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Equity compensation and talent retention
EQUITY COMPENSATION: WHAT IS IT ABOUT?
Concept : form of variable remuneration that seeks to reward employees and{colaboradores} based on and in accordance with the {variation} of the company’s valuation .
Purpose : to align interests and incentives of employees/collaborators, company and shareholders.
Equity Compensation Plan: plan formally approved by the company to implement the compensation of executives, key employees, consultants and advisors for shares or options to purchase shares of the company. It determines the species of grants that may be granted, their basic rules and conditions.
Grant or Award : right, or asset, granted as a form of equity compensation. Are the possible species within a equity compensation plan (eg stock option , restricted stock and others)
Vesting : any and all requirements necessary to exercise the right or fruition of the asset received. Vesting is not just about time !!
Full-value award : Award that consists of the good itself, and therefore reflects the full value of the good received (Ex: stock bonus, restricted stock)
Not full-value award : Award that consists of the right to acquire or enjoy the good, and therefore reflects the value of the appreciation of the good received (Ex: stock option , SAR).
In addition to “stock options” , there are other types of stock compensation in the US and Brazil – with some adaptations of course – such as Stock Bonus , Phantom Stock and Restricted Stock Units .
BONUS STOCK
- Beneficiaries: Employees only
- Shareholder Rights: Same as class
- Restrictions and related rights
- salary nature
- How to pay tribute? Cash bonus, loan, liquidity.
PHANTOM STOCK
- Beneficiaries: Employees, executives, contracted third parties (PJ, self-employed) or any other beneficiary.
- Benefit: right to a “phantom”/”virtual” share that entitles you to the value of that share (money) on a certain date or future event.
- Various vesting criteria
- Shareholder Rights: No voting rights. You can receive “virtual” dividends.
- “Rescue” price: market price of the shares, appraised value a fair market equivalent value determined by the board, recent runds of investor financing or book value.
- It normally does not incur any cost to the beneficiary.
What are Stock Options?
Concept: type of variable pay that seeks to compensate employees {and associates} based on and according to the company’s valuation {variation}.
Purpose: align interests and incentives of employees/associates, company and shareholders.
Equity Compensation Plan: plan formally approved by the company for the implementation of the compensation of executives, key employees, consultants and advisors with shares or company stock option. Establishes the types of grants that may be awarded, their rules and basic conditions.
Grant or Award: right or asset granted as equity compensation. These are the types possible within an equity compensation plan (ex: stock option, restricted stock and others)
Vesting: each and every requirement needed for the exercise of the right or fruition of the asset received. Vesting is not only time!!
Full-value award: Award consisting of the property itself, and, therefore, reflects the full value of the property received (Ex: stock bonus, restricted stock)
Not full-value award: Award consisting of the right to purchase or enjoy the property, and, therefore, reflects the appraised value of the property received (Ex: stock option, SAR).
In addition to the “stock options”, there are in the USA and in Brazil – with a few adjustments, of course – other types of stock compensations, such as Stock Bonus, Phantom Stock and Restricted Stock Units.
STOCK BONUS
Beneficiaries: Only employees
Rights of Shareholders: The same for the class
Related restrictions and rights
Salary nature
How to afford the tax? Bonus in cash, loan, liquidity.
Phantom Stock
Beneficiaries: Employees, executives, contracted third parties (legal entities, independent contractors) or any other beneficiary.
Benefit: right to a “phantom”/”virtual” stock that grants the right to the stock value (cash) on a specific date or future event.
Various vesting criteria
Rights of Shareholder: Without voting right. May receive “virtual” dividends.
“Redemption” price: stocks market price, appraised value at fair market equivalent value determined by the board, recent rounds of investor financing or book value.
Usually brings no cost to the beneficiary.
What are Stock Options?
Stock Options is the most common form of compensation of associates with equity interest in Brazil. But there are other ways for companies to achieve the purpose of aligning their interests with that of their associates. Both in Brazil and in the United States, different mechanisms of compensation in stocks are being developed.
