Compliance Made Easy: Internal Revenue Service (IRS) Regulations and RSUs‍

Casey Fenton

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December 7, 2023

Picture this: John, the owner of a rapidly growing tech startup. He's just received a letter from the Internal Revenue Service (IRS), and it's not the kind of correspondence any business owner wants to see. John's heart races as he reads somewhere along the lines of “Potential Penalties for Non-Compliance."

His mind races back to the moment when he first decided to offer Restricted Stock Units (RSUs) to attract and retain top talent in his company. At the time, it seemed like a fantastic incentive, a golden opportunity to reward his dedicated employees. Little did he know that the path to compliance with IRS regulations on RSUs would be challenging.

Now, faced with the looming threat of substantial fines for non-compliance, John realizes the magnitude of his predicament. This article will equip you with the insights needed to ensure compliance, minimize tax burdens, and ultimately thrive in the world of RSUs.

What are The Important IRS Regulations for Restricted Stock Units?

Navigating the intricate landscape of IRS regulations is the first step in ensuring your compliance with Restricted Stock Units (RSUs). Here are the critical IRS regulations you need to be aware of:

1. Grant Date Valuation (IRC Section 409A)

The IRS requires that the fair market value (FMV) of RSUs be determined on the grant date. This valuation serves as the basis for taxation when the RSUs vest. Failure to correctly value RSUs can lead to compliance issues. Ensure you have a reliable valuation method in place, adhering to the guidelines outlined in Internal Revenue Code (IRC) Section 409A.

2. Vesting and Taxation (IRC Section 83)

The IRS views vested RSUs as taxable income. The timing of taxation is significant. According to IRC Section 83, RSUs are generally taxable upon vesting, even if the employee doesn't sell or transfer them. It's necessary to accurately track vesting schedules to comply with this regulation.

3. Tax Reporting (IRC Section 6051)

Under IRC Section 6051, employers are required to report the value of vested RSUs on employees' W-2 forms. This reporting ensures transparency and helps employees accurately report their RSU income on their tax returns.

4. Timing of Tax Payment (IRC Section 409A)

IRS regulations allow companies to choose between immediate taxation upon vesting or deferred taxation when RSUs are sold. IRC Section 409A outlines the rules for deferred taxation, including the permissible timing and circumstances.

5. Deferral Elections (IRC Section 83(i))

For private companies, IRS regulations under IRC Section 83(i) offer eligible employees the option to defer income recognition upon RSU vesting, subject to specific conditions. Understanding these rules is important for both employers and employees.

6. Form 1099-B Reporting (IRC Section 6045B)

While employers don't typically file Form 1099-B themselves, they may need to collaborate with brokers or brokerage entities responsible for RSU transactions to ensure accurate reporting. Employers should facilitate the proper reporting of RSU sales, which ultimately contributes to overall compliance.

6. Penalties for Non-Compliance (IRC Section 6652(e))

The IRS can impose penalties for non-compliance with RSU regulations. IRC Section 6652(e) outlines the penalties for failing to furnish employees with accurate statements or returns, underscoring the importance of precise record-keeping and reporting.

Guiding Your Employees for Internal Revenue Service (IRS) Regulations Compliance 

Ensuring your employees understand and comply with IRS regulations regarding Restricted Stock Units (RSUs) is not just a legal obligation but also a way to empower them with valuable financial knowledge. Here's a step-by-step guide to help you guide your employees through the compliance process:

Step 1: Educate Your Employees

Start by providing your employees with a comprehensive education on RSUs and IRS regulations. Host workshops, webinars, or one-on-one sessions to ensure they grasp the significance of RSU grants and their tax implications. Cover essential topics such as vesting, taxation timing, and IRS reporting requirements. Remember, informed employees are more likely to make financially sound decisions.

Step 2: Grant Agreement Review

Encourage your employees to carefully review their RSU grant agreements. These documents contain critical information about vesting schedules, the fair market value (FMV) of RSUs at the grant date, and tax implications. Understanding the terms of the RSU grant is the foundation for compliance.

Step 3: Tax Planning

Advise your employees to consult with tax professionals to create a personalized tax plan based on their RSU grants. This plan should address the timing of RSU vesting, potential deductions, and strategies for minimizing tax liabilities. Emphasize the importance of proactive tax planning.

