Taxation of Dividends and Dividend
Equivalents Paid on Stock Awards
Granted by U.S. Corporations
Originally published in The Journal of Corporate Taxation, November / December 2013 issue
Author: DENISE M. GLAGAU
DENISE M. GLAGAU is a Partner, Global Equity Services,
in the San Francisco office of Baker & McKenzie LLP.
Generally, the board of directors of a company may declare and pay
dividends on the company’s shares, subject to any restrictions under the
corporate laws of the jurisdiction in which the company is incorporated and
the company’s certificate or articles of incorporation.1 When a company
decides to declare and pay dividends on its shares, that decision may or
may not trickle down to shares underlying stock awards granted under the
company’s equity incentive plans.
Many dividend-paying companies also pay dividends on restricted stock
awards2 and dividend equivalents on restricted stock unit awards.3 A 2010
survey of 597 companies (96% of which are U.S. companies and 98% of which
are publicly traded on an exchange in the U.S.) found that among dividendpaying
companies that grant restricted stock and restricted stock unit
awards to employees, 82% paid dividends to restricted stock award holders
and 64% paid dividend equivalents to restricted stock unit award holders.4
In contrast to restricted stock and restricted stock unit awards, other types
of equity awards such as stock options, stock appreciation rights, and purchase
rights under an employee stock purchase plan do not typically involve any dividend
or dividend equivalent rights until shares are issued pursuant to the award.5
1 See, e.g., Delaware Code, Title 8: Corporations, Chapter 1: General Corporation
Law Subchapter V: Stock and Dividends, section 170.
2 Under a restricted stock award, shares are issued to the employee at grant
but the shares are forfeitable until the fulfillment of certain vesting conditions
(e.g., continuous employment through a specified date).
3 In this context, a dividend equivalent is meant to replicate a dividend where a real
dividend cannot be paid, typically under a restricted stock unit award where the
company promises to issue shares to the employee at a later time, subject to the
fulfillment of certain vesting conditions (e.g., continuous employment through a
specified date or achievement of specified performance goals).
4 See “National Association of Stock Plan Professionals and Deloitte Consulting LLP,
Trends and Analysis from the 2010 Stock Plan Design Survey: A Review of U.S. Equity
Compensation Plan Trends,” 8/10/10, www.naspp.com/members/webcast/2010/08_10/
materials.pdf, slide 45.
5 In the case of an extraordinary (large) dividend, it is common that options and stock
appreciation rights are adjusted to reflect such dividend.
The practice of paying dividends and dividend equivalents on restricted stock and restricted stock unit awards makes a certain amount of sense when one considers two of the primary reasons that companies grant employee equity awards-to align employee interests with shareholder interests and to motivate employees to work toward increasing the value of the company.6 There are many additional issues for a company to address if it decides to make dividend/dividend equivalent payments to employee award holders. There are often different tax consequences for dividend/dividend equivalent payments made to employee award holders than for dividends paid to shareholders. Moreover, special tax and other considerations may arise once shares are issued to employees pursuant to such awards and dividends are paid on those shares, especially for companies issuing such shares and paying dividends to employees outside the U.S. This column will explore some of these issues and highlight the key points of which companies should be aware when paying or considering paying dividends or dividend equivalents on employee equity awards in connection with paying cash dividends to its shareholders.
Key decision points
Once the decision has been made to pay dividends/dividend equivalents on restricted stock and/or restricted stock units, additional decision points that must be considered include:
Will the dividend/dividend equivalent payment be made at the same time the dividend payment is made to other shareholders or will the payment accrue and be paid to the employee only if and when the underlying award vests?
Will the payment be made in cash or reinvested in additional shares of stock?
If the payment will be made in cash, will it be delivered to the employee by depositing the cash into a brokerage account with the designated broker for the equity plan or will it be delivered to the employee through payroll?
The aforementioned 2010 survey found the following: Of companies paying dividends on restricted stock awards, 64% paid the dividend in cash to award holders when the dividend was paid to other shareholders, 15% paid the dividend in cash to award holders when the underlying award became nonforfeitable, and 15% reinvested the dividend into additional restricted stock paid to award holders when the underlying award was paid. Of companies paying dividend equivalents on restricted stock unit awards, 36% paid the dividend equivalent in cash to award holders when the dividend was paid to shareholders, 21% paid the dividend equivalent in cash to award holders when the underlying award was paid, and 36% reinvested the dividend equivalent into additional restricted stock units paid to award holders when the underlying award became nonforfeitable.7
There are a host of factors that companies consider when deciding on these points, including accounting treatment, cash flow, dealing with fractional
6 See WorldatWork Research, “Employee Equity Plans: Do They Have a Future?
A Collaborative Research Initiative Among PARC, WorldatWork and Hewitt New
Bridge Street,” January 2010, www.worldatwork.org/waw/adimLink?id=36366,
Figure 2.5, page 12.
