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Obituary for Equity Compensation

Stock Options, Restricted Stock Units, young Performance Units and their cousin Non-Qualified Deferred compensation tragically died in 2017 as an unintended consequence of colliding with the 429 page U.S. tax reform called the ‘‘Tax Cuts and Jobs Act.’’ It should be noted that Employee Stock Purchase Plan is currently in critical condition at a local hospital.

Stock Options had lived an exciting and robust life since the 1980s. Friends and associates attribute the success of their business and the growth of nearly all technology we enjoy today to Stock Options.

Restricted Stock Units, fondly remembered as “RSUs,” had recently provided stability to the family. After gaining prominence in the early 2000s, RSUs had recently become a leader in the family.

Performance Units were just youngsters at the time of the accident. Vibrant and imaginative, their creative approach was an inspiration to companies and investors looking to build a brighter, more just, tomorrow. Their surprising loss will change the course of history for years to come.

Non-Qualified Deferred Compensation (“NQDC” to its friends), a beloved cousin, lived a quiet life at edges of the family. While less well-known, NQDC was a vital component for many of its supporters.

Also impacted by the accident was Employee Stock Purchase Plans (ESPP). ESPP is a beautiful blend of many of the best features found in other members of the family. A favorite of a broad section of the population, ESPP’s mission was to provide an uplifting experience to the “regular folks” who often did not get a chance to meet other family members. ESPP is currently on life-support, with no additional information available at the time this was written.

The Equity Compensation family was often misunderstood, but lived to make people more successful. They enjoyed spending time with small, private companies in need of a spark for growth and well-known public companies working to provide the tools, system, medicine and other advancements that make the world a better place. Their extended family has moved all over the world and remain exciting contributors to the success of individuals in nearly every country on the planet. The loss of Equity Compensation in the United States will put all of us at a disadvantage in the competitive future.

Please visit https://waysandmeansforms.house.gov/uploadedfiles/bill_text.pdf to learn more and send the family online condolences.

Comments from friends and associates:

Baker McKenzie“Time-vested restricted stock units (RSUs) that are paid out when the employee meets the time-vesting conditions will continue to be taxed at vesting.  It will no longer be possible to defer taxation until delivery of shares following the vesting date, unless the conditions of the short-term deferral exception are met, which are more narrow under the bill than they are under the current rules under section 409A.  In addition, RSUs that provide for continued vesting in case an employee becomes retirement eligible (or terminates due to retirement) will be subject to federal income tax (as well as FICA taxes) upon reaching retirement eligibility.  This likely means that such a provision would not be advisable going forward.”

Pay Governance“The proposed tax reform would “subject all compensation to tax when it is no longer subject to a substantial service obligation, essentially eliminating NQDC arrangements and impacting incentive plan designs, nonqualified retirement benefits, and severance arrangements.”

Performensation“Performance Stock Units will no longer be viable since they would be taxed at the date of Grant. Even if a time-based vesting element was added it would only delay income and taxation until the time-based was achieved. This would effectively kill the common practice of linking the vesting of pre-IPO grants to a reasonable liquidity event that could be used to help cover employee taxes.”

The proposed tax reform bill of 2017 would eliminate many of the time-tested and successful components of equity compensation, effectively removing one of the three legs of many companies’ three-legged stool of compensation philosophy.

Under the proposed rules:

  • Appreciation vehicles such as stock options and SARs would be taxed at vesting, instead of at the time of exercise. This would effectively shorten their useful lives from potentially 10 years to perhaps 4 or 5 years. It would also make the use of these tools for pre-IPO or other illiquid companies too risky to be a recommended practice.

  • Full value vehicles like RSUs, would be taxed much as they are today, but with far less flexibility in deferring income or linking vesting to performance conditions.

  • Performance vested awards would be taxed immediately, instead of at the time of performance achievement and associated vesting. While these are currently investors’ preferred tool for executive long-term incentives, the change in taxation would make them a punitive form of pay beginning in 2018.

  • It appears that all outstanding equity would be subject to these rules as of January 1, 2018. This would result in changes for both companies and employees that would include the death of long-term motivation and retention tools, immediate taxation for employees, acceleration of expense associated with all equity-based incentives and much, much more.

It is essential that every executive, Compensation Committee, HR professional, compensation professional, and finance or accounting professionally review, internally and with advisors, the impact and process for surviving these new rules. Every company who is concerned should immediately contact their representatives and work together to correct these oversights or errors in the tax reform bill.

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