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Put Your Best Vest Forward Emerging Best Practices Article Header

Put Your Best Vest Forward: Emerging Best Practices

Wednesday, May 10, 2023

When it comes to equity compensation plans, and vesting in particular, taxation is routinely cited as the biggest challenge for companies and plan participants.

Getting out in front of taxation issues will help your organization feel prepared for tax season and when vesting questions inevitably arise. One question that always comes up at conferences and in client meetings: can equity plan participants elect any tax rate for share witholdings?

For companies with U.S. participants, Notice 1036 issued by the Internal Revenue Service ("IRS") is clear. Released in December of 2016, it sets the statutory rate for any supplemental holding under $1 million at 22% and a 37% tax rate for earnings greater than $1 million.

Please note that, if you deviate from the IRS’s statutory share withholding rates, your grant will fall into liability accounting, which will bring another layer of complexity when you are preparing your financial statements.

Ambiguity comes into play, however, when equity compensation plan participants reside outside the U.S., because tax rates can vary based on income, marital status and several other factors.

The emerging best practice for companies with non-U.S.-based participants is to use a flat tax rate and calculate withholdings at a higher local rate—so the difference can be reconciled later. This way, when non-U.S. based participants file with their local tax authorities at the end of the calendar year, the taxes will be adjusted—just as they would be in the U.S.—and the issuer is able to true-up through its payroll or with the local tax authorities.

Share withholding is far and away the most common method of tax collection for stock awards because it reduces the risk of dilution. Essentially, share withholding means that there is no transfer of money between a company and its plan, so that the company can use those shares when issuing new shares. When fractional shares arise, most companies opt to round up to the nearest share and then include any excess with tax payments.

What's Your Default?

Share withholding for taxes is automatic at some firms; others let equity compensation plan participants choose their preferred method of tax collection for stock awards. But having a clearly defined default method, such as reverting to share withholding or selling the shares for a tax obligation, is important for all companies. It reduces the likelihood of surprises, which can mean less time spent chasing plan participants to determine next steps.

Having set procedures for what to do if a grant has not been accepted prior to the vest date is also important. Companies can reject or accept a grant on behalf of employees, but if a company chooses to do nothing with the grant, it still has to incur that expense on its books and in its quarterly and annual reports.

Communication and Organization: Two Sides of the Same Coin

Communication and organization are critical when granting awards, during an election notification period, at grant acceptance and during follow-ups.

At the most basic level, granting equity that vests over time allows a company to retain an employee who is doing a good job. It’s one more way to let employees know that they are part of the team and that they are contributing to the company’s success.

Also, remember that people have varying communication preferences. Simply making sure that the information is clearly presented in plain English and delivered in a timely manner isn’t enough, but rather, cultural factors and personal preferences have to be considered. While some employees are comfortable with an email, others prefer a formal letter, a personal phone call or even a text.

In addition to aiding communication, solid organizational practices mean a smoother process for all involved. Since vests are scheduled well in advance, they offer ample opportunity for pre- and post-vest date accounting, administrative and other adjustments.

Practical steps, like running a pre-vest date report to get a sense of what might need to be changed prior to an election, and structuring a grants program that has a sell-to-cover component to vest when the trading window is open, will reduce headaches.

In addition, companies should make sure that plan participants’ brokerage accounts are active and ready to receive shares from the transfer agent before a vesting event. Some companies use a plan administrator that is also a brokerage firm to make this a seamless process.

Vesting events occur for different companies throughout the calendar year, so there's no time like the present to take stock of best practices. While it can be tricky to get taxation and communication just right, advance preparation can go a long way towards achieving your “best vest.”

About EQ

EQ are specialists in helping you better understand and manage the ownership of your company through critical events across the corporate lifecycle. As trusted advisors, we provide strategic insight and operations expertise through our core business units in Private Company Services, Transfer Agent Services, Employee Plan Solutions, Proxy Services, and Bankruptcy. Globally we serve 6,700 clients (49% of the FTSE 100 UK and 35% of the S&P 500), with over 30 million shareholders, through 6,500 employees in 5 markets around the world.

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