In June 2016, section 159 of the tax code was amended by section 162(m) of the Tax Cuts and Jobs Act (TCJA) (commonly referred to as the “Tax Cuts and Jobs Act”). This section affected a number of tax provisions that govern the treatment of qualified prior-year compensation. Specifically, the TCJA generally recognized an exception to certain limitations in section 162(m) (which imposes a $500 income limitation for certain specified tax credits) for certain qualified performance-based compensation, such as stock options. The TCJA generally recognized an exception to the tax law that is generally imposed on certain qualified annuity payments. We will refer to such prior-year compensation as “qualified vesting of stock-based awards.”
Qualified vesting of stock-based awards generally requires that stock-based compensation be given to the executive only when certain conditions are satisfied. Section 162(m) provides that a CPA must retain a reasonable percentage of the total value of the stock options granted within the four-year vesting period. For purposes of determining whether an executive retained his or her “reasonable” amount of stock-based compensation, section 162(m) does not apply to a qualifying vesting of stock-based compensation, provided the executive retains an appropriate percentage of the total value of the stock options granted within the vesting period.
Exceptions to the Limitations in Section 162(m)
The TCJA generally recognized an exception to the tax law that is generally imposed on certain qualified annuity payments. Specifically, the employee retention credit is not available for a CPA who sells or otherwise disposes of qualified annuities or annuity-related payments within the four-year vesting period, because such CPA retains only a reasonable portion of the annuity payments given when a qualifying vesting of stock-based compensation occurred, as described below.
The TCJA generally recognized an exception to the tax law that is generally imposed on certain qualified annuity payments. Specifically, the employee retention credit is not available for a CPA who sells or otherwise disposes of qualified annuities or annuity-related payments within the four-year vesting period, because such CPA retains only a reasonable portion of the annuity payments given when a qualifying vesting of stock-based compensation occurred, as described below.
Qualified vesting of stock-based compensation must occur within a reasonable time. This requirement is generally met by companies that provide for the vesting of stock options in connection with the grant of performance-based stock options, so long as the four-year vesting period begins before the vesting date of the new stock-based award and the employee remains eligible for the stock-based award for the vesting period.
The requirement is generally met by companies that provide for the vesting of stock options in connection with the grant of performance-based stock options, so long as the four-year vesting period begins before the vesting date of the new stock-based award and the employee remains eligible for the stock-based award for the vesting period. The applicable percentage is the number of shares of stock received when the stock-based award was granted.
For purposes of vesting a qualified vesting of stock-based compensation, a CPA is deemed to have received the full value of the stock option, unless the employee forfeits, in whole or in part, all the shares that have been held in an account, or be quested to a trust or other entity, to vest in the grant date of the new stock-based award. For example, if an employee receives 100 shares of stock for the new stock-based award, then he or she will be deemed to have received a 100 percent (or $100 per share) value of the stock option granted as a qualified vesting.
Qualified vesting is not limited to issuing a qualifying stock-based award. It applies to any sales or other distribution of securities to satisfy the payment of qualified dividends, or to satisfy other conditions, but does not apply to purchases of common stock for the purpose of avoiding the vesting of equity compensation awards.
Employee Retention Credit for Stock Options
The definition of the vesting period is included in the Internal Revenue Code at 31 U.S.C. Section 1104(h)(2)(B)(ii), while the closing date for any vesting of qualifying Employee Retention Credit for stock options is generally 12 months prior to the beginning of the new vesting period of the stock-based award. In general, for purposes of the Employee Retention Credit, any restricted stock issued to an employee that remains unexercised for a year or more is included in the vesting of Employee Retention Credit. The effect of the Employee Retention Credit will generally be to reduce the amount of stock required to be issued to vest in order to satisfy the stock option grant if the employee remains in his or her job. In this case, the employee is entitled to receive a portion of the value of the employee-specific award (or an amount determined in accordance with the Internal Revenue Code) based on a vesting schedule based on the four-year vesting period.
For example, if the employee has been employed by the company for a minimum of 24 months, and has exercised a stock option, and has remained employed for a minimum of 12 months, the vesting schedule will generally result in the employee receiving a share of the Employee Retention Credit equal to 15% (or $15,000) of the maximum amount of Employee Retention Credit that would otherwise be available to the employee. In addition, the employee will be entitled to a refund equal to the lesser of either 15% (or $15,000) of the maximum amount of Employee Retention Credit that would otherwise be available to the employee or 25% (or $5,000) of the exercise price of the stock option.
Note: If a stock-based award vested on the grant date of a qualified stock-based award must be, in fact, exercised in the first fiscal quarter of the following calendar year, the four-year vesting period begins before the vesting date of the new stock-based award and the employee remains eligible for the stock-based credit.
