The myStockOptions.com Blog

Million-Dollar Question: A Week After The IPO, What's The Latest On Facebook's Stock Comp?

It's been one week since Facebook's initial public offering. Last month, this blog provided various insights into the company's stock grants and the related tax issues for Facebook employees.

As we mentioned then, and as Facebook's registration statement (page 48) explains, the restricted stock units granted by the company before 2011 will not pay out and fully vest until six months after the IPO. They face two vesting hurdles: time worked at company and a liquidity event (i.e. the IPO). We have seen these types of vesting requirements in grants made by some other pre-IPO companies, such as Twitter (see an FAQ at myStockOptions.com).

Facebook continues to rely on the broad use of RSU grants, though these will vest in the standard time-based way. In the 6th amendment to its S-1 registration statement, the company disclosed that in early May it awarded more than 25 million RSUs in what it termed "employee refresher grants" (see page 78 of the S-1 and an article at the blog TechCrunch).

Now for the million-dollar question (literally). How much wealth has the IPO created for employees at Facebook? How many are now millionaires? According to Aaron Boyd, Director of Research at the compensation research firm Equilar, at the time of the IPO the average paper value of equity per employee was $4.9 million (excluding CEO Mark Zuckerberg's vast holdings). Equilar used the information in the prospectus for the most recently completed quarter for the number of options and restricted stock outstanding as of March 31, 2012, and calculated the values with the IPO price. In an article on May 21, The Washington Post reported that 600 of Facebook's 3,700 employees and 250 former employees will become millionaires, according to PrivCo, a research firm.

The wealth created for senior executives will be much greater. An insider of a company registering stock for the first time under Section 12 of the Securities Exchange Act must file Form 3 under the SEC's Section 16 rules no later than the effective date of the registration statement. It's worth looking at the data in these fillings by Facebook insiders for the stock grants and outright stock holdings and how they are reported with the SEC on Form 3.

For example, the Form 3 for CFO David Ebersman shows he holds 1.2 million RSUs that vest quarterly between early 2012 and early 2019, along with options to buy 4.5 million shares at $3.23 per share. These began vesting in 2010, starting with a fifth of the grant, followed by monthly tranches that will bring the grant to full vesting by 2015. In a footnote, the Form 3 also discloses that the RSUs he holds in which vesting is based on both continued service and liquidity (additional 6.75 million RSUs) are not considered reportable under SEC rules. The Form 3 for COO Sheryl Sandberg also contains new details on her options and RSU grants, such as the vesting provisions. Mark Zuckerberg's Form 3 discloses his stock options, along with the company stock he owns through various trusts (an estate-planning technique to minimize taxes).

When these executives and other senior executives at Facebook get more stock grants or sell company stock, they will have to make filings on Form 4. In addition, sales will also need to follow the SEC's Rule 144 requirements. These will be worth following, as they may reveal some information about individual financial planning, such as whether sales are made under Rule 10b5-1 trading plans, along with showing any changes in Facebook's stock compensation practices after the IPO.

Section 409A Developments Affect Nonqualified Deferred Compensation And Stock Plans

Internal Revenue Code Section 409A, added by the American Jobs Creation Act and provoked by the abuses at Enron, greatly influences nonqualified deferred compensation plans and also has an impact on stock compensation. Any professional involved with these two areas of compensation needs a working knowledge of 409A. Even participants must know about 409A, as substantial penalties for violating its rules fall on the participant and not the company.

myNQDC.com has clearly written, reader-friendly FAQs on Section 409A that reflect the types of questions participants care about. The 409A rules explained in these FAQs, and other content elsewhere on the site, permeate all aspects of nonqualified deferred compensation. For its part, myStockOptions.com features a detailed FAQ on 409A and its impact on stock plans, along with covering certain aspects of 409A in other content. Although initially there was concern about the impact of Section 409A on regular at-market stock option and SARs grants in publicly traded companies, and on employee stock purchase plans, these worries faded after more regulations emerged. However, companies must still be careful about various aspects of 409A to avoid discounted stock options, delays in paying out performance share awards, and mistakes in restricted stock unit plans that allow deferral of share delivery at vesting.

The following Section 409A developments will be of interest to both professionals and participants:

1. W-2 reporting for NQDC. As we explain in FAQs on this topic in the myNQDC.com section Taxes: Reporting, the amount of income deferred during the tax year may be indicated in Box 12 of Form W-2 using Code Y once the IRS has issued more guidance on the point. (For income from a 409A violation, Code Z is currently used.) This guidance—and thus the required W-2 reporting—is not expected for some time, according to Bloomberg BNA's Compensation Planning Journal. It seems that the IRS is currently preoccupied with other proposed and final rules, including the Income Inclusion Regulations that relate to 409A and the penalty calculations.

