SEC T+1 Rule May Affect Tax Withholding for Equity Compensation

The Securities and Exchange Commission has adopted a final rule that eventually will shorten the standard settlement cycle for most broker-dealer securities transactions to one business day after the trade date (T+1) from two business days (T+2) . This rule could affect tax withholding and deposit rules for certain equity awards.

Under the IRS’ latest informal guidance, from Generic Legal Advice Memorandum 2020-004 in May 2020, withholding obligations for both federal income taxes and payroll taxes under the Federal Insurance Contribution Act for certain stock-settled equity awards arise on the day when the award either is exercised (in the case of stock options or stock-settled stock appreciation rights) or when the employer initiates payment of the award (in the case of restricted stock units).

Ultimate settlement of the award might not be completed until two business days after the exercise or transfer initiation date under T+2. But the GLAM says that as a technical matter, the withholding and deposit obligation arises on the date of the exercise or transfer initiation.

Once the obligation arises, under what’s often referred to as the next-day deposit rule, an employer that has accumulated a tax withholding obligation of $100,000 or more on any day within a deposit period must deposit the required withholding amount by the close of the next business day to timely satisfy its tax withholding obligation.

Administrative Relief

Shortly after releasing the GLAM, the IRS updated Section 20.1.4.26.2 of its internal review manual to ease the administrative burden posed by the timing of the withholding obligation in the GLAM and in the next-day deposit rule.

The manual says that if the settlement date occurs within two days of the exercise or transfer initiation date, any failure-to-deposit penalties due to an employer not depositing tax withholding obligations in time will be calculated from the settlement date of the award—not the exercise or transfer initiation date.

As a result, employers won’t be penalized if they treat the settlement date of the award as the trigger date for applying the next-day deposit rule, provided that settlement occurs within T+2. This occurs even though the technical withholding obligation under the GLAM arises on the exercise or transfer initiation date.

Such administrative relief already applied to stock options under the manual, but its 2020 updates extended the same relief to stock-settled stock appreciation rights and restricted stock units.

The update also shortened the permitted settlement period of all three types of awards—options, stock-settled stock appreciation rights and restricted stock units—to T+2 from T+3 to reflect the SEC’s corresponding change in the standard settlement cycle for broker-dealer securities transactions in 2017.

Implication of the Adoption

Given the adoption of the SEC’s final rule, the IRS similarly may look to update the manual to shorten the relief period to one business day once the rule is fully in effect on May 28, 2024. Such a change would affect all stock-settled equity awards, including options, stock-settled stock appreciation rights, and restricted stock units.

Even though the technical withholding obligation under the GLAM arises on the exercise or transfer initiation date, it’s expected that employers won’t face failure-to-deposit penalties if they treat the settlement date of the stock-settled equity award as the trigger date for applying the next-day deposit rule—provided that settlement occurs within T+1.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Shalom D. Huber is an executive compensation and benefits partner at Skadden, Arps, Slate, Meagher & Flom. His practice focuses on advising public and private companies, executives, and boards on executive compensation and employee benefits issues.

Genia Gokhmark is an executive compensation and benefits counsel at Skadden. His practice focuses on providing executive compensation and employee benefits advice to private and public companies.

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