7 See supra note 4.
shares, availability of shares under the equity plan, and administrative ease. For employees subject to U.S. taxation, the decision a company makes on these points will not necessarily impact the tax treatment of the payment or the underlying award. On the other hand, for employees subject to taxation outside the U.S., the decision a company makes on these points will often impact the tax treatment of the dividend/dividend equivalent payment (or the withholding or reporting obligations of the company or the employer in connection with the payment) as well as the treatment of the underlying award. Although a company might not make a particular decision based on the tax treatment, in some cases it may make sense to do so to achieve (or avoid) a certain result.
Regardless of where employees are located, it is crucial for companies to understand how dividend and dividend equivalent payments will be treated for tax and social insurance contribution purposes and the employee and employer obligations related to such payments.
Restricted stock and dividend payments
In the U.S., restricted stock is generally taxed at vesting, when the shares are no longer subject to a substantial risk of forfeiture. The taxable amount is the fair market value of the shares at vesting and this amount is treated as compensation income.8 However, an employee may elect, pursuant to Section 83(b) , to be taxed at grant of the restricted stock in which case the taxable amount is the fair market value of the shares at grant and, again, this amount is treated as compensation income.
If a Section 83(b) election has not been made, dividends paid on unvested restricted stock will be treated as compensation income and taxed at the award holder’s marginal tax rate rather than the special tax rate that applies to regular dividends (described below) and the employer must withhold the tax. It does not matter if the dividends are paid out at the same time as dividends are paid to other shareholders or if the dividends are accrued and paid only at vesting, nor does it matter if the dividends are paid in cash or reinvested and paid in stock or, if paid in cash, paid into a brokerage account or delivered through payroll.
If a Section 83(b) election has been made, dividends paid on unvested restricted stock will be taxed as they are taxed in the hands of any other shareholder, at the 0% to 20% tax rate that applies to net capital gain (assuming they are qualified dividends and provided the award holder has met the required holding period9),
8 The taxable amount is also subject to: (i) employee- and employer-paid Federal Insurance Contribution Act (FICA) contributions as well as state and local social insurance contributions (if applicable), but wage ceilings apply to some of the contributions, and (ii) employer-paid Federal Unemployment Tax Act (FUTA) payments as well as state unemployment tax payments (if applicable) but a wage ceiling applies to FUTA payments and may apply to state unemployment tax payments. An employer may be able to claim credits against its gross FUTA payments with respect to any state unemployment tax payments.
9 To qualify for the 0% to 20% rate that applies to net capital gain, all the following requirements must be met: (i) the dividend is paid by a U.S. corporation or a qualified foreign corporation, (ii) the dividends are not considered “Dividends that are not qualified dividends” and (iii) the shareholder has held the shares for more than
60 days during the 121-day period that begins 60 days before the ex-dividend date (i.e., the first date following the declaration of a dividend on which the buyer of stock is not entitled to receive the next dividend payment). See IRS Publication 550 (2012), “Investment Income and Expenses,” Chapter 1: Investment Income; Dividends and Other Distributions.
and the employer is not required to withhold the tax. As with dividends paid
on restricted stock where a Section 83(b) election has not been made, the
treatment of the dividends is not impacted by the details of how and when the
dividends are paid. Instead, for U.S. taxpayer employees, the most significant
factor impacting the taxation of dividends is whether or not an effective
Section 83(b) election has been made.