2. IRS audits. According to the newsletter HRS Insight by PricewaterhouseCoopers the IRS is "now stepping up its enforcement activity" in 409A compliance for nonqualified plans and stock plans. Some areas of IRS attention in corporate audits that could expose costly compliance errors:

• incorrect reliance by companies on the short-term deferral rule in making payouts to avoid 409A consequences
• inappropriate identification of specified employees, a point that matters for various purposes, such as in the six-month delay in payouts to these employees after employment termination
• tax implications of discounted stock options and how the fair market value is set for the exercise price, particularly in privately held companies
• plan documents that do not clearly specify the time and form of payment for deferred amounts, as with an employment agreement's severance provision allowing an employee to elect a lump-sum or installment distribution at termination

Nonqualified Deferred Comp In Kodak Bankruptcy: A Snapshot Of The Latest Proceedings

Bankruptcy is the biggest risk with nonqualified deferred compensation (NQDC) plans, though there are ways to manage and limit it (as we explain in a thorough FAQ and article on our sister website myNQDC.com). The recent Chapter 11 bankruptcy of Eastman Kodak is currently providing a real-world example of the way NQDC is treated after a company goes bust. Back in January, we published an update in this blog about the fate of nonqualified deferred comp in the proceedings carving up the remains of Kodak. Recently, we revisited Kodak to find out what has been happening with executives' interests in its elective nonqualified deferred compensation plan and its excess benefit pension plans.

Since our last update on Kodak, we have learned that the bankruptcy court has told Kodak to form a retirees' committee for purposes of working out of its large legacy costs, including some $1.2 billion in retiree health care and survivor welfare benefits, and an estimated $200 million in nonqualified deferred compensation plans. The committee is expected to have about 15 members selected by the trustee from the names submitted to it by Kodak and the independent Eastman Kodak Retirees Association (EKRA).

We have heard that the former executives, as unsecured general creditors through their unfunded pensions and elective deferred compensation plans, are concerned that the extremely large health care costs for 30,000 retirees will overshadow the obligations due to 1,000 executives in the nonqualified plans. The bankruptcy court will probably allow only one retirees' committee, so the positioning for influence on it is intense. The retirees' committee will be formed in addition to the official unsecured creditors' committee that was put together shortly after Jan. 19, including the Pension Benefit Guaranty Corporation but excluding any representation of retirees' interests.

While the number of executives and the amounts of NQDC at risk are relatively small by contrast with Kodak's overall legacy costs, the deferred compensation participants were the first to feel the sting of reorganization (their payments stopped on Jan. 19 without advance notice or a hearing). For some participants, the loss of deferred compensation payments was around 70% of monthly income. On the other hand, Kodak's motion to eliminate its health care contributions for Medicare eligible retirees was recently rejected by the court over the objections of the unsecured creditors' committee—the scramble is just beginning for remaining assets, which may prove to be elusive after all lenders and other secured lien holders have been satisfied.

For more on nonqualified deferred compensation, see our website myNQDC.com. To receive our next update on Kodak and other topics in NQDC, be sure to register at the website and sign up for our email alerts.

John Lawson, VP of Executive Compensation at Tompkins Financial Advisors and a member of the myNQDC.com Advisory Board, provided input on the Kodak update above.

Stock Compensation At Facebook: What Facebook's SEC Registration Statement Reveals

With Facebook planning to go public next month, its S-1 registration statement is worth perusing for details about its stock plans and some of the tax issues the company and its employees face (other than the obvious fact that they will be very rich and can thus afford the best tax and financial advisors!).

Below are a few of the tidbits that can be gleaned from the SEC filing to go public.

Switch To RSUs; Tax Bill Due

Facebook initially granted stock options to employees during its early days but switched almost entirely to restricted stock units in 2007. RSUs granted by Facebook before January 1, 2011, vest after two conditions: a specified length of employment at the company plus a liquidity event such as an IPO (see page 48). Grants made after that date do not have this liquidity condition, as they vest over four or five years (see page 60). We have been seeing this two-part vesting grant structure at other large pre-IPO companies.

Vesting will occur six months after Facebook's IPO. At that time, employees will owe taxes on the income from these pre-IPO RSUs at ordinary income rates. (In comparison, employees who had stock options before the move to RSUs will see most of the stock's appreciation taxed at capital gains rates, assuming they exercised them more than one year ago.) The company expects that many of its employees with RSUs will see 45% of the value of their shares withheld for taxes (see page 56).

Facebook intends to net-settle the shares at vesting, instead of leaving employees to sell shares for the taxes they owe. To come up with the cash needed to meet its withholding obligations and remit the funds to the IRS, the company plans to sell stock near the settlement date in an amount that is roughly equivalent to the number of shares of common stock that it withholds for taxes (see page 21).

Stock Option Grant Held By Mark Zuckerberg

In 2005 Mark Zuckerberg, the CEO and founder of Facebook, received nonqualified stock options to acquire 120 million shares of Facebook class B (voting) stock (see page 113). These have all vested, and the option term is scheduled to expire on November 7, 2015. With the exercise price of 6 cents per share and Facebook's valuation of over $100 billion, he will owe a giant amount of taxes at exercise. Some of the tax issues he faces are covered in The Federal Taxation Developments Blog.

Company's Tax Deduction & Earnings Charge

The company's tax deduction for the income realized by employees, from both RSU vesting and NQSO exercise, could generate a tax refund of up to $500 million in the first six months of 2013 (see page 63). This attracted attention when Senator Carl Levin again proposed his bill to limit the corporate tax deduction for stock compensation. According to an article on this in The Washington Post, some analysts calculate that the tax savings from stock compensation at Facebook could be much higher than the figures mentioned in the company's registration statement. (Estimates run up to $7.5 billion in deductions, translating into $3 billion in federal and state tax savings.)

According to Amendment 4 of Facebook's S-1 registration statement, as of March 31, 2012, Facebook had $2.381 billion in unrecognized stock compensation expenses on its income statement, with $2.319 billion for RSUs and $62 million for restricted stock and options (see page 53 of Amendment 4). For pre-2011 RSUs that met the first vesting trigger of a service condition on or before March 31, 2012, Facebook will recognize a $965 million expense when it goes public at the start of the IPO (see page 53), though net of income taxes this amount will be $640 million (see page 37 in Amendment 4).

