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Accounting Help - Taxes Paid Relating to Net Share Settlement of Equity Awards


Tintin
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I would be grateful for any help in getting my head around this topic.  In essence, I am currently looking at a company that has a considerable cash outflow relating to the above, and this cash outflow is shown under financing on the cash flow statement.

 

Since these taxes relate to stock compensation, and stock compensation is essentially an operating expense, would it not also follow that such amounts are better understood as an operating cash flow item rather than a finance outflow?  I am trying to get my head around the mechanics of the topic and want to understand if the tax payable is truly a finance outflow as the accounting rules seem to permit.

 

Any help is greatly appreciated.  Thanks.

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When there's net settlement, the company withholds a number of shares that were dedicated to a specific employee in order to pay tax authorities (according to regulated percentages) in the name of that employee but it's effectively the same as if the company would have bought back these granted shares from the employee at fair value and then the employee used the cash proceeds from the sale in order to pay same taxes. Since it's share buyback activity in substance, it's still classified as a cash outflow from financing activity.

Since 2016 (new GAAP standard), a lot of the stock-based compensation-related cashflows have moved from the financing to the operating section but not that specific one.

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Thanks Cigarbutt for the reply.

 

From what you are saying a company essentially pays the employee's personal taxes directly to the tax authorities on behalf of those employees, by withholding some of their stock options at the time of vesting.  When looked at from this perspective, the company is just acting as an intermediary for its employees with the taxman, and those cash outflows actually represent the employees' personal liabilities rather than the company's liabilities. 

 

When I value a company that pays a ton of SBC, I always prefer to add it back to operating cash flows and treat it as if it were a genuine cash expense.  That being the case, it makes little sense for me to also treat these net settlement of tax cash outflows as an operating expense for valuation purposes, since doing so would be 'double-counting' the same expense twice.  The original SBC recorded as an annual expense on the Income Statement several years before vesting would already include the portion of tax expense that individual employees would subsequently have to pay out of their SBC awards.

 

The conclusion therefore appears to be as follows - if investors add back SBC expense to operating cash flows, they should leave net settlement tax payments exactly where they are in financing outflows.

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Yes and the paid taxes show up on your W2 ( or at least should). You should clarify with HR what that line item that is that indicates the taxes paid on your behalf. I had this issue one year, because the brokerage that is used for the stock sales also gives you a 1099-B. The part that relates to stock sales in this 1099-B needs to be eliminated, or you are paying the taxes twice.

 

I once had to defend myself form an IRS mini audit because they stated that part of my 1099-B transactions were missing. Those were ESOP stock sales that related to stock sales already reflected in my W2. I could explain this in a letter detailing the W2 line item that this stock sales refer to and it was fine, but it is something watching out for.

Edited by Spekulatius
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Yes, that's the fast and easy way to do it and likely works fine in most circumstances.

With share-based compensation, there are potentially many valuation issues including timing issues. When shares move from the company to the employee, to calculate the compensation cost, one has to wonder if shares had been bought back before, are being bought back concurrently or will be bought back later. At least, when cash settled, you know that shares are being bought back concurrently and the tax-withholding-part of the share-based compensation is basically a cash bonus paid upon vesting.

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