Stock Options
Stock option for a fixed price and with a fixed time limit if certain conditions are met.
In short, in Brazil, we have two types of stock options: those of compensatory nature and those of non-compensatory nature. Such distinction was established based on CARF’s court precedents and cases which companies feel 100% safe that their SOP plan will have a non-compensatory nature are very rare. The effect of that is the moment of taxation of the compensation: grant (compensatory) x exercise (non-compensatory). The assignment of one type or another takes into account different aspects of the plan, such as the price, share restrictions and the risk involved in the stock option grant contract.
In the United States, the scenario is much clearer. American jurisdiction brings two types well defined by tax law: the Incentive stock options (ISOs) or nonqualified or nonstatutory stock options (NSOs). In the NSOs, the tax effect takes place in the moment of the exercise, even if there is no liquidity event, while the ISOs allow for the deferral and payment of tax rate on capital gain at the time of liquidity and not “ordinary income”. There are several criteria for a Stock Option grant to be characterized as ISO.
There is also the Restricted Stock Unit (RSU), which is a type of compensation made by the company to be associate in the form of company stocks. RSUs are delivered after the associate reaches performance goals established by the company or work for the company for a certain period. These stocks seek to attract the associates’ interest, but have no tangible value until the stock acquisition period is complete. It is worth emphasizing that they receive a fair market value when acquired.
When choosing the type of compensation in stocks, the company must consider its corporate effects, the political and economic rights that will be granted to the future shareholder, the dilution that granting such stocks will cause to founding shareholders and the tax effects for the company and for the beneficiary. If it is an option, there must be purchase/cash disbursement by the beneficiary. Using the right compensation mechanism is very important for the mitigation of tax risk and future conflict with the beneficiary.
Form 1041
Executor, trustee or personal representative of the estate or trust
- Form 1041
- Certain income/deductions accompanied by additional schedule
15th day of the fourth month following close of tax year
IRS, Kansas City
- Outlines the value of a descendants assets they owned on the date of their death
- Trusts ensure assets are distributed appropriately to benefishiaries
- Estate or trust generated more that $600
- A beneficiary is a nonresident of the U.S.
- Send by mail
- E-file Online
- Late filing penalties (5% tax due each month late, 25% max)
- $280 penalty for far failure to provide Schedule K-1 to beneficiaries, max $3,426,000 penalty
- Other penalties imposed for negligence, understatement of tax, and fraud
Form 1065
Business that are treated as partnerships for federal tax purposes file Form 1065, unless They receive no income, incur no expenses treated as deductions, and pass through no credits for federal income tax purposes. Form 1065 is not considered to be a return unless it is signed. One general partner or LLC member must sign the return.
Form 1065 includes a Schedule K, which is a summary of all the partners’ income, and a Schedule K-1, which shows each partner’s separate share. The partnership return must state the items of partnership gross income and deductions and must include the names and address of all the partners and the amount of the distributive shares of income, gains, loss, deduction, or credit allocated to each partner.
Generally, a domestic partnership must file Form 1065 by the 15Th day of the 3rd month following the date its tax ended as shown at the top of Form 1065.
The IRS office where the Form 1065 is filed depends on where the partnership’s principal business, office, or agency is located and whether or not the partnership has $10 million or more in total assets at the end of he year.
Less than $10 million and Schedule $10 million or more Schedule M-3 is filed
M-3 is not filed
Department of the Treasury Department of the Treasury
Internal Revenue Service Center Internal Revenue Service Center
Kansas City, MO 64999-0011 Ogden, UT 84201-0011
Because the partners are liable for tax on their shares of the partnership’s income, the information return that the partnership files on Form 1065 contains certain data that is also provided to the individual partners for inclusion in their individual tax returns.
All partnerships with more than 100 partners are required to file their partnership electronically. Failure to comply is treated as failure to file a return (Code Sec. 6011(e)(6)).