Would Stock Options Have Been Better?

The move to granting restricted stock units instead of stock options may have been better for the company for many reasons, including the prospect of minimizing share dilution, along with the relief of having fewer post-IPO multi-millionaire employees to retain and motivate (well, fewer with gains of $10–$100 million, anyway). Depending on the size of the RSU grants relative to previously made stock options grants at Facebook, a basic calculation shows that, given the stock-price appreciation, employees with RSUs would be sitting on much larger gains if they had received stock options.

Example: Regardless of whether employees exercise options earlier or later after the IPO, the following example shows the potential magnitude of their gains from receiving stock options instead of restricted stock (pre- and post-tax calculations are easy to do with the tools on myStockOptions.com). For this example, let's use the exercise price of 6 cents for the options Mr. Zuckerberg received in 2005 (other employees would have received grants at same price at that time, assuming these were not discounted stock options). Let's assume Facebook granted four times as many stock options as RSUs (the actual ratio may have been much greater). With the current value of Facebook stock at $30.89 (see page 77 of Amendment 4), the following shows the pre-tax gains:

Current gains/spread for grant of 400,000 stock options made in 2005 ($0.06 exercise price): $12.332 million (400,000 x [$30.89 – $0.06])

Grant of 100,000 RSUs: $3.089 million

The blog Inside Facebook also wonders whether Facebook employees would have been better off with options, at least from a tax perspective. While employees would have had the opportunity to exercise shares earlier, when the spread was small, and to start the capital gains holding period sooner, they would also have had to come up with cash to hold the stock while risking the possibility that a liquidity event did not occur.

Given the big tax bills that employees at Facebook will incur, along with the much larger upside they would have realized if they had received stock options instead of RSUs, we wonder whether other pre-IPO companies will rethink whether to grant stock options again. Some private companies use a special type of stock option grant that allows immediate exercise, after which the stock received is subject to vesting. One reason for granting this type of option is to let employees start the capital gains holding period earlier and to allow them to decide when they want to pay the taxes (i.e. early if the options are granted with little or no spread, or later if employees are certain the stock will eventually have real value).

Taxocalypse Now: Major Tax Changes Ahead For Stock Compensation (And Everything Else) In 2013

Now that (hopefully) tax returns are behind us all, attention is shifting toward the sunset of the current tax law at the close of 2012 and the yawning gulf of the unknown that opens beyond that horizon. The post-2012 tax treatment of equity compensation will be swept along amid a comprehensive flood of necessary new legislation affecting all areas of the tax system. A report recently published by the Joint Committee on Taxation in Congress lists the mighty number of tax provisions that are set to expire at the end of this year. (With your filed tax return in hand, you can base planning projections on possible new tax rates in 2013.)

"Taxmageddon"

The upheaval to come is well summarized by a recent article in The New York Times (Coming Soon: "Taxmageddon") by David Leonhardt, the Washington bureau chief of the Times. As the lowered tax rates of the Bush administration, reluctantly extended through 2012 by President Obama, are due to finally expire at the end of this year, the prospect of sudden tax increases for most people across the United States has become both economically and politically alarming on all sides in Washington. Once the November election has decided the future of the White House and Congress, the president and current Congress will have less than two months to agree on an effective new tax law to take the place of the current legislation. "All in all," writes Mr. Leonhardt, "the end of 2012 will be unlike any other time in memory for the federal government." This is why, he explains, aides in Congress have begun bandying the term "Taxmageddon" (and only half in jest). Even the normally unflappable Fed chairman Ben Bernanke has called the approaching changes "a massive fiscal cliff," writes the author, who reports that many economists "are also frightened of what such a sharp shift in government policy might do to a still fragile economy."

The problem of creating a fiscally responsible new tax code is partly economic and social. As Mr. Leonhardt observes, "the [federal] deficit reflects a basic disconnect between the government we have and the taxes we are willing to pay." However, as he adds, much of the difficulty is political: the by now familiar disagreement between political parties about what the changes tax law should be, and what or whom they should affect most. Nevertheless, all observers agree that some type of tax reform is necessary, so it seems we must all brace ourselves.

Tax Rates For Equity Compensation: Whither?

At myStockOptions.com, we are keenly watching for signs of what may happen to the tax treatment of equity compensation and company stock sales on January 1, 2013. President Obama's 2013 budget seeks to extend the current tax rates for everybody whose annual income does not exceed $200,000 ($250,000 for married joint filers) but promises higher tax rates for incomes above that level. For those high earners, rates in 2013 would revert to pre-Bush levels:

• the 33% and 35% ordinary income rates would rise to 36% and 39.6%
• the 15% rate on long-term capital gains would go back up to 20%
• qualified dividends would lose their favorable 15% rate and would be taxed as ordinary income, up to the top rate of 39.6% (this differs from previous budget plans, which proposed to let the lower rate continue)

In addition to these potential rate increases, a new 3.8% Medicare tax on investment income will become effective in 2013. It was adopted with President Obama's law for health-care reform.