Step 4: Reporting RSUs

Make sure your employees understand their role in accurately reporting RSU income on their annual tax returns. Mistakes in reporting can lead to IRS audits and penalties, so stress the need for precision. Provide guidance on where to report RSUs and the importance of maintaining records.

Step 5: Compliance with Vesting

Educate your employees about the significance of adhering to the vesting schedule outlined in their RSU grant agreements. Failure to comply with this schedule can result in tax consequences, including premature taxation of RSUs. Encourage them to mark vesting dates on their calendars and set reminders to stay on track.

Keep in mind that a well-informed workforce not only fosters compliance but also strengthens the financial well-being of your employees. Open communication and support play a crucial role in ensuring that your employees understand and meet their IRS compliance obligations related to RSUs.

IRS Regulations for Filing Company Taxes on RSUs

Complying with Internal Revenue Service (IRS) regulations when filing your company's taxes related to Restricted Stock Units (RSUs) is vital to maintaining financial transparency and adherence to the law. Here's what you need to know about IRS regulations for filing company taxes on RSUs:

Form 3921 and 3922 Reporting

One of the key IRS regulations companies must adhere to is the filing of Forms 3921 and 3922. These forms are used to report RSU transactions to both the IRS and the employees. Here's what you need to know:

  • Form 3921: This form is used to report the transfer of RSUs to employees. It includes details such as the grant date, FMV at grant, vesting date, and the number of RSUs granted.

  • Form 3922: Employers must use this form to report the exercise or sale of RSUs by employees. It provides information about the date of exercise or sale, the FMV at that time, and the number of RSUs involved.

Employee Identification Numbers (EINs)

Ensure that you have accurate Employee Identification Numbers (EINs) for all employees who receive RSUs. Incorrect EINs can lead to compliance issues and potential delays in filing forms accurately.

Timing of Reporting

Companies are required to file Forms 3921 and 3922 with the IRS by specific deadlines. Generally, electronic filing must be done by the end of February, while paper filing is due by the end of March. Failing to meet these deadlines can result in penalties, so stay organized and adhere to the filing schedule.

Penalties for Non-Compliance

The IRS takes compliance with these reporting requirements seriously. Failure to file Forms 3921 and 3922 accurately and on time can result in penalties. Penalties vary depending on the degree of non-compliance and the size of your business, so it's crucial to stay organized and meet these obligations to avoid potential financial consequences.

Form 1099-MISC vs. Form 3921 and 3922

It's important to note that Forms 3921 and 3922 are specific to RSU transactions. In some cases, companies may mistakenly report RSUs on Form 1099-MISC. Understanding the distinction and ensuring accurate reporting is crucial to compliance.

Adherence to these IRS regulations and fulfilling your reporting obligations related to RSUs helps you maintain transparency, avoid potential penalties, and demonstrate your commitment to compliance. Accurate and timely filing of Forms 3921 and 3922 is a fundamental aspect of responsible RSU administration, ensuring that both the IRS and your employees have the necessary information for tax reporting and compliance.

Withholding Requirements for RSUs

Navigating the withholding requirements for Restricted Stock Units (RSUs) is a crucial aspect of IRS compliance for both employers and employees. Here's what you need to know about the withholding requirements:

Withholding Methods

Employers are responsible for withholding the appropriate amount of taxes when RSUs vest. There are two common methods for withholding:

  • Flat Rate: With this method, employers withhold a flat tax rate of 22% for federal income taxes, regardless of the employee's tax bracket. While this is a straightforward approach, it may not accurately reflect the employee's actual tax liability.

  • Supplementary Wage Rate: Alternatively, employers can calculate withholding based on the employee's overall income and tax bracket, known as the supplementary wage rate. This method may result in more accurate withholding but requires more complex calculations.

State Withholding

In addition to federal withholding, companies must consider state tax withholding requirements. State tax rates and regulations can vary significantly, so it's essential to comply with state-specific withholding rules. Consult your state's tax agency or a tax professional to ensure compliance.

Timing of Withholding

The IRS generally requires employers to withhold taxes at the time RSUs vest. This timing ensures that the appropriate taxes are withheld when the RSUs become taxable income to the employee.