Outside the U.S., the tax treatment of restricted stock and dividends paid
in connection with such stock varies. A large number of countries tax
restricted stock at grant and the taxable amount is the fair market value of
the shares at grant. This is, for example, the case in Canada, Italy, Norway,
Sweden, and Switzerland, although Canada and Switzerland allow for a
reduction in the taxable value due to the restrictions. Where restricted
stock is taxed at grant, dividends paid on unvested restricted stock are often
taxed similarly to dividends received by other shareholders in that country
and withholding is generally not required. For example, in Canada, Italy,
Sweden, and Switzerland, dividends paid on unvested restricted stock are
taxed the same as dividends paid on unrestricted shares, although how such
dividends are taxed varies from country to country. In Canada, dividends are
included in income and taxed at marginal tax rates. In Sweden, dividends are
subject to capital gains tax. In Switzerland, dividends are subject to ordinary
income tax. In these three cases, neither the company nor the employer is
required to report the income or withhold the tax resulting from the dividend
payment. In Italy, dividends are taxed at a flat rate and neither the company
nor the employer is required to report the income or withhold the tax if the
dividend payment is made into a U.S. brokerage account but if the payment
is made through local payroll (or another Italian paying agent), reporting and
withholding will be required. In other countries that tax restricted stock at
grant, dividends paid on unvested restricted stock may be taxed differently
from dividends received by other shareholders. In Norway, dividends paid on
unvested restricted stock are taxed as income from employment (at marginal
tax rates up to 40%) and the local employer must report the income and
withhold the tax, whereas dividends paid on vested, unrestricted shares are
taxed as capital income (at a rate of 28%) and no reporting or withholding
A number of countries tax restricted stock at vesting and the taxable amount
is the fair market value of the shares at vesting. For example, restricted
stock is taxed at vesting in India, Singapore, and the United Kingdom.10
In these countries, dividends paid on unvested restricted stock may be
taxed the same as dividends paid to other shareholders in that country are
taxed or differently depending on various factors. In India, all dividends
from a foreign company are taxed similarly, regardless of whether paid on
unvested restricted stock or on unrestricted stock and regardless of how
paid. In Singapore, if a cash dividend is paid on unvested restricted stock,
the payment will be subject to income tax and social insurance contributions,
whereas if a cash dividend is paid on vested restricted stock, the payment
will not be subject to tax or social insurance contributions. In the U.K., any
cash dividends paid on restricted stock will be taxed under the U.K. dividend
tax regime, regardless of whether the restricted stock is vested or not,
provided the award holder obtains the same rights as other shareholders
10 In the United Kingdom, restricted stock is taxed at vesting, provided the restrictions
are for less than five years from the date of grant and the employee has not elected
with the employer to be taxed at grant.
proportionate to their shareholding. In this case, the dividends are subject
to U.K. income tax but not national insurance contributions, the dividend
income must be declared to the tax authorities by the employee under the
self-assessment tax system and there are no obligations for the company
or the local employer to withhold the tax. However, if the award holder does not
receive the same rights as other shareholders or if the dividend payment is not
paid out at the time it is paid to other shareholders and is instead subject to the
vesting schedule applicable to the restricted stock award, any cash dividends
will be treated as employment income, subject to U.K. income tax and employee
and employer national insurance contributions, and the local employer will be
required to withhold the tax and national insurance contributions.
In some countries, whether restricted stock is taxed at grant or vesting
depends on whether shareholder rights-such as dividend rights and voting
rights-attach at the time of grant or are deferred until vesting. In Austria,
restricted stock is subject to tax at grant, but if no shareholder rights (such
as voting rights and dividend rights) apply to the shares, taxation should
occur at vesting. In Japan, the taxation of restricted stock is somewhat
uncertain but it is likely that the payment of dividends during the restricted
period will accelerate the taxable event to grant whereas if dividend payments
and other shareholder rights are deferred until vesting the taxable event is
likely to be at vesting.
Restricted stock units and dividend equivalents
In the U.S., restricted stock units generally are subject to income tax when
the shares are delivered or constructively received and the taxable amount
is the fair market value of the shares at that time.11
However, because restricted stock units are potentially subject to Section
409A, it is important to structure the restricted stock units either to exempt
them from Section 409A or, to the extent the restricted stock units are
considered an item of non-qualified deferred compensation, to comply with
Section 409A. This is to ensure that the restricted stock units are taxable
when the shares are delivered and to avoid other adverse tax consequences,
including an additional 20% federal tax charge.12 Dividend equivalents paid
on restricted stock units will be treated as ordinary income and taxed at
the award holder’s marginal tax rate and the employer must withhold the
applicable taxes on that income. Similar to the restricted stock unit award
itself, the dividend equivalents must comply with or be exempt from Section
409A. The “easiest” way to achieve this is for the dividend equivalents to
be paid at the same time and in the same form as the restricted stock unit
award, assuming the award itself is exempt or compliant. It is possible to
structure the dividend equivalents to be paid at a separate time and in a
different form from the restricted stock unit award, but careful attention
must be paid to structuring the dividend equivalents to be exempt or
compliant in this case.