Penalties for late filing is $220 for 2022. This penalty is in addition to the criminal penalties that may be imposed (under Code Sec. 7203) Shall be fined not more than $25,000 ($100,000 in the case of a Corporation) or imprisoned not more than 1 year or both for failure to file a required return, supply information, or pay tax (Code Sec. 6698(a)).
The penalty for failure to file a partnership return is $195 per partner for each month, or fraction of a month, during which the failure continues, up to a maximum of twelve months (IRC § 6698(b)).
For each failure to furnish a Schedule K-1 to a partner including all information required to be shown a $50 penalty may be imposed subject to a $100,000 limit. This limit can be increased if the requirement is intentionally disregarded.
Form K1
Partnerships & S-Corporpations
Partner’s or Shareholder’s Share of Income, Deductions, Credits, etc.
April 15th
Partnership or S-Corp files a copy of Schedule K-1 (Form 1065 or 1020S) with the IRS. Partners & Shareholders should not file it with their tax return unless they are specifically required to do so. However, they should keep it for their records.
The purpose is to report each Partner’s or Shareholder’s share of the entity’s earnings, losses, deductions, and credits.
For each failure to provide Schedule K-1 to a shareholder or partner when due and each failure to include all the information required, a $260 penalty may be imposed with respect to each Schedule K-1 for which a failure occurs.
If the requirement to report correct information is intentionally disregarded, each $260 penalty is increased to $520 or, if greater, 10% of the aggregate amount of items required to be reported.
Form SS-4
Employer, Sole propritors, corporations, partnerships, estates, trusts, certain individuals and other entities for tax filing and reporting purpose.
Form SS-4.
Complete Form SS-4 at least 4 – 5 weeks before you will need the EIN.
You can apply for an EIN online (only for applicants in the U.S. or U.S. possessions), by telephone (only for applicants outside of the U.S. or U.S. possessions), by fax, or by mail, depending on how soon you need to use the EIN. Use only one method for each entity so you don’t receive more than one EIN for an entity
Form SS-4 is filled to apply for an employer identification number (EIN)
Providing false information could subject to penalties.
Form 8832
An entity uses Form 8832 to elect how it will be classified for federal tax purposes: corporation, partnership, disregarded entity
Form 8832
- No deadline
- Tax status election effective date can be up to 75 days before Form 8832 is filed
- Tax status election effective date cannot be more than 12 months after Form 8832 is filed
Department of the Treasury / Internal Revenue Service Center / Kansas City, MO 64999
Initial classification or change tax status – can only be changed every 60 months
Mail to:
Department of the Treasury / Internal Revenue Service Center / Kansas City, MO 64999
Filing of Form 8832 is not mandatory. Penalties are not applicable.
Form 3520
U.S. person who transferred property or money to a related foreign trust in exchange for an obligation/qualified obligation that is outstanding
U.S. person who is an owner of any part of the assets of a foreign trust under sections 671-679
U.S. person/executor of the estate of a U.S. person who received a distribution from a foreign trust, a loan of cash or marketable securities, or the uncompensated use of trust property
U.S. person who received over $100,000 of gifts or bequests from a nonresident alien/foreign estate. U.S. person who received over 6039F threshold of gifts from foreign corporations/partnerships
- Form 3520 Annual Return to Report Transactions with Foreign Trusts & Receipt of Certain Foreign Gifts
- A separate Form 3520 must be filed for each foreign trust
- 15th day of the 4th month of the tax year (April 15th for majority)
- 15th day of the 6th month of the tax year
- Live outside the U.S. and Puerto Rico and place of business is outside
- In military/naval service on duty outside U.S. and Puerto Rico
Mail to the IRS Center (P.O. Box 409101 Ogden, UT 84409)
- Report certain transactions with foreign trusts
- Report ownership of foreign trusts under sections 671-679
- Report receipt of certain large gifts/bequests from certain foreign persons
- Section 6677 Failure to Timely File Form 3520 or Incomplete/Incorrect Information
- Penalty: Greater of $10,000 or…
- 35% of gross value of property transferred to a foreign trust
- 35% of gross value of distributions received from a foreign trust
- 5% of gross value of foreign trust’s assets owned
- Section 6039F Failure to Timely Report Foreign Gifts
- Penalty: 5% of the amount of such foreign gifts applies for each month for which the failure to report continues (up to 25%)
- Section 6662(j) Underpayment of Tax
- Failure to disclose all foreign financial assets
Form 8865
A U.S. person qualifying under one or more of the Categories of Filers
Category 1
A U.S. person who controlled the foreign partnership at any time during the partnership’s tax year. Control of a partnership is ownership of more than a 50% interest in the partnership.