Mr. Obama's budget also proposes to replace the alternative minimum tax (AMT) with a simpler tax law for the wealthy. The new law would ensure that people with annual incomes of more than $1 million always pay at least 30% of their income in federal tax. This is the so-called "Buffett" rule, named after billionaire Warren Buffett, who famously pointed out that people who make most of their income from investments (like him) have lower tax rates than many wage-earners who toil for a living (like his secretary). However, this proposed change in the tax code faces a long road of opposition in Congress.

Ending the AMT would help everyone who has incentive stock options, as the spread at ISO exercise is currently part of the AMT calculation. While there are strategies to minimize the AMT, they are a hassle for anybody who exercises ISOs and holds the shares.

Helpful Articles On Financial Planning In An Uncertain Tax Environment

For people with equity grants or deferred compensation, financial planning in 2012 may end up feeling a lot like it did in 2010. There will be uncertainty about future tax rates and probably no decisive action by Congress until after the election in November. However, unlike the situation in 2010, tax change is now much more likely to occur—one way or another. Either the current tax cuts will expire, raising the rates, or the tax code will be reformed altogether. Having already deferred these tough tax-law decisions for two years in 2010, Congress and the White House (whoever has it after the election) will be under much more political pressure this time to find a tax system that is seen to be fair while still having a meaningful chance of reducing the federal budget deficit.

With tax increases in mind, now may be a good time to re-evaluate your current financial-planning strategy. Should you take action with equity awards and company shares now or wait until new rates apply? On myStockOptions.com, see our article series How Tax Rate Changes Impact Your Stock Grant Strategies, in the section Financial Planning: Advanced. The articles provide an analytical framework to help you determine the impact of a tax increase. In general, the analyses and examples in the articles show that, in most situations, the likelihood of higher tax rates in the near future does not on its own make a good reason to exercise nonqualified stock options or sell shares received from restricted stock vesting or an employee stock purchase plan. Even a modest appreciation in your company’s stock price will offset the tax increase.

For people with nonqualified deferred compensation, our website myNQDC.com will be an essential resource this year and beyond. For guidance on decision-making about income deferral with higher future tax rates, the website has much helpful content, including the following:

• Article: The Growing Importance Of Nonqualified Deferred Compensation Amid Rising Tax Rates
• Article: Advantages To Deferring Income In An Uncertain Tax Environment
• FAQ: If my income tax rates will be higher in the future, does it make sense to defer my income this year?

Depending on the length of the deferral period, even with higher future tax rates you typically come out ahead by deferring your salary or bonus, as these commentaries and our NQDC calculator show.

Stock Comp And Tax Returns: IRS Deadline, Extensions To File, And Estimated Taxes

For those who haven't yet filed, the clock is ticking down for federal tax returns. For all taxpayers in the US, the deadline for filing tax returns with the IRS for the tax year 2011 is April 17 (next Tuesday).

In any tax season, the recognition of income from stock compensation or an employee stock purchase plan can complicate your return. Examples include income from an NQSO exercise, an ISO or ESPP disqualifying disposition, or the vesting of restricted stock. However, as regular readers of this blog will know, this tax season has the potential to be more confusing than most if you sold any stock last year. For stock sold during 2011, you must file with your tax return the new IRS Form 8949 along with Schedule D, which has significantly changed upon the introduction of Form 8949. This change stems from the expansion of the information that brokers must report to you on IRS Form 1099-B. For help, including  annotated diagrams of Form 8949 and Schedule D, see the special section of myStockOptions.com called Reporting Company Stock Sales.

IRS Deadline Extensions For Tax Returns

The new IRS forms may cause more late filing than usual this year. If you can't beat the buzzer, you can get an extension of the federal filing deadline by up to six months. No explanation or signature is needed. You can request an extension in any of three traditional ways: on IRS Form 4868, through a paid tax preparer, or via tax-return software. Alternatively, you can also now file an extension online with Free File Fillable Forms, offered by Free File, a private company that works with the IRS.

To enlighten and entertain an expectant public about extensions for tax-return filing, the IRS has uploaded videos on this topic to its riveting YouTube channel, and it has also recorded a podcast delivering the same information.

Note that an extension for your federal tax return applies only to the filing of your return, not to the tax itself, which you must pay by the original IRS filing deadline. Therefore, if you get an extension you must accurately estimate how much tax you must pay by the 18th. By paying 100%, you avoid interest and penalties; if you can't manage that, you can still avoid the penalty by paying 90%. If you owe additional taxes when you eventually file, you will have to pay interest on the unpaid amount going back to the original April due date.

For more details on extensions to file and the penalties for the late payment of taxes, see the related FAQ at myStockOptions.com.

Looking Ahead: Estimated Taxes For 2012

If you expect additional income from stock comp in 2012, and if your salary withholding and the withholding at the statutory rate for supplemental income (25%, or 35% for amounts over $1 million) will be inadequate to cover the taxes you will owe for the full year, you may want to make estimated tax payments (or see if you can adjust your salary withholding). To avoid penalties, be sure that you pay the IRS either 90% of your expected tax bill or 100% of this year's taxes (for adjusted gross incomes over $150,000, it is 110%). Penalties are calculated quarterly, so you must make estimated tax payments in the quarter when you earned the income.

Note: Details of estimated taxes, including the due dates, are discussed in IRS Form 1040-ES, and on myStockOptions.com in the sections NQSOs, ISOs, Restricted Stock, and SARs.