11 However, FICA contributions are imposed at vesting and, therefore, may be due prior
to delivery of the shares where the vesting and delivery dates do not coincide. Certain
rules may permit the FICA contribution date to coincide with the income taxation date.
12 In brief, if the restricted stock units are not exempt from the application of Section
409A and the payment terms do not comply with Section 409A , the restricted stock
units may be subject to tax at vesting (even if the shares are not delivered at that time),
a 20% additional tax may be imposed on the income recognized at the time of vesting,
and interest may be imposed to the extent tax was not paid at vesting. Such tax and
interest is imposed on the taxpayer but the employer may also be subject to penalties
for failure to withhold and report income tax at vesting.
Outside the U.S., restricted stock units are typically subject to tax either
at vesting (when the right to the shares becomes non-forfeitable) or at
settlement (when the shares are delivered). If there is not a significant
delay or significant share price fluctuation between these points, there
is not usually a reason to make a distinction. If there is a significant delay
between these points, the company may need to review the specific rules
in a jurisdiction. The taxable amount is typically the fair market value
of the shares at the taxable event (vesting or delivery). There are a few
notable exceptions to this general rule. For example, in Australia, under
some circumstances restricted stock units may be taxed at grant, upon
termination of employment, or on the seventh anniversary of the grant
date (and the taxable amount is the market value of the restricted stock
units at the taxable event). In Denmark, there are some circumstances under
which restricted stock units may be taxed at grant (and the taxable amount
is the fair market value of the shares at that time). In Israel, restricted stock
units are subject to tax when the shares are ultimately sold (and the taxable
amount is the sale proceeds). Importantly, for the topic at hand, there are
a number of countries where the payment of dividend equivalents prior to
vesting creates a risk that the restricted stock units will be taxed at grant
rather than at vesting. For example, this is the case in Japan, South Korea,
and South Africa.
Dividend equivalents paid in connection with restricted stock units, whether
paid at the time the dividend is declared or accrued or paid at vesting, tend
to be taxed as income from employment and follow the same treatment as
applies to the underlying award income. Therefore, where income tax and
social insurance contributions apply to the fair market value of the shares
at vesting, income tax and social insurance contributions also apply to the
dividend equivalent payment. In addition, where the employer is required
to report the income and withhold the tax at vesting of the restricted
stock units, the employer will also be required to report the income and
withhold the tax resulting from the dividend equivalent payment. However,
this is not the case across the board. In Australia, where there is usually
only a reporting obligation but not a withholding obligation for restricted
stock units, this same treatment will apply to dividend equivalents if paid
in shares. However, if dividend equivalents are paid in cash, withholding
obligations will apply. In New Zealand, where there is no reporting or
withholding obligation for restricted stock units, this same treatment will
apply to dividend equivalents if paid in shares. If dividend equivalents are
paid in cash, however, reporting and withholding obligations will apply. In
a few countries, dividend equivalents will be taxed like a dividend payment.
For example, in Turkey, both dividends and dividend equivalents are subject
to tax only if the dividend/dividend equivalent income exceeds a certain
threshold for the fiscal year (TRY1,390 for 2013).
Dividends paid to employee shareholders
Once shares have been issued and are freely held by employees pursuant
to equity incentive awards, the dividends will be subject to the same
tax treatment applicable to any shareholder. On one hand, this puts the
employees on the same footing as any other shareholder and, provided the
company, or in some cases the broker or the company’s transfer agent,
complies with applicable requirements and obligations, a company could
take the view that there are no additional considerations. On the other hand,
unlike the somewhat distant relationship companies have with most of their
shareholders (majority shareholders excluded), the employee shareholders
are in close proximity and are likely to bring any questions or complaints
they have about being a shareholder or receiving dividends to the stock plan
administration, legal, or tax teams with whom they may be familiar because
of communication and interactions related to the equity award. In addition,
many companies are likely to feel more responsibility for their employee
shareholders than for other shareholders and so may be inclined to provide
more “hand-holding” to employee shareholders than to other shareholders.