Category 2
uA U.S. person who at any time during the tax year of the foreign partnership owned a 10% or greater interest in the partnership while the partnership was controlled by U.S. persons each owning at least a 10% interest.
Category 3
A U.S. person who contributed property during that person’s tax year to a foreign partnership in exchange for an interest in the partnership (a section 721 transfer), if that person either:
Owned directly or constructively at least a 10% interest in the foreign partnership immediately after the contribution, or
The value of the property contributed exceeds $100,000.
Attach Form 8865 to your income tax return and file both by the due date (including extensions) for that return. If you don’t have to file an income tax return, you must file Form 8865 separately with the IRS at the time and place you would be required to file an income tax return
April 18th
To report the information required under section 6038 (reporting with respect to controlled foreign partnerships), section 6038B (reporting of transfers to foreign partnerships), or section 6046A (reporting of acquisitions, dispositions, and changes in foreign partnership interests).
Mailed or filed be electronically only if filing Form 1040, 1041, 1120, 1120S, or 1065
Categories 1 & 2
A $10,000 penalty is imposed for each tax year of each foreign partnership for failure to furnish the required information within the time prescribed. If the information isn’t filed within 90 days after the IRS has mailed a notice an additional $10,000 penalty (per foreign partnership) is charged for each 30-day period, which the failure continues after the 90-day period has expired. A maximum of $50,000 for each failure.
Any person who fails to furnish all of the information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901 and 960. If the failure continues 90 days or more after the date the IRS mails notice of the failure, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired.
Category 3
Any person that fails to properly report a contribution to a foreign partnership that is required to be reported under section 6038B and the regulations under that section is subject to a penalty equal to 10% of the fair market value (FMV) of the property at the time of the contribution. This penalty is subject to a $100,000 limit
Category 4
Any person who fails to properly report all the information requested by section 6046A is subject to a $10,000 penalty, in addition to the section 7203 criminal penalty, unless it is shown that such failure is due to reasonable cause. If the failure continues for more than 90 days after the IRS mails notice an additional $10,000 penalty will apply for each 30-day period during which the failure continues after the 90-day period has expired. Shall not exceed $50,000.
Form 8858
1.) A US person that is a tax owner of an FDE (Foreign Disregarded Entity) or operates a FB (Foreign Branch) at any time during the U.S person’s tax year.
2.) A US person that directly or Indirectly is a tax owner of a Foreign Disregarded entity or operates a Foreign Branch during the tax year
3.) Certain US persons that are required to file form 5471 specifically category 4 filers and category 5 filers , Category 4 filers must complete the entire form 8858, Category 5 filers only complete the identifying information on page 1 of form 8858.
4.) Certain US persons who are required to file Form 8865 with respect to a controlled foreign partnership that is a tax owner of a foreign disregarded entity or operates a foreign branch. Specifically, Category 1 filers and Category 2 filers of form 8865 will be required to file form 8858.
5.) A U.S. partnership that directly or indirectly through a tier of Foreign Disregarded entities or partnerships is a tax owner of a Foreign Disregarded entity or operates a Foreign Branch
6.) A U.S corporation that is a partner in a US partnership which is required to file form 8858. Partnership must provide all necessary information for Corp to file form 8858.
Explanation of US Person
Attach/File form 8858 with your corporate 1120, partnership 1065, or individual 1040.