Restricted Stock & RSUs On Tax Returns: How To Avoid Costly Mistakes

Restricted stock, restricted stock units (RSUs), and performance shares bring their own very special issues to tax returns. In addition, this tax season has many more changes in the reporting of stock sales on tax returns than in past years. It is easy to make expensive mistakes that lead to paying more than necessary or (perhaps worse) unwanted IRS attention. This tax season in particular has been more confusing than most because of the new IRS Form 8949 and the corresponding revisions to Schedule D, which has significantly changed upon the introduction of Form 8949. These alterations, in turn, stem from the expansion of the information that brokers must report on IRS Form 1099-B.

In any year, however, there are many potential costly mistakes that can befall taxpayers with restricted stock issues on their tax returns.

One Mistake: Double-Counting Income

When restricted stock vests, even if you don't sell any shares, the value of those shares at vesting will be treated as ordinary income and included in Box 1 on IRS Form W-2 with your other compensation, and in the other boxes for state and local income (see our related FAQ with a diagram of Form W-2). Companies may voluntarily break out the income in Box 14 ("Other").

This Box 14 reporting is not required and is done only to help you understand what part of the income reported in other boxes resulted from the restricted stock. When you fill in the line for "Other income" on your Form 1040 (Line 21 of the 2011 form), don't make the mistake of listing the amount shown in Box 14 of your W-2 or any income already included in Box 1 for stock compensation. That would be double counting.

Instead, you include this value of the stock at vesting on your tax return as part of your salary/compensation income on Line 7 of Form 1040. It's the same for restricted stock units, as long as all the shares are delivered at vesting (see another FAQ on RSUs with deferred delivery of shares).

Another Mistake: Waiting Until The Entire Grant Has Vested

For restricted stock that vests incrementally over a number of years (e.g. 25% per year), you realize and report for each year the W-2 income from the portion that vested during that year. Do not wait till the whole grant has vested—unless, of course, the grant vests all at once (i.e. cliff vesting).

However, if you made a Section 83(b) election (not available for RSUs or performance shares) to pay tax on the full value of the restricted stock at grant, you report the value in that tax year, and thus you do not later report the income from the value of the shares at vesting. Should you have performance shares or units that pay out when certain corporate goals are met (either yearly or at end of cycle), but the payout and share delivery occur in a different calendar year than the achievement of the goals, you report the income for the year in which you actually received the shares (i.e. not in the year when the goals were met).

Complex Topic; Many Potential Mistakes

Believe it or not, the two errors discussed above are just the beginning. Our exclusive article on tax-return mistakes with restricted stock lists a total of 10 common blunders to avoid. Want a quicker read? See the companion FAQ that also explains errors to avoid on tax returns that involve restricted stock, restricted stock units, or performance shares.

In general, the Tax Center at myStockOptions.com is a one-stop shop of information about the tax-return reporting and filing issues presented by stock compensation and employee stock purchase plans, including a special section with annotated diagrams of Form 8949 and Schedule D.

Apple's Stock Plans At The Core Of Its New Buyback And Dividend Program

Last week, Apple Inc. announced new dividend and share-buyback programs. "Combining dividends, share repurchases, and cash used to net-share-settle vesting RSUs," said CFO Peter Oppenheimer, "we anticipate utilizing approximately $45 billion of domestic cash in the first three years of our programs." The extensive news coverage prompted by this announcement has largely ignored the fact that two of the three main reasons for this cash expenditure relate to Apple's stock plans:

• First, Apple will repurchase shares in a three-year buyback program to offset dilution stemming from its stock plans, which currently consist of restricted stock units and an employee stock purchase plan. Apple said that with the buyback it is "neutralizing" the dilution that would otherwise be caused by "future employee equity grants and employee stock purchase programs."

• Second, Apple intends to put part of the cash outlay into paying the withholding taxes for its net-share-settled RSUs. Under this withholding method, employees pay the taxes by surrendering some shares back to the company instead of selling shares to pay the taxes. While this also reduces dilution, Apple must pay the IRS cash for the taxes.

Repurchase programs to reduce dilution are unusual. Few companies buy back shares to offset dilution from employee stock plans (of course, not many companies have Apple's deep pockets). Dilution, rather than the oft-cited noncash earnings charge on the income statement, is really the one true "cost" of equity compensation for shareholders. Companies typically try to manage dilution with an overhang and run rate for their stock plans that are acceptable to investors, particularly the proxy advisory firms such as ISS. Companies with too much dilution and a high overhang rate will find it hard to get shareholders to approve additional shares for new or amended stock plans.

Surprisingly, Apple's buyback has annoyed some observers, such as one commentator who posted an opinion piece at the website Seeking Alpha. This critic thinks it would make more sense for Apple to simply give employees the cash that would be used in the buyback instead of repurchasing stock and separately issuing shares, and adds that this would have the same net effect on the company's finances. Of course, this opinion leaves out one of the main reasons why companies make stock grants in the first place: to align the financial interests of employees with those of shareholders and thus create an ownership culture.

Even the third reason for the $45 billion cash outlay, to fund dividends, has a component that involves Apple's stock plans: the company plans to pay dividend equivalents on unvested restricted stock units and future RSU grants. These will be deferred until the grants vest. According to reports about a financial analysts' call on the dividend and repurchase program, Apple's CEO will, at his request, not receive dividend equivalents on his grant of one million RSUs.

