Awarding EMIs, growth shares and other stock to U.S. taxpayers

Executive summary: Tax considerations for UK companies offering US employees equity compensation

US tax law regarding equity compensation is complex, and it’s important for UK companies to be aware of the implications of extending existing UK stock compensation plans to US employees. 

Awarding EMIs, growth shares and other stock to U.S. taxpayers

Regardless of where a company is based, equity compensation is a popular reward system for key management and executive personnel. Companies based outside the US who hire US employees often look to extend existing incentive plans to those US employees without understanding the differences between their home country’s tax system and US federal income tax law. This is particularly true for UK-based companies extending plans to US individuals. Consultation with a tax advisor is key to avoiding unexpected tax liability or penalties due to an under-researched compensation structure.

Here are the top ten items we highlight when advising UK companies on equity compensation schemes for US individuals:

1. The US taxes its citizens on their worldwide income, even if that income was earned abroad. UK companies with US employees must be cognizant of US tax law related to compensation income, regardless of where the US employee lives and works.
2. Consequences for incorrect compensation reporting and withholding, when required, can be hefty. Penalties for failure to file the correct information returns are calculated on a per form basis, and additional penalties are proscribed for the failure to withhold federal income and payroll taxes – up to 25% of the tax due.
3. In addition to federal and payroll withholding, US employees may be subject to state and local income tax withholding and reporting.
4. Transfer of property, including shares, to an employee in connection with the performance of services is a taxable event in the US. The fair market value (FMV) of the shares, less any amount paid for the shares, is includible in the employee’s income at the time of transfer unless the property is subject to a substantial risk of forfeiture. Note that loans provided to employees to pay for the shares can also create some complexity and must be planned appropriately.
5. US employees who receive shares subject to restriction (a “substantial risk of forfeiture”) are able to make a section 83(b) election, taxing them on the FMV of the shares (less any amounts paid) at grant, rather than at vesting (the default). Employers must keep careful track of employee 83(b) elections to report compensation income at the proper time. An 83(b) election must be made within 30 days of the date the equity is transferred so it is important to be aware of this short timeline before the grant is made.
6. US valuation rules are often more stringent than the valuation rules in other countries, including the UK. An independent valuation conducted under the rules of section 409A will typically satisfy these requirements, and without a drastic change in the company’s facts and circumstances, may be relied upon for up to twelve months.
7. US stock options must be issued with an exercise price equal to or greater than FMV at grant or unintended tax consequences may occur. Below-market stock options can create deferred compensation for employees and in some cases result in additional penalties and interest for both employers and employees. Heavily-discounted stock options (such as “nil paid” options) may even be considered restricted stock, resulting in additional tax and reporting considerations for employers.
8. There are no tax consequences for stock options vesting in the US. Employees recognize ordinary compensation income at exercise for stock options in the US unless the options are structured as incentive stock options (ISOs) under section 422. While it is possible for a UK plan to comply with the requirements of section 422, it is unlikely if planning does not occur prior to the employer granting those options.
9. ISO exercises do not result in compensation income for the employee or deduction for the employer unless a disqualified disposition occurs. A disqualified disposition involves the disposal of stock received upon exercise of an ISO prior to the later of 1) more than two years after the ISO is granted, or 2) more than one year from the date of exercise. A disqualified disposition requires employers to report compensation income to employees similar to the reporting required for NSO exercises so it is important to track the future disposition of shares.
10. Upon exercise of nonqualified stock options, employers are required to report compensation income to employees equivalent to the FMV of the stock less the amount paid to exercise (the spread).

US tax law related to equity compensation is complex. If you are considering expanding your UK equity compensation plan to cover your US employees, please consult a tax advisor.