Equity Compensation and Payroll Reporting Obligations

1. Equity Compensation and Payroll Reporting Obligations Merianne White, CPP CEP Rainier Chapter Meeting January 21, 2016

2. Overview • Equity and Common Equity Instruments • Communication Flow • Principle of Constructive Payment • Tax Trigger Terminology • Reporting and Remittance Timing • Penalties for Late Remittance • What You Can Do Now

3. What is Equity? Executive hiring and retention tool Broad-based grants in tech startups Potentially substantial supplement to salary Customary equity instruments: • Stock grants, usually at zero cost Stock awards (RSA, PSA) Stock units (RSU, PSU) • Stock options, usually at Market price Incentive Stock Options (ISO) Nonqualified Stock Options (NQ/NSO) See PS Section 3.4-24: Stocks and Stock Options

4. Equity Instrument Comparison

5. Cross-Functional Communication

6. Information Flow Tax deposit & reporting; W-2 creation Grant, price, vest schedule, expiration; communication b d a Grant authorization; management reporting c e 1099-MISC Nonemployees, Directors Trade details; cash disbursement

7. Principle of Constructive Payment Under the principle of constructive payment, an employee is considered to have been paid when the wages have been made available to the employee without “substantial limitation or restriction.” See PS Section 6.1: The Principle of Actual or Constructive Payment

8. Tax Trigger Terminology Vesting Lapse of “substantial risk of forfeiture” IRC Section 83(b) tax election Accelerates tax liability to grant date instead of vesting date; must be filed <30 days from grant date Deferral of Compensation/Section 409A Per Plan, Agreement, and/or Notice provision; FICA due at vesting, FITW due at transfer See PS Section 3.4-24: Stocks and Stock Options

9. Tax Remittance Timing When shares are made available, withholding is due to IRS per semiweekly deposit schedule One-Day Deposit Rule (>$100,000) Employee Federal, Social Security, Medicare, Employer Social Security and Medicare Tax remittance due 1-3 days from triggering exercise/trade date See PS Section 8.2-1: Payroll Tax Deposit Rules

10. Timely Remittance of Taxes from Equity Transactions IRS will allow a Trade Date+3 closingof the transaction for broker-assisted option exercises before transaction is deemed closed; see Field Directive dated March 14, 2003 IRS will not allow the same lag time on the taxes due on full value award vesting events (RSAs and RSUs); withholdings are due the next day So, deposit when withholding accumulates to $100,000, unless… Restricted Stock/RSU (next day), or; Broker-assisted option exercise (TD+3)

11. Reporting and Remittance Example

12. Penalty Example

13. Penalties for Late Remittance If late 5 days or fewer, penalty is 2% of the tax If late 6 to 15 days, penalty is 5% of the tax If more than 15 days late, penalty is 10% of the tax Individuals in the company that are responsible to make these payments can also be found to be liable for the tax If non-payment is deemed to be intentional, individuals can be held criminally liable

14. Penalty Calculation

15. Penalty Mitigation

16. What You Can Do Now Work closely to help your equity group to understand the transaction date and the resulting required remittance obligations Communicate remittance rules; propose mitigation Review your tax rates annually and periodically to ensure correct withholding Communicate YTD income and withholdings to your equity administrator or application in a timely manner (e.g., after each pay period)

17. Form Examples

18. Form W-2 for NQSO Reporting The gain from nonqualified stock option exercise is totaled on the W-2 with other income in the following boxes: Box 1: Wages, tips, and other compensation Box 3: Social Security wages (up to the income ceiling) Box 5: Medicare wages and tips Box 16: State wages, tips, etc. (if applicable) Box 18: Local wages, tips, etc. (if applicable) Box 12 (Code V)

19. Form W-2for ISO Disqualifying Disposition Reporting For an ISO exercise in which you hold the stock (i.e. not a cashless exercise/same-day sale), your Form W-2 does not include the value of the spread. The spread value appears on the W-2 only when you make what is technically called a disqualifying disposition*. It is reflected on the W-2 as compensation income (without any reduction for fees and commissions) in: Box 1: Wages, tips, and other compensation Box 16: State wages (if applicable) Box 18: Local wages (if applicable) * When you sell or gift the stock before you have met the required holding periods of one year from exercise and two years from grant, the preferential tax treatment is forfeited. • Companies may voluntarily report the income from ISO DDs in Box 14 ("Other").

20. Form 3921 for ISO Exercise Reporting Incentive stock option exercises in a given tax year are reported on IRS Form 3921 and delivered by January 31st the following year (e.g., Forms 1099 & W-2). The form helps you collect information for reporting sales of ISO shares on your tax return. It also helps in the AMT calculation at exercise. The IRS receives a copy of the form, ensuring that it knows about your ISO exercise and therefore any AMT triggered by the exercise income. An annual survey is required to report when the ISO is subsequently sold for Corporate Tax purposes.

21. Form W-2 for Restricted Stock Unit Reporting RSUs result in ordinary income when the grant vests and shares are delivered. Compensation is the fair market value (FMV) of the stock at vesting multiplied by the number of shares vested. The income is reported on Form W-2, as follows: Box 1: Wages, tips, and other compensation Box 3: Social Security wages (up to the income ceiling) Box 5: Medicare wages and tips Box 16: State wages(if applicable) Box 18: Local wages (if applicable) The amount withheld in connection with your RSUs is included, when appropriate, in Boxes 2, 4, 6, 17, and 19. • Companies may voluntarily report the income from RSUs in Box 14 ("Other").

22. Form W-2 for Performance Stock Unit Reporting Performance shares result in ordinary income when the grant vests after specified targets are reached and shares are either delivered or paid out. Compensation is the FMV of the stock at vesting (or when vested shares are paid out after targets are reached) multiplied by the number of shares vested. The income will be reported on Form W-2, in the totals of your other income, as follows: Box 1: Wages, tips, and other compensation Box 3: Social Security wages (up to the income ceiling) Box 5: Medicare wages and tips Box 16: State wages (if applicable) Box 18: Local wages (if applicable) • Companies may voluntarily report the income from PSUs in Box 14 ("Other").

23. Form 1099-MISC for Nonemployees Nonemployees (e.g. Directors, consultants, independent contractors) receive this for to report income/compensation. It is similar in concept to the W-2 for employees. Withholding does not apply when nonemployees exercise NQSOs. The spread at exercise is compensation for services; therefore, self-employment tax, along with state and federal income tax, applies when you file your tax return. The income is reported on Form 1099-MISC, as follows: Box 7: Nonemployee compensation

24. Resources Wright, Alison, et al. The Stock Options Book. 16th ed. Oakland: The National Center for Employee Ownership, 2015 American Payroll Association: www.americanpayroll.org E*TRADE Financial Services: www.etrade.com MyStockOptions.com: www.mystockoptions.com National Association of Stock Plan Professionals: www.naspp.com National Center for Employee Ownership: www.nceo.org Merianne White: meriannewhite@gmail.com