ESPP Mistakes That Can Mess Up Your Tax Return, And How To Avoid Them

The taxation of employee stock purchase plans is confusing. After you sell ESPP shares, the taxes you owe depend on various factors, including the purchase price, the market price at purchase, the price at the start of the offering, the discount, how long you held the stock, and the price at sale. In this blog entry, we present some common tax-return mishaps involving ESPPs and explain how you can avoid them. Understanding these points will help you prevent overpaying your taxes or (perhaps worse) provoking the annoyance of the IRS for underpaying.

Form 3922 Can Help

ESPP purchases in a given tax year are reported on IRS Form 3922 for ESPPs. The form, which your company should issue before the end of the January after the year of purchase, helps you collect information for reporting sales of the shares on your tax return. The forms also give the IRS information about your transactions. For details, see the related FAQ on myStockOptions.com.

Alert: For stock sold during 2011 and later, you must file with your tax return the new IRS Form 8949 along with Schedule D, which has significantly changed upon the introduction of Form 8949. This change stems from the expansion of the information that brokers must report to you on IRS Form 1099-B. The information on Form 3922 can help you calculate the cost basis of your ESPP stock if the cost basis is omitted or too low on Form 1099-B.

Common ESPP Errors On Tax Returns

1. Not filing Form 8949 after an immediate sale of ESPP shares at purchase. With an immediate sale of your ESPP shares at purchase, the discount is reported on your W-2 and on your tax return as ordinary income. Even though you never held the stock (or at least not for long) after purchase, you still need to report this sale transaction on Form 8949 and Schedule D, which are used to report capital gains and losses on all stock sales. You may even have some small gains or losses, depending on how your company calculates the discount at purchase, how long it takes for the shares to become available in your account, and any commissions and fees for the stock sale. For an annotated example showing how you report this on these forms, see a related FAQ on myStockOptions.com.

Alert: If the IRS were to receive a report of your gross sale proceeds from your broker (on Form 1099-B) but without a corresponding report of the sale on your Form 8949, it would think you had failed to report the gain on the sale. Assuming a tax basis of $0, the IRS computers would then automatically send you a notice for the taxes due.

2. Paying tax on the discount too early. Depending on the design of your company's ESPP, Section 423 of the Internal Revenue Code lets you buy company shares through after-tax payroll deductions at a discount of up to 15% off the fair market value of your company's stock. You should not include the discount as part of your taxable income for the year of purchase unless you also sold the shares in the same year. When you don't satisfy the ESPP holding periods, you have compensation income in the year of sale equal to the spread at purchase, i.e. the difference between the fair market value of the stock on the purchase date and the discounted price you actually paid for it.

For sales of stock from ESPPs that are not tax-qualified under IRC Section 423, the taxation, along with the potential reporting mistakes, is similar to that for NQSOs. The income would be reported, and would appear on your W-2, in the year of purchase, regardless of whether you sell the stock. See the section ESPPs: Taxes Advanced for details and examples.

3. Directly using what appears as the cost basis on your Form 1099-B. The expanded Form 1099-B does not need to report the compensation element of your cost basis, and the basis does not need to be included for stock that was purchased before 2011 (see a related article for details). This means you must check the accuracy of the basis and make any necessary adjustments in the 1099-B data that you transfer to Form 8949.

Alert: If compensation income is not part of the tax basis reported in Box 3 on Form 1099-B, make an adjustment in column (f) of Form 8949 and add code B in column (b). Should Box 3 be blank, report the full basis in column (f).

See the section Reporting Company Stock Sales for annotated diagrams of Form 8949 for ESPP stock sales.

Only The Beginning

For six other tax-return blunders involving employee stock purchase plans, see the FAQ on myStockOptions.com that gives full coverage to this topic. Need more background before you proceed? Listen to an engaging summary of basic ESPP concepts in our podcast about employee stock purchase plans. For a general overview of the new developments in IRS forms and reporting for the 2012 tax season, see our special tax-season video.

2012 Tax Season: The Trickiest Ever? Brace Yourself With The Tax Center At myStockOptions.com

"This tax season has the potential to be more confusing than most if you sold any stock last year." This dire warning begins the article Avoid Tax Return Mistakes With Stock Options & ESPPs: What You Need To Know In 2012, a centerpiece article in the award-winning Tax Center at myStockOptions.com. A companion article on tax returns with restricted stock and RSUs starts with similarly ominous augury.

The point is no exaggeration. Even in a normal tax season, IRS forms and reporting rules are confusing enough. However, for people with stock compensation who sold shares in 2011, the 2012 tax season presents its own very special complications. Starting this tax season, the IRS Form 1099-B sent by brokers includes not only the gross proceeds from stock sales but also:

• their cost basis (also called the tax basis)
• the date when the shares were acquired
• whether gains or losses were short-term or long-term

For people who sold shares in 2011 that were acquired through equity compensation, these stock sales carry an extra twist in their cost basis. In fact, cost-basis reporting in general is now more complex, confusing, and vulnerable to errors. And that's not all: the changes in the 1099-B information also required a complete revamp of the tax-return forms used to report stock sales. To report a sale of shares on your tax return, you must now complete the new IRS Form 8949 along with Schedule D, which has significantly changed upon the introduction of Form 8949.

These tricky innovations make it all the more important to be aware of costly mistakes in other areas of tax-return reporting that might otherwise slip by somebody trying to figure out Forms 1099-B or 8949. The two articles mentioned above present a comprehensive list of perennial potential errors involving stock comp that it is all to easy to make on tax returns even at the best of times. When you combine these flagship articles with our article and FAQ on the newly expanded 1099-B, our FAQ on figuring out cost-basis reporting on Form 8949, and our special FAQs featuring annotated diagrams of Form 8949 and Schedule D, you will start out well prepared in this most trying of tax seasons.

