Don’t Forget to Update Withholding Procedures
On December 22, 2017, President Trump signed into effect the Tax Cuts and Jobs Act. The ink was barely dry before tax departments mobilized to evaluate the impact on their deferred balances, 162(m) compliance, and performance awards. But the spotlight on corporate taxation has overshadowed another reform-related issue. Given the changes in personal income tax brackets, how should corporations withhold on vesting events occurring in early 2018?
The maximum statutory rate, we learned, is falling from 39.6% to 37%. However, it wasn’t until January 11 that the IRS published granular tax tables and finalized its guidance for 2018. IRS Notice 1036 spells out the new supplemental income withholding rates that are used for stock compensation. For employees who receive $1 million or less in supplemental payments in the tax year, the rate is 22%. For those who receive more than $1 million, the rate is 37%.
Even with the guidance, withholding policies may take some time to adjust. Why? Because in many organizations, the stock plan system has elaborate customization that prevents a simple flipping of the switch.
The main potential problem is a situation of over-withholding that then triggers liability classification of the award. Accounting Standards Updates (ASU) 2016-09 amended the accounting rules such that withholdings would not cause liability classification, so long as they didn’t exceed the maximum statutory rate. But under the new tax code, failing to update withholding procedures could cause withholding to occur at 39.6% when the statutory maximum is now 37%.
The IRS briefly addressed this question, stating that
Employers should begin using the 2018 withholding tables as soon as possible, but not later than Feb. 15, 2018. They should continue to use the 2017 withholding tables until implementing the 2018 withholding tables.
Based on this guidance, if you withhold (or have already withheld) at the 2017 maximum rate for January vestings, you’re not at risk of triggering liability accounting. However, the IRS gave a bright line of February 15 to have your withholding procedures updated. So be sure to implement and test changes as soon as possible.