Form 8858 is due when your income tax is due. For Individual Form 8858 would be due on 04/15 or if extended it would be due on 10/15
For Corporations Form 8858 would be due on 04/15 or if extended it would be due on 10/15
For Partnerships it would be due on 03/15 and if extended it would be due on 09/15
The information provided on Form 8858 is specifically for US persons who run or operate a Foreign Branch or own a Foreign Disregarded entity indirectly or directly.
Mail or electronic with Form 1040,1065,1120
A $10,000 penalty is imposed for each annual accounting period of each CFC or CFP for failure to provide the necessary information. If information is still not provided after an IRS notice is sent to T/P an additional $10,000 is charged for each 30-day period. Additional penalty is limited to $50,000 max.
Form 5472
- U.S. corporation with 25% or more foreign ownership (including a foreign ownedU.S. DRE)
- 25% foreign ownedif at least one direct or indirect foreign shareholder holds 25% of vote or value of all classes of stock
- Foreigncorporationengaged in a U.S. trade or business
- That has a reportable transaction during the tax year of the reporting corporation
- Reportable transactions included in Parts IV – VI of Form 5472
- Form 5472 information return annexed toForm 1120/1120-F
- For a foreign owned U.S. DRE, pro forma Form 1120 will need to be filed to transmit form 5472
- On the due date of yourcorporation income tax return
- Generally 4/15 or 10/15 with a timely filed Form 7004 Application for Extension
- Filed with your Form 1120, either e-File or mailed tolisted address
- Exception for foreign owned U.S. DREs, who must use address in Page 3 form instructions
Provide information required under Sections 6038A & 6038C
- $25,000 penalty assessed on any corporation that fails to timely file Form5472. Penalty also applies for failure to maintain records as required bySection 1.6038A-3
- If a group of corporations are filing a consolidated information return, each member is subject to separate$25,000 penalties
- If failure continues for more than 90 days after notification by IRS, additional$25,000 penalty will apply for each 30-day period that the failure continues. No limit.
- Criminal penalties under sections 7203, 7206, and 7202 may also apply for failure to submit information or for filing false or fraudulent information
Form 5471
A US person has certain ownership or control over a Foreign Corporation, they have to file a form 5471
There are five (5) different categories of filers
Categories 1 Filers
U.S individuals who are considered to have 10% or more ownership over controlled foreign corporation will have to file form 5471
Categories 2:
U.S citizen or resident who is an officer/director of a foreign corporation has acquired
Categories 3:
A U.S. person who acquires stock in a foreign corporation which added to any stock owned on the date of acquisition, meets the 10% stock ownership requirement with respect to the foreign corporation;
A U.S. person who acquires stock without regard to stock already owned on the date of acquisition, meets the 10% stock ownership requirement with respect to the foreign corporation;
A person who is treated as a U.S. shareholder under section 953(c) with respect to the foreign corporation;
A person who becomes a U.S. person while meeting the 10% stock ownership requirement with respect to the foreign corporation; or
A U.S. person who disposes of sufficient stock in the foreign corporation to reduce his or her interest to less than the 10% stock ownership requirement..
- 10% stock ownership requirement
- 10% or more (in value/voting power) of the foreign corporation
Categories 4:
This category includes a U.S. person who had control of a foreign corporation during the annual accounting period of the foreign corporation.
Categories 5:
These categories include a U.S. shareholder who owns stock in a foreign corporation that is a CFC at any time during any tax year of the foreign corporation, and who owned that stock on the last day in that year on which it was a CFC.
CFC is control foreign corporation
Form 5471 is generally due to be filed at the same time the filer’s tax return is due to be filed (including extensions).
Attach Form 5471 to your income tax return (or, if applicable, partnership or exempt organization return)
Same place as your normal tax return, as it is attached to your normal return
- There are various penalties the IRS can issue if the 5471 is not filed timely
- Any person who fails to file or report all of the information requested by section 6046 is subject to a $10,000 penalty for each such failure for each reportable transaction. If the failure continues for more than 90 days after the date the IRS mails notice of the failure, an additional $10,000 penalty will apply for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000.