Dividends paid to U.S. tax residents will be taxed, for federal tax purposes,
at the 0% to 20% tax rate that applies to net capital gain (assuming qualified
dividends and provided the award holder has met the required holding
period13). State tax may also apply. No withholding is required, provided the
taxpayer has provided his or her taxpayer identification number (TIN) to the
payer of the income or the withholding agent (the company or the broker or
transfer agent holding the shares). The company must report the dividend
income on Form 1099-DIV. The taxpayer must also report the dividend
income on his or her annual tax return and is responsible for paying any
Dividends on shares of a U.S. company paid to foreign persons are subject
to U.S. federal tax and withholding at source by the payer of the income
or the withholding agent (the company or the transfer agent), usually at a
rate of 30%.14 It may be possible, however, to claim an exemption from the
withholding or a reduction in the withholding rate based on a treaty. Many
non-U.S. jurisdictions have treaties with the U.S. that allow for reduced
withholding at a rate of 15%.15 To claim the treaty rate, the recipient of
the income must provide IRS Form W-8BEN to the withholding agent. It
seems to be a common refrain among companies with non-U.S. employees
that it is difficult to ensure that all the employees provide a properly
completed W-8BEN. However, if withholding is done at the 30% rate,
employee shareholders are not pleased. Effective communication about
the requirement to complete the Form W-8BEN and the consequences
of not doing so are key to avoiding employees who are uninformed and
unhappy in this respect. The company has the opportunity to do this in the
plan prospectus, which U.S. public companies are required to provide to
award holders under the SEC Form S-8 rules, in which the material tax
consequences of the award are disclosed. It is perhaps possible to take the
position that the company does not have to go as far as describing the details
of what form must be provided to avoid the 30% withholding rate when
dividends are paid, but it may be worth doing so to avoid complaints to the
stock administration, legal, or tax teams when these employee shareholders
start receiving dividend payments on their shares.
Employees outside the U.S. will often also be subject to tax on the dividend
payment in their country of residence. As described above in the discussion
about dividends paid on restricted stock, dividends are taxed in different ways
in different countries, e.g., as ordinary income subject to marginal tax rates
or as capital gain taxed at lower rates. In a few countries, there is no tax on
13 See supra note 9.
14 See Section 1441.
15 See lRS Publication 515 (2013), “Withholding of Tax on Non-Resident Aliens and
Foreign Entities, Tax Treaty Tables,” page 38.
dividends at all or no tax on dividends paid by a foreign company. In many
countries where dividends paid by a U.S. corporation are taxed locally, a tax
credit or some kind of tax relief will be available for the U.S. tax withheld on
the dividend payment. In most countries, there is no non-U.S. withholding
obligation for the dividend payment and employees will be responsible for
paying the taxes in their local country on their own. Again, although it may
be arguable whether this kind of detail must be provided to employees under
the Form S-8 rules, it may be helpful to do so to avoid employee questions or
complaints about the taxes imposed on the dividends.
In any case, for all employees-in the U.S. and outside the U.S.-companies
should ensure that the documentation related to equity awards includes clear
language that the employee is responsible for paying any taxes related to the
award, the shares as well as any dividends (and dividend equivalents) that
may be paid in connection with the shares. Further, the employee should be
required to accept or acknowledge such provisions to protect the company
from any claims from employees in connection with taxation of the award.
Dividend reinvestment programs
Some companies (or brokers) implement dividend reinvestment programs
whereby dividends are automatically reinvested in the company’s shares.
Although a full analysis of the issues related to such programs is beyond the
scope of this article, it is important for companies to be aware of regulatory
issues that may arise with such programs. In particular, there are a number of
countries that, although they allow residents to invest in shares of a foreign
company, impose a repatriation requirement on all proceeds or funds
recognized in connection with such investment. An automatic dividend
reinvestment program may prevent a resident of such a country from
complying with repatriation requirements. Therefore, companies should
consider these issues prior to implementing such a program. Like the taxation
of dividend comments above, this is also an issue that could apply to any
shareholder; however, some dividend reinvestment programs are put in place
specifically because some employee shareholders hold so few shares that
making dividend payments to them is not efficient. In this case, the problem is
created only for employees/former employees and companies should consider
whether any risks exist for the countries where their employee shareholders
are located. In addition, where dividends are automatically reinvested, the
employee shareholders may not appreciate that they have received a taxable
benefit and it may be prudent to highlight this to them.
Knowledge and communication are the best protection for companies paying
(or considering paying) dividends/dividend equivalents on employee equity
awards. Therefore, companies should understand, and inform employees
about, the tax consequences of the dividend/dividend equivalent payments
in the countries where employee award holders are located to ensure that
the company, local employers, and employees can be in compliance with the
related tax obligations. This will allow the benefits of dividends and dividend
equivalents to be fully appreciated by employees without a downside.
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