate applicable in the jurisdiction and clarifies that companies can use the maximum statutory rate even if that rate exceeds the tax rate that is applicable to the specific employee.
- Classification of awards with a repurchase feature: The FASB decided to defer any amendments to the current guidance until a later project.
Is Early Adoption Right for You?
When contemplating early adoption, companies should consider the following:
- Is the company prepared to implement each of the amendments in the same reporting period?
- After adoption, all excess and deficient tax benefits will be recognized in the income statement and any existing additional paid in capital (APIC) pools are irrelevant. Is the company anticipating or experiencing excess tax benefits or tax deficiencies? Does the company currently have an APIC pool that can be used to offset tax deficiencies?
- Are the proper procedures in place to ensure a smooth transition?
- Are the appropriate individuals informed of how the changes will affect their duties?
Elimination of the Hypo-APIC Pool
One of the more dramatic changes relates to the tax accounting when awards are settled (stock option exercise or expiration, restricted stock vesting, etc.). As expected, ASU 2016-09 requires that, on a prospective basis for awards settled after adoption, any excess or deficient tax benefits resulting from future settlements will run through the tax expense line on the income statement, which eliminates the need to track an APIC pool. Although companies will no longer need to track an APIC pool, the calculation of excess tax benefits and deficiencies remains unchanged. These amounts will be reported in the company’s earnings, requiring companies to be extra vigilant in ensuring that these calculations are performed correctly.
Using Shares to Cover Tax Withholding
While the new rules will allow companies to net-settle shares for tax withholding purposes up to the maximum statutory tax rate, which will likely be welcomed whole-heartedly by employees, there are many things companies should consider:
- The company must have a statutory obligation to withhold taxes on the employee’s behalf. Therefore, this exception would not apply in jurisdictions without a withholding obligation or for awards where withholding is not statutorily required (e.g., incentive stock options).
- Most equity plans are currently structured so that they do not allow for net share settlement for more than the minimum withholding amount. If a company wants to take advantage of the ability to withhold at the maximum rate, its equity plan document (and potentially individual award agreements) will need to be amended to allow for more than the minimum withholding. Also, companies should consider if this amendment will be treated as a modification for accounting purposes.
- Will the IRS allow withholding for more than the minimum? For supplemental wages (including share-based payments) in excess of $1 million, the company must withhold at the 39.6 percent rate, and no additional withholding is allowed. If an employee’s supplemental wages are less than $1 million and the company uses the optional flat rate withholding of 25 percent, then the company must withhold at the 25 percent rate, and no additional withholding is allowed. However, there may be other ways that companies can withhold more than the minimum.
Alvarez & Marsal Taxand Says:
ASU 2016-09 brings about significant changes to the status quo. Companies need to consider whether early adoption is in their best interest and need to be sure the proper controls are in place to ensure quality reporting. Additionally, companies need to be aware of potential traps related to net-settlement of shares and should be extra vigilant with the changes to the accounting for income taxes, as all tax benefits and deficiencies will be reflected in the company’s earnings, rather than being lumped into equity.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisers. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisers before determining if any information contained herein remains applicable to their facts and circumstances.
About Alvarez & Marsal Taxand
Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisers who are free from audit-based conflicts of interest and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the United States and serves the United Kingdom from its base in London.
Alvarez & Marsal Taxand is a founder of Taxand, the world's largest independent tax organization, which provides high quality, integrated tax advice worldwide. Taxand professionals, including almost 400 partners and more than 2,000 advisers in nearly 50 countries, grasp both the fine points of tax and the broader strategic implications, helping you mitigate risk, manage your tax burden and drive the performance of your business.