- Criminal penalties. Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file the information required by sections 6038 and 6046.
Form 8938
A specified person that has an interest in specified foreign financial assets that has a value above the reporting threshold
Specified Individual:
- A US citizen
- A resident alien of the US
- A nonresident alien who makes an election to be treated as a resident alien for joint filing purposes
- A nonresident alien who is a bona fide resident of American Samoa or Puerto Rico
Specified Domestic Entity:
- A closely held domestic corporation that has at least 50% of its gross income from passive income
- A closely held domestic corporation where >50% of its assets produce or are held to generate passive income
- A closely held domestic partnership that has at least 50% of its gross income from passive income
- A closely held domestic partnership where >50% of its assets produce or are held to generate passive income
- A domestic trust described in section 7701(a)(30)(E) that has one or more specified persons as a beneficiary
Attach the form to your annual return (1040, 1041, 1065 or 1120)
File by the due date of your annual return (1040, 1041, 1065 or 1120)
To report specified foreign financial assets and their value
- Failure to File: $10,000 penalty if the form is not complete or correct by the due date.
- Continuing Failure to File: An additional penalty of $10,000 is issued per each 30-day period if a correct and complete form is not sent within 90 days of an IRS Failure to File Notice.
- The maximum additional penalty is $50,000
- Additional accuracy-related and fraud penalties may apply.
Form 8621
Qualifying insurance Corporation
A U.S person that owns stock of a foreign corporation and elects to treat such stock as a qualifying insurance corporation under section 1297(f)(2).
Passive Foreign Investment Corporation (PFIC)
A U.S person that is direct or undirect shareholder of a PFIC
75% or more of the corporation’s gross income for its tax year is passive income
At least 50% of the average percentage of assets
Is reporting information with respect to a Qualified Electing Fund (QEF) or section 1296 mark-to-market election,
Attach the form 8631 to tax return
April 18
Internal Revenue Service Center, Ogden, UT 84201
To report income from foreign mutual funds/PFICS
E-file or Mail
If the form is not filed the return would cause incomplete tax return
8938 penalties
$10,000 penalty & max penalty of $50,000
Report of Foreign Bank and Financial Accounts (FBAR)
U.S. person, including a citizen, resident, corporation, partnership, limited liability company, trust and estate that has:
a financial interest in or signature or other authority over at least one financial account located outside the United States if the aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year reported
Electronically file FBAR on the Financial Crimes Enforcement Network (FinCEN) Form 114
- April 15th
- If not filed by April 15th, you will get an automatic extension to October 15th and do not need to file for the extension
- Can file for a further extension if there are extenuating circumstances
Following the Bank Secrecy Act (1970), you must provide information on all certain foreign financial accounts (bank accounts, brokerage accounts, mutual funds, etc.) to the US government to show you are not avoiding US domestic laws
Need to report the following:
- Name on the account,
- Account number,
- Name and address of the foreign bank,
- Type of account, and
- Maximum value during the year.
Electronically
Negligent Violation
- Civil Penalty – $500 (31 USC 5321(a)(6)(A))
Pattern of Negligent Activity
- Civil Penalty – $50,000 (31 USC 5321(a)(6)(B))
Non-Willful Violation
- Civil Penalty – $10,000 (31 USC 5321(a)(5)(B))
Willful Violation
- Civil Penalty – Greater of $100,000 or 50% of the amount in the account
- Criminal Penalty:
- Knowingly and Willfully Filing False FBAR – up to $10,000 or 5 years or both
- Failure to File FBAR – up to $250,000 or 10 years or both
Form 926
A U.S transferor (individual, partnership, corp) of property to a foreign corporation
Form 926
With personal incom tax return due April 15
Any exchange or transfer of tangible or intangible (copyrights, patents, trademarks) property
Online, paper
10% of fair value of property
