RSUs in General

RSUs are a common form of equity-based compensation issued by an employer to an employee in the form of company shares, and are typically favored by start-up and technology companies. Generally, an RSU is a grant valued in reference to the employer’s stock, but such stock is not issued at the time of the grant. RSUs are generally issued through a vesting plan and distribution schedule that the employee satisfies by meeting certain performance benchmarks and/or continued employment with the issuing company. RSUs can be attractive to employers because they reduce the amount of cash employers must pay out in the form of compensation, and they permit an employer to defer issuing shares unless and until vesting benchmarks are satisfied, which helps mitigate and delay dilutive effects. In the current COVID-19 environment, businesses have been considering issuing additional RSUs and other equity awards as a way to conserve cash in order to weather the economic storm.

RSUs have no tangible value until they vest. A recipient of RSUs is not eligible to make an IRC Section 83(b) election, which allows a recipient to pay income tax upon receipt of certain deferred compensation before vesting. IRC Section 83(b) elections are commonly made with other types of deferred compensation awards, such as restricted stock awards.

The rules relating to the US taxation of RSUs (and certain other deferred compensation arrangements) in an international context are often complex, daunting and, in some cases, uncertain. Unlike other types of compensatory awards, RSUs are not subject to US income taxation at grant. During the vesting period, holders of RSUs do not have voting rights, nor are they entitled to receive dividends (although dividend equivalent payments are present in some RSU plans), as the holders do not yet hold actual shares of the company. Upon vesting, the value of the vested RSUs is considered ordinary income, and the issuing employer frequently withholds a portion of the shares representing the US tax amount. Depending on each company and the respective plan documents, an employee may receive the net shares or the cash equivalent value of the shares.

RSUs and Inbound Assignments

It is common for US multinational corporations to host employees from overseas affiliates for short- to long-term assignments, and such employees may have received RSU grants before their US assignment began. Identifying the appropriate US taxation of RSUs for employees who are not US citizens, lawful permanent residents (i.e., green card holders) or otherwise US income tax residents (i.e., nonresident aliens (NRAs)) requires analysis of US sourcing rules. “Multi-year compensation arrangements” can complicate an employer’s US withholding obligations with respect to RSUs issued to NRAs. “Multi-year compensation” refers to compensation that is included in the income of an individual in one taxable year but which is attributable to a period that includes two or more taxable years. NRAs may be subject to US income tax on portions of their RSU income even if they are not considered US income tax residents.

To the extent an NRA physically works in the United States between the date RSUs were granted and the date they vest, a portion of the value of the RSUs will be sourced to the United States and therefore be subject to US income taxation. That portion is calculated by summing the total number of days the employee provided services in the United States for the employer during the period between the grant date and the vesting date, divided by the total number of days between the grant and the vest date. For example, suppose an NRA employee is granted RSUs on January 1, 2020, with a vesting date of January 1, 2023. The RSUs are worth $100 upon vesting. If the NRA employee works for the employer in the United States during all of 2020 and thereafter provides services in Ireland (from 2022 through December 31, 2023), one-third of the $100 (i.e., $33) upon vesting would be sourced to the United States and therefore be subject to US income tax.

Social security withholding is another important consideration for NRA employees who receive multi-year compensatory equity awards. Generally, and with certain exceptions, in the absence of a social security totalization agreement between the United States and the non-US employee’s home country, Federal Insurance Contributions Act (FICA) taxes will apply to the RSU. Where an NRA is from a totalization agreement country (with the exception of Italy) and is transferred to the United States for a period of five years or less, FICA taxes generally will not apply, provided the foreigner obtains a “certificate of coverage” from her home country and provides it to her US employer. A certificate of coverage confirms that the NRA employee remains subject to her home country’s social security system.

RSUs and Outbound Assignments

US tax resident employees who participate in outbound assignments (i.e., transfer to a foreign affiliate of the US corporation) face their own set of unique tax issues regarding RSUs. The outbound employees may become tax resident of the country to which they are transferred, and in the absence of an exclusion or exception, US federal income tax income and wage withholding and reporting obligations will remain applicable.

Limited exclusions exist from US withholding for US citizen and resident employees who work outside the United States on an international assignment. One such exclusion is the US foreign earned income exclusion, which generally permits a US taxpayer to exclude a certain amount of foreign earned income, including RSU income (for 2020, the amount is $107,600). For a US employer to rely on the foreign income exclusion with respect to withholding on RSU income, the employer must have a reasonable belief that the employee is a qualified individual who is permitted to exclude the equity income from his gross income. A second exception that may be useful for RSU income applies if a US citizen’s (the exception does not apply to other US income tax residents, including green card holders) income is subject to mandatory non-US tax withholding in the country in which she is employed. Third, a US employer may not be required to withhold on RSU income to the extent the transferred employee has indicated eligibility for a US foreign tax credit. Finally, if an individual employee is subject to double tax on RSU income, relief may be available under the terms of an applicable tax treaty. Notwithstanding the applicability of an exclusion, the US employer is required to report the entire amount of the employee’s RSU income on the employee’s Form W-2 for the applicable tax year.

With regard to FICA withholding, in the absence of a totalization agreement, where a US citizen or permanent resident is employed outside the United States by a US employer (e.g., a branch of a US corporation), US FICA taxes apply and must be withheld from the individual’s income, including RSU income. If a totalization agreement applies and an individual’s RSU income would otherwise be subject to non-US social security taxes, US FICA taxes are generally inapplicable if the transfer is for more than five years. Unlike the federal income tax regulations, the FICA regulations provide no basis for apportionment of multi-year compensation such as equity award income.

Introducing COVID-19 into the Mix of Tax Ramifications

Because an employer’s US income and wage withholding obligations on internationally mobile employees generally turns on where the employees provide services, employers should consider the effect of COVID-19 travel restrictions on their withholding obligations, including with regard to RSU income, if their mobile employees are “stuck” in the United States but continue to work for the company. For example, an NRA employee who intended to leave the United States for his home country (or another non-US host country) but who is unable to leave the United States will require the US company to review and adjust his US withholding obligations to account for the apportionment of additional US source income to that employee when the RSUs vest. Although the Internal Revenue Service issued Revenue Procedure 2020-20 to provide a limited “COVID-19 Emergency” exception from the substantial presence test (as to whether an NRA has become US income tax resident), such guidance does not address the sourcing of personal services income (such as RSUs and other compensatory equity awards) for those NRAs who will not otherwise be substantially present in the United States. Accordingly, in light of the current travel restrictions, employers should examine any outstanding and anticipated RSU vesting and revisit their withholding requirements in advance of RSUs vesting.

[View source.]