Adequate Record-Keeping

Employers should maintain accurate records of RSU grants, vesting, and tax withholding. This documentation is necessary for both IRS compliance and addressing any employee inquiries regarding their RSU transactions.

Reporting on Form W-2

Employers must accurately report the income from RSUs on employees' Form W-2. This form includes details about the RSU income, such as the amount of income recognized, any taxes withheld, and other pertinent information.

Communicating Employee Responsibilities

Employees should be aware that the withholding methods chosen by their employer may not always align perfectly with their individual tax situations. It's essential for employees to review their pay stubs and Form W-2 to ensure that the correct amount of taxes was withheld.

Current IRS Memorandum on RSUs

On July 7, 2023, the Internal Revenue Service (IRS) released a memorandum known as the Office of Chief Counsel Memorandum 2023270141. Here, valuable guidance on several matters is provided, particularly how income from restricted stock units (RSUs), which accrues over multiple tax years, should be attributed for U.S. Social Security (FICA) taxation purposes.

The significance of this Memo lies in the fact that there has been a lack of official guidance on how compensation should be sourced for FICA, leaving employers to interpret tax regulations and apply them to FICA taxes as best as they can. While the Memo's scope is somewhat limited, its principles offer broader insights. Employers can find assurance that their FICA calculations are likely to align with IRS expectations should their payroll practices undergo IRS scrutiny.

Here are the key details of the Memo:

  1. Recipient and Scope: The Memo is directed toward a U.S. company that grants RSUs to common law employees, both within the U.S. and its foreign affiliates. It primarily deals with scenarios in which the RSU vesting period spans periods when the employee's regular compensation was partially exempt from FICA taxation.

  1. Determining RSU Income Subject to FICA: Typically, U.S. citizens and residents are subject to FICA on all compensation received from U.S. employers. However, compensation received from international employers is subject to FICA only for the portion linked to services provided within the United States. In situations where the vesting period includes periods of service both within and outside the U.S., the Memo suggests using a "reasonable method," such as counting workdays during the vesting period within and outside the U.S., to determine the portion of RSU income subject to FICA.

  1. Impact of Totalization Agreements: The Memo also discusses how bilateral Social Security totalization agreements, which aim to harmonize Social Security taxation and benefits between two countries, interact with domestic FICA rules. Totalization agreements can alter the applicability of FICA tax, potentially subjecting compensation to FICA that wouldn't otherwise be taxable under U.S. domestic law or exempting compensation that would usually be subject to FICA. When an RSU vesting period spans a period influenced by a totalization agreement, the agreement's rules should also apply to the portion of RSU income earned during that period.

It's important to note that IRS memoranda like this one don't establish legal precedent; they are issued in response to specific taxpayer requests and apply exclusively to those taxpayers. Nonetheless, they serve a valuable purpose in offering insights into the IRS's current approach to complex topics when clear guidance is lacking. 

While this Memo specifically relates to RSUs granted to US citizens and residents, its principles can be used as a reference for understanding multi-year compensation, addressing nonresident aliens, and dealing with various types of employers in a similar context.

Bottomline

Compliance with IRS regulations regarding RSUs is vital for both employers and employees. By understanding the key rules, guiding your employees through compliance steps, and staying informed about IRS updates, you can successfully navigate the complexities of RSU taxation. Remember to consult with tax professionals to ensure full compliance and make the most of tax-efficient strategies for your company's RSU program. With careful planning and adherence to IRS regulations, RSUs can remain an attractive and effective tool for talent retention and compensation.

Stay in the loop about RSU trends and updates by following Upstock on social media. Or browse our blogs for more relevant info.

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ABOUT THE AUTHOR

Casey Fenton

Founder, Upstock & Couchsurfing, AI and Equity Innovator

Casey Fenton, the founder of Upstock & Couchsurfing and an AI and equity innovator, has revolutionized how we perceive and implement equity in the workplace. His foresight in creating platforms that not only connect people but also align their interests towards communal and corporate prosperity has established him as a pivotal figure in technology and community building. Casey speaks worldwide on topics including ownership mindset, worker equity, With Upstock and Couchsurfing, he has demonstrated an unparalleled expertise in harnessing technology for the betterment of community interaction and organizational benefits.

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