Want To Enhance Participant Protections In Nonqualified Deferred Compensation Plans? New Article Has Expert Ideas

As we pointed out in the context of the recent Kodak bankruptcy, nonqualified deferred compensation (NQDC) plans always involve some risk, even at high-profile companies. At our sister website myNQDC.com, some of the protections that NQDC participants can seek from their companies are outlined in a new article by noted compensation and benefits expert Michael Melbinger, a partner at Winston & Strawn and a member of the myNQDC.com Advisory Board. (See Added Protections To Look For In Your Company's Nonqualified Deferred Compensation Plan.)

The article starts by pointing out the most important factor to consider: all contributions and benefits under the NQDC plan will be subject to claims of the company's creditors if the company becomes insolvent. Nothing in the plan document can fully protect you from that. However, some NQDC plans contain features, such as a rabbi trust, that can increase the likelihood that you will receive your benefits even if the company suffers financial difficulty.

In addition, the article adds, you also should review your company's NQDC plan and related documents to determine the circumstances under which you can forfeit your benefits even if your company remains financially sound, and to understand what would happen in a merger or acquisition. NQDC plans are not subject to the same minimum vesting rules that apply to tax-qualified retirement plans regulated by ERISA. Therefore, you should become familiar with any special longer vesting provisions that are common with company contributions or matches.

To address these concerns, the author presents plan and design provisions you can try to negotiate for in an employment agreement, which can specify or alter the terms of the company's NQDC plan in certain situations. For example, you can try for some type of protection against the risk that the plan or its operation may not be in compliance with Section 409A. This provision might require your company to amend the plan or indemnify you to cover any penalties or additional taxes owed. The article also suggests negotiating for the right to an immediate lump-sum distribution of your account upon certain triggering events allowed by 409A, such as death, disability, or a change in control.

For details of the related protections, see the article at myNQDC.com. Meanwhile, Mr. Melbinger's extensive knowledge of executive comp and employee benefits is available almost daily at the superb Melbinger's Compensation Blog.

Insider Trading: A Daily Risk For Companies With Stock Plans

Insider trading is an almost daily problem in the US capital markets: the Financial Industry Regulatory Authority (FINRA) annually hands the SEC about 250 potential cases of insider trading—an average of one case every market day. Not surprisingly, the issue is seldom far from the news headlines. The latest outbreak of interest centers on a federal investigation into a rash of suspected and alleged insider tipping and trading at the prestigious securities firm Goldman Sachs.

As we have written before in this blog, the best remedy against insider-trading violations at any company is prevention. By its very nature, stock compensation can be on the front lines of insider-trading potential, and companies should do all they can to prevent insider trading and be prepared to demonstrate their compliance efforts. The core of this is education. At myStockOptions.com, companies and stock plan participants have a superb resource in the SEC Law section of the website. This includes not just clearly written articles and FAQs but also an interactive quiz, to test what you've learned, and an engaging podcast that you can download and listen to if you get tired of reading. Certified Equity Professionals and Certified Financial Planners can earn continuing education credit by taking the advanced course and exam on SEC law and insider trading.

One proven means of corporate compliance that companies routinely adopt is showing employees educational videos on preventing insider trading. The leading resource in this field is the Think Twice video series, which was produced by our sister company Brumberg Publications and recently celebrated its 20th anniversary. At once entertaining, informative, and sometimes downright scary, the videos make superb use of scripted dramas and SEC interviews to clearly portray the rules against insider trading, along with the harrowing ordeal of an SEC investigation and its potential consequences.

For fun trailers of all three videos in the series, see the Think Twice channel on YouTube, or watch the preview of Think Twice: The Sequel right here:

Despite Overall Slight Decrease, ESPPs Remain Common At High-Tech Companies

What is the state of employee stock purchase plans today? For people (like us) who love survey data, the National Association of Stock Plan Professionals recently shed some light on ESPP usage. In its 2011 Domestic Stock Plan Administration Survey, the NASPP found that the percentage of responding companies which have ESPPs (52%) was slightly lower than it was in its prior survey, in 2007 (60%). Of the companies without an ESPP, 9% reported that they had eliminated their ESPP since the 2007 survey. However, among the companies with ESPPs, 8% reported that their ESPP was new within the prior three years. ESPPs are most common in the high-tech sector (72% of high-tech companies) and lowest in the manufacturing sector (29%).

The NASPP survey reported that 82% of the surveyed companies had tax-qualified ESPPs in 2011, an increase of five percentage points over the figure in 2007. While only 24% had nonqualified plans, this figure has risen from just 9% in 2004.

For Section 423 ESPPs, the most common length of offering period in the 2011 survey is, by far, six months (53%). The next most common length is three months, a distant second at 19%. Interestingly, the once more common 12-month offering period now occurs at only 11% of the surveyed companies, and a 24-month period is even scarcer (9%). These trends indicate some small effort to reduce the FAS 123(R) expense. For nonqualified ESPPs, the most common lengths of offering period are three months (31%) and six months (27%).

