The IRS has confirmed that stock-based plans of non-U.S. employers under which options and stock appreciation rights are settled in stock do not result in acceleration of income for US tax purposes. However, the ruling also confirmed that stock appreciation rights that may be settled in cash can result in acceleration of income for employees or independent contractors who are U.S. taxpayers.
Revenue Ruling 2014-18 gives some welcome clarity to employers on how to structure equity-based compensation awards in order to avoid adverse tax consequences for participants. In general, Internal Revenue Code Section 457A provides that compensation deferred under a “nonqualified deferred compensation plan” of a nonqualified entity (i.e., generally a non-U.S. entity whose income is not subject to U.S. tax or a comprehensive foreign income tax) is included in the taxable income of the plan participant at the point when there is no substantial risk of forfeiture under the plan, as opposed to when the amount is actually paid.
Section 457A generally defines a nonqualified deferred compensation plan in the same manner as IRC Section 409A. Under Section 409A, the term “nonqualified deferred compensation plan” does not typically include nonstatutory stock options or SARs, if the exercise price is equal to the fair market value of the stock at the time of grant. However, Section 457A(d)(3) specifically provides that any plan that provides a right to compensation based on the appreciation in value of equity units of the employer is treated as a nonqualified deferred compensation plan, even if the plan would otherwise be exempt from Section 409A.
In 2009 the IRS provided interim guidance that, notwithstanding this language, stock options (whether nonstatutory or incentive) and SARS that were required to be settled in stock were both exempt from Section 457A. The new ruling confirms this interim guidance, and also specifically provides that SARs that may be settled other than in employer stock (including settlement in cash), are not exempt from the application of Section 457A even though such SARs are exempt under Section 409A.
The ruling gives some useful clarity on stock options and SARS that can only be settled using employer stock. Non-U.S. employers considering issuing SARs that may be settled in cash (or property other than employer stock) will need to review the provisions of Section 457A to avoid the possible acceleration of income for U.S. plan participants.