Does your company offer employee stock options and other share-based payments? These add-ons can enhance compensation packages without draining operating cash flow and provide incentives for employees to work harder toward maximizing the company’s value. One downside, however, is the complex requirements for reporting the tax consequences of share-based compensation on your financial statements.

In March 2016, the Financial Accounting Standards Board simplified its rules for reporting stock options. The changes go live next year for many employers, so let’s get up to speed now.

Existing Rules

Under current practice, you must determine whether the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting purposes results in either an excess tax benefit or a tax deficiency.

If the deduction for a share-based payment for income tax purposes exceeds the compensation cost for book accounting purposes, you report an excess tax benefit in additional paid-in capital on the balance sheet. This is known as an additional paid-in-capital (APIC) pool, which needs to be tracked. Excess tax benefits aren’t recognized on the income statement until the deduction reduces taxes payable. Conversely, tax deficiencies are recognized either as an offset to accumulated excess tax benefits, if any, or in the income statement.

New Rules

Reporting is simplified under Accounting Standards Update (ASU) 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.

Under the updated guidance, all accounting for the income tax consequences of share-based payments will move to the income statement.

In other words, excess tax benefits and tax deficiencies will be recognized as income tax benefit or expense. The tax effects of exercised or vested awards will be treated as discrete items in the reporting period in which they occur. Additionally, you’ll be allowed to recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. So, in addition to reducing the accounting complexity, this guidance will impact net income and earnings per share.

Private Company Breaks

ASU 2016-09 also provides practical expedients for companies that offer compensation based on stock that’s not traded on the public markets. For service or performance-based payments, the updated guidance provides a simplified formula for private companies to estimate the expected term — that is, the time a stock option is expected to be outstanding before it vests.

In addition, the updated guidance permits private companies to elect a one-time switch from measuring all liability-classified awards at fair value to intrinsic value, without having to evaluate whether intrinsic value is preferable.

Ready, Set, Report

Public companies that offer share-based payments must comply with the updated guidance for fiscal years that start after December 15, 2016. Private companies will have an extra year to implement the changes, although early adoption is permitted.

Contact KLR’s accounting and auditing team for help switching over to these new-and-improved rules or for guidance on whether it makes sense for your company to offer share-based payments to employees.