For more survey data showing ESPP trends, see the FAQ on the topic at myStockOptions.com. If you're not familiar with ESPPs, take a few minutes to hear our fun introductory podcast (The Basics of ESPPs). And if you think you know your ESPP stuff, try your hand at our interactive ESPP quiz

Buckle Up: 2012 Tax-Rate Uncertainty May Be A Wild Ride For Stock Compensation & Nonqualified Deferred Comp

Although nobody expects it will survive this election year in its current form, President Obama's budget for the 2013 fiscal year was recently published by the White House. It is the first line to be drawn in the mighty battle over taxes predicted to rage later this year, as the sun (once again) sets on the tax rates that were enacted under President Bush in 2001 and 2003 and then extended for a further two years by Congress in 2010. To anybody familiar with Mr. Obama's tax policies, the 2013 budget contains few surprises—in fact, it closely resembles his ill-fated 2010 budget, which lost out to the extension of the tax cuts through 2012.

Basic Policy Outline

Like its predecessor in 2010, President Obama's 2013 budget seeks to extend the current tax rates for everybody whose annual income does not exceed $200,000 ($250,000 for married joint filers) but promises higher tax rates for incomes above that level. For those high earners, rates in 2013 would revert to pre-Bush levels:

• the 33% and 35% ordinary income rates would rise to 36% and 39.6%
• the 15% rate on long-term capital gains would go back up to 20%
• qualified dividends would lose their favorable 15% rate and would be taxed as ordinary income, up to the top rate of 39.6% (this differs from previous budget plans, which proposed to let the lower rate continue)

In addition to these potential rate increases, a new 3.8% Medicare tax on investment income will become effective in 2013. It was adopted with President Obama's law for health-care reform.

End Of The AMT?

A fresh twist in this budget is a proposal to replace the alternative minimum tax (AMT) with a simpler tax law for the wealthy. The new law would ensure that people with annual incomes of more than $1 million always pay at least 30% of their income in federal tax. This is the so-called "Buffett" rule, named after billionaire Warren Buffett, who famously pointed out that people who make most of their income from investments (like him) have lower tax rates than many wage-earners who toil for a living (like his secretary). However, this proposed change in the tax code faces a long road of opposition in Congress.

Ending the AMT would help everyone who has incentive stock options, as the spread at ISO exercise is currently part of the AMT calculation. While there are strategies to minimize the AMT, they are a hassle for anybody who exercises ISOs and holds the shares.

Helpful Articles On Financial Planning In An Uncertain Tax Environment

For people with equity grants or deferred compensation, financial planning in 2012 may end up feeling a lot like it did in 2010. There will be uncertainty about future tax rates and probably no decisive action by Congress until after the election in November. However, unlike the situation in 2010, tax change is now much more likely to occur—one way or another. Either the current tax cuts will expire, raising the rates, or the tax code will be reformed altogether. Having already deferred these tough tax-law decisions for two years in 2010, Congress and the White House (whoever has it after the election) will be under much more political pressure this time to find a tax system that is seen to be fair while still having a meaningful chance of reducing the federal budget deficit.

With tax increases in mind, now may be a good time to re-evaluate your current financial-planning strategy. Should you take action with equity awards and company shares now or wait until new rates apply? On myStockOptions.com, see our article series How Tax Rate Changes Impact Your Stock Grant Strategies, in the section Financial Planning: Advanced. The articles provide an analytical framework to help you determine the impact of a tax increase. In general, the analyses and examples in the articles show that, in most situations, the likelihood of higher tax rates in the near future does not on its own make a good reason to exercise nonqualified stock options or sell shares received from restricted stock vesting or an employee stock purchase plan. Even a modest appreciation in your company’s stock price will offset the tax increase.

For people with nonqualified deferred compensation, our website myNQDC.com will be an essential resource this year and beyond. For guidance on decision-making about income deferral with higher future tax rates, the website has much helpful content, including the following:

• Article: The Growing Importance Of Nonqualified Deferred Compensation Amid Rising Tax Rates
• Article: Advantages To Deferring Income In An Uncertain Tax Environment
• FAQ: If my income tax rates will be higher in the future, does it make sense to defer my income this year?

Depending on the length of the deferral period, even with higher future tax rates you typically come out ahead by deferring your salary or bonus, as these commentaries and our NQDC calculator show.

Got Eight Minutes? Get The Facts On The New IRS Forms & Reporting For Stock Sales

If there's a way to make learning about tax forms fun, we'll try it. In the Tax Center at myStockOptions.com, we just published an animated presentation on the expanded IRS Form 1099-B, the new IRS Form 8949, and the revised Schedule D. It's a painless way to learn these important developments and prevent expensive mistakes on tax returns during the imminent tax season.

In a concise, engaging overview, our editor-in-chief Bruce Brumberg will inform you about:

• the expanded reporting on Form 1099-B, and why the reported cost basis may be wrong or omitted
• how to figure out the right cost basis for your stock sales
• the new Form 8949 and how to report stock sales on it
• how to interpret Form 1099-B when completing Form 8949
• what to do when the cost basis in Box 3 of Form 1099-B is too low or not given
• totaling the reported stock sales on the revised Schedule D

Need further information? There's plenty more where that came from. A new article and FAQ at myStockOptions.com give full coverage of these tax-return topics. Additionally, our special section Reporting Company Stock Sales presents FAQs with annotated diagrams of Form 8949 and Schedule D. Each FAQ explains and illustrates a different reporting situation involving stock options, restricted stock, restricted stock units, performance shares, employee stock purchase plans, or stock appreciation rights. Clear instructions and diagrams show how to complete the forms, whether the cost-basis information on Form 1099-B is accurate, too low, or omitted.