In an apparent follow-up to its General Legal Advice Memorandum dated May 18, 2020 (GLAM 2020-004), the IRS has issued an internal procedural update that (1) extends the application of the administrative waiver of late employment tax deposit penalties for stock options to stock-settled restricted stock units (“RSUs”) and stock appreciation rights (“SARs”) and (2) shortens the waiver’s deposit period by one day to align with current SEC securities open-market transaction settlement rules. The internal procedural update has not yet been publicized by the IRS or incorporated into the IRS’s Internal Revenue Manual (“IRM”).  However, it serves to amend subsection 20.1.4.26.2 of the IRM as it relates to the IRS’s administration of the rule requiring an employer that accumulates $100,000 or more of employment taxes to deposit those taxes with the IRS on the next business day (the “next-day rule”). As the GLAM had asserted the IRS’s authority to impose late deposit penalties on employers not making required next-day deposits within one day of “initiation of payment” of RSUs or exercise of options or SARs (as we discussed in our prior blog), the relief provided by the IRS’s internal procedural update is both welcome and much-needed. It is also somewhat unexpected, given the GLAM’s express statement that the guidance under the GLAM was not intended to affect the application of the administrative waiver applicable to options and its failure to note that the IRS would be extending the waiver to apply to other awards (as had been requested by the stakeholders who sought the IRS advice that triggered the GLAM).

Amended Administrative Waiver and Deadline for Next-Day Rule Deposits

Under the instructions provided by the amended administrative waiver, IRS agents are permitted in the circumstances described below to use the settlement date of an option or stock-settled RSU or SAR as the liability date for determining whether the late deposit penalty under the next-day rule will apply, rather than the earlier date specified by the GLAM (specifically,the option/SAR exercise date or the date the employer initiated payment of RSUs). In recognition of the SEC’s current securities transaction settlement cycle rule requiring the settlement of an open-market stock transaction within two business days of the transaction date (“T+2”) — reduced from three business days (“T+3”) as of September 5, 2017 — the instruction provides that the penalty for late employment taxes may be waived where the taxes are deposited within one business day of the settlement date of the awards, provided that such settlement occurred within two business days of the option or SAR exercise date or the RSU payment initiation date, as applicable. As stated in the GLAM, the IRS considers the “payment initiation date” of an RSU to be the date the employer requests its transfer agent to transfer shares underlying the RSU award to the RSU holder (and which will generally coincide with the RSU vesting date for RSUs that are to be settled upon vesting).

Conclusions

Although the GLAM’s conclusions on the timing of income inclusion and payroll liabilities are questionable under the tax regulations and prior precedent, particularly with respect to RSUs, the IRS’s update of the IRM to extend the administrative waiver to RSUs (and SARs) will help to resolve many of the concerns raised by the GLAM. This is especially the case for employers who need to receive the proceeds from the sale of shares in order to meet their next-day rule obligation. However, employers now need to ensure they have revised their procedures to ensure that they deposit employment taxes relating to option exercises within the shortened period set out in the internal procedure update, i.e., by the third business day following exercise of an option settled within T+2.

Author

Sinead Kelly is a partner in Baker McKenzie’s Compensation practice in San Francisco. She advises on U.S. executive compensation and global equity and has practiced in the compensation field since 2005. In her practice, Sinead counsels U.S. and non-U.S. public and private companies on all aspects of equity and executive compensation plans and arrangements, including plan design, drafting, administration and governance. In this regard, Sinead advises on and assists companies with compliance with U.S. federal and state securities and tax laws relating to compensation arrangements, as well as with preparing SEC disclosures, complying with stock exchange rules and addressing non-U.S. tax and regulatory requirements. She has been repeatedly recognized by Legal 500 as a leading lawyer for Executive Compensation and Employee Benefits.

Author

Victor Flores is a partner in Baker McKenzie’s Employment & Compensation Practice, with a focus on Executive Compensation and Employee Benefits. Victor advises global US and non-US companies – both public and private – on all aspects of executive compensation and benefits matters, including the corporate, securities and tax law, and ERISA issues arising in the implementation and administration of compensation programs. He regularly helps clients with the design and implementation of equity and non-equity based incentive compensation programs and nonqualified deferred compensation programs. Victor also has extensive experience advising on compensations and benefits issues in mergers and acquisitions, corporate reorganizations, private equity and other corporate transactions.

Author

Anne Batter is a partner in Baker McKenzie's Tax Practice Group with 25 years of tax experience. She focuses her practice on the tax treatment of executive compensation and fringe benefits arrangements. She also handles excise tax matters, particularly those involving the air transportation excise tax. She previously served as an attorney in the Income Tax & Accounting Division of the IRS’s Office of Chief Counsel and as attorney-advisor with the US Tax Court.