Example: Al is an employee of XYZ, Inc., and has been with the company for the past 4 years. During his time with the company, he has purchased 300 shares of XYZ stock at an exercise price of $10 per share for a total purchase price of $60,000. After the new stock-based award was granted, it became vested immediately. The new stock-based award was not required to be exercised by the date of grant because it would have expired on the anniversary date of the grant (after one full year had elapsed) under the conditions of this definition.
Al has been an employee for a minimum of one year (the one-year anniversary date of the new stock-based award), and during that time has exercised or forfeited the exercise of no more than 150 shares of stock for a total of $40,000. Since this time he has not been employed by the company, his interest in XYZ has not vested, and he is not eligible for the Employee Retention Credit because the employee will be entitled to receive a refund equal to the lesser of 15% ($10,000) of the maximum amount of Employee Retention Credit that would otherwise be available to the employee or 25% ($5,000) of the exercise price of the stock option, or the difference between the exercise price and the minimum $10 per share amount.
Recall that in some instances, stock-based awards are not “vested” and do not require a particular trigger event to vest. There are some cases when companies are able to award awards that are not “vested.” In those situations, you can receive a refund equal to the lesser of the exercise price of the stock option or $10,000, the difference between the exercise price and the minimum $10 per share amount. If you receive a stock-based award for the first time or if the award vests on or before a date listed in the Internal Revenue Code, but you subsequently have to exercise it (or forfeit the option), the stock-based award will remain vested. If it is granted for a vesting schedule longer than 4 years (on or after the vesting date), it will only take effect when you exercise the award.
If an employee who had a stock option exercised the stock option to acquire shares of XYZ stock and is no longer with the company, the exercise of the stock option will also affect the employee’s employer share of the Employee Retention Credit. For the period in which the employee was with the company, the company will be entitled to a refund equal to the lesser of 25% (or $5,000) of the employee’s exercise price of the stock option or $5,000. However, if the employee received a new stock-based award within the first fiscal quarter of the year the option was exercised, the new award will remain vested until the employee exercises the new award or the employee forfeits the option. The employee’s employer share of the Employee Retention Credit will therefore be equal to 25% of the employee’s exercise price or $5,000, whichever is less.
Why ERC Is Not A Common Benefit?
Although the Employee Retention Credit is frequently used by companies as a way to attract and retain their best employees, it is not a common benefit offered to employees, and many employees do not have any way of obtaining it. As you have seen, the Employee Retention Credit is typically based on the employee’s salary for a particular year, and the company’s ERC will be dependent on the employee’s salary for that year.
In most cases, the ERC will not be available to employees if the employee leaves the company before the end of that year. However, if the employee does leave the company, the ERC will still be available if the employee leaves within the first year following the vesting date of the award. This means that if you have to exercise an award on or before the date it vests, you can still potentially receive the ERC even if you resign with less than 18 months left on your contract.
What It Means For You
The Employee Retention Credit is only available to employees, and therefore only employees can obtain the ERC. In many cases, ERC is not a common benefit, and therefore few, if any, employees have any way of obtaining it. You need to know about the ERC before applying for a job. As we mentioned above, the Employee Retention Credit is contingent on the employee leaving the company within one year of the vesting date of the award.
Because the IRS applies the ERC to the employee’s salary, if the company does not have a common benefit that provides the same amount to all of its employees in the same year, the ERC may not be available to employees. If this is the case, you may be able to obtain an ERC by using either an accumulated earnings exclusion or a flat salary deduction. These exemptions are given on an annual basis, so if you are able to obtain one of these deductions for the year you are considering exercising the stock option, you can use that deduction to get the ERC.
If you are unable to take an accumulated earnings exclusion for the year that you are using to obtain an ERC, you can use the cash value of the option to apply for an ERC. This will be taxed in the same way as any other bonus. You should be aware that if you apply for the ERC on a stock option that is exercise-eligible, you can only get the ERC if the company exercises the option. If the option is not exercise-eligible, the employee will not receive the ERC.
Only the employee and the employer are entitled to a credit for an exercise price adjustment. You will not receive a credit if you exercise the option with the purpose of giving the stock to the company. The IRS may determine that a company’s ERC has to be approved by the IRS before it can be used in this manner.
The ERC was intended to provide employees with additional financial incentives to retain their best employees. Because of this, the IRS carefully scrutinizes the criteria used in calculating the ERC, and if it finds any errors, it will do its best to fix those errors. Although it is not guaranteed, in most cases the IRS will approve an ERC if the employee has no other means of acquiring the ERC.
The ERC is also only available for the stock option award value, not the market price of the stock. The IRS only considers the cash value of the stock when calculating the ERC, not the market value of the stock. Have you ever had to decide between a small signing bonus and the ERC? How did you make the decision?