McGowan Comments on Equity-Based Compensation Awards in Tax Analysts

News / March 26, 2012

Partner John McGowan commented on equity-based compensation awards in Tax Analysts (“Executives Beware: States May Look to Equity Compensation for Revenue”) on March 26.

According to the article, “many public corporations and even some closely held businesses use equity-based compensation awards to attract, motivate, and reward employees.” Although an equity-based compensation plan can create an ownership culture at a corporation, it comes with several burdens, including the administrative tasks of properly structuring an equity compensation plan, in addition to federal and state tax compliance for both the corporation and the employee.

Tax Analysts explained that “Residency challenges may occur when an individual who received an award while a resident of a high-tax state moves to a low- or no-tax state before a realization event regarding the equity award.” McGowan noted, however, “In the context of equity compensation, states do not frequently encounter the issue in which an executive receives the equity compensation only after having moved out of state because most executives receive those awards while they are still working. ‘‘The amount of slippage isn’t that great’’ in that area.

Another difficulty employers face is determining how much state income tax to withhold on income from equity-based awards. “That calculation can be challenging because different states do not necessarily use the same formula for determining the amount of tax due on an equity compensation award,” explained Tax Analysts.

McGowan added that although most state tax commissioners know the value of every public company in the state, non-public companies can discount their value for a variety of reasons and move equity around to be more tax efficient.

“Although states have not historically been aggressive in going after nonresident individuals with equity-based compensation awards, that may change,” said Tax Analysts.

As states have become more desperate for revenue, some are questioning whether to follow federal AGI for purposes of calculating an individual’s state taxable income, McGowan said. They are also becoming more open-minded when thinking about how income is defined and are more focused on exactly how income is being reported on a taxpayer’s W-2, McGowan noted.

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