2.2 Definition of Employee

ASC 718-10 — Glossary

Employee

An individual over whom the grantor of a share-based compensation award exercises or has the right to exercise sufficient control to establish an employer-employee relationship based on common law as illustrated in case law and currently under U.S. Internal Revenue Service (IRS) Revenue Ruling 87-41. A reporting entity based in a foreign jurisdiction would determine whether an employee-employer relationship exists based on the pertinent laws of that jurisdiction. Accordingly, a grantee meets the definition of an employee if the grantor consistently represents that individual to be an employee under common law. The definition of an employee for payroll tax purposes under the U.S. Internal Revenue Code includes common law employees. Accordingly, a grantor that classifies a grantee potentially subject to U.S. payroll taxes as an employee also must represent that individual as an employee for payroll tax purposes (unless the grantee is a leased employee as described below). A grantee does not meet the definition of an employee solely because the grantor represents that individual as an employee for some, but not all, purposes. For example, a requirement or decision to classify a grantee as an employee for U.S. payroll tax purposes does not, by itself, indicate that the grantee is an employee because the grantee also must be an employee of the grantor under common law.

A leased individual is deemed to be an employee of the lessee if all of the following requirements are met:

The leased individual qualifies as a common law employee of the lessee, and the lessor is contractually required to remit payroll taxes on the compensation paid to the leased individual for the services provided to the lessee.
The lessor and lessee agree in writing to all of the following conditions related to the leased individual:
1. The lessee has the exclusive right to grant stock compensation to the individual for the employee service to the lessee.
2. The lessee has a right to hire, fire, and control the activities of the individual. (The lessor also may have that right.)
3. The lessee has the exclusive right to determine the economic value of the services performed by the individual (including wages and the number of units and value of stock compensation granted).
4. The individual has the ability to participate in the lessee’s employee benefit plans, if any, on the same basis as other comparable employees of the lessee.
5. The lessee agrees to and remits to the lessor funds sufficient to cover the complete compensation, including all payroll taxes, of the individual on or before a contractually agreed upon date or dates.

A nonemployee director does not satisfy this definition of employee. Nevertheless, nonemployee directors acting in their role as members of a board of directors are treated as employees if those directors were elected by the employer’s shareholders or appointed to a board position that will be filled by shareholder election when the existing term expires. However, that requirement applies only to awards granted to nonemployee directors for their services as directors. Awards granted to those individuals for other services shall be accounted for as awards to nonemployees.

ASC 718-10

Identifying an Employee of a Physician Practice Management Entity

55-85A A physician practice management entity shall determine whether an employee of the physician practice is considered an employee of the physician practice management entity for purposes of determining the method of accounting for that person’s share-based compensation as follows:

An employee of a physician practice that is consolidated by the physician practice management entity shall be considered an employee of the physician practice management entity and its subsidiaries.
An employee of a physician practice that is not consolidated by the physician practice management entity shall not be considered an employee of the physician practice management entity and its subsidiaries.

Determining whether a grantee meets the definition of an employee under ASC 718 is important for certain aspects of the accounting for a share-based payment award. On the basis of an examination of cases and rules, the IRS issued Revenue Ruling 87-41, which establishes 20 criteria for determining whether an individual is an employee under common law. The degree of importance of each criterion varies depending on the context in which the services of an individual are performed. In addition, the criteria are designed as guides to help an entity determine whether an individual is an employee. An entity should ensure that the substance of an arrangement is not obscured by attempts to achieve a particular employment status. The criteria include the following:

Instructions — “A worker who is required to comply with other persons’ instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the person or persons for whom the services are performed have the right to require compliance with instructions.”
Continuing relationship — “A continuing relationship between the worker and the person or persons for whom the services are performed indicates that an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring although irregular intervals.”
Set hours of work — “The establishment of set hours of work by the person or persons for whom the services are performed is a factor indicating control.”
Hiring, supervising, and paying assistants — “If the person or persons for whom the services are performed hire, supervise, and pay assistants, that factor generally shows control over the workers on the job. However, if one worker hires, supervises, and pays the other assistants pursuant to a contract under which the worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status.”
Working on the employer’s premises — “If the work is performed on the premises of the person or persons for whom the services are performed, that factor suggests control over the worker, especially if the work could be done elsewhere. . . . Work done off the premises of the person or persons receiving the services, such as at the office of the worker, indicates some freedom from control. However, this fact by itself does not mean that the worker is not an employee. The importance of this factor depends on the nature of the service involved and the extent to which an employer generally would require that employees perform such services on the employer’s premises. Control over the place of work is indicated when the person or persons for whom the services are performed have the right to compel the worker to travel a designated route, to canvass a territory within a certain time, or to work at specific places as required.”
Full-time employment requirement — “If the worker must devote substantially full time to the business of the person or persons for whom the services are performed, such person or persons have control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work. An independent contractor on the other hand, is free to work when and for whom he or she chooses.”
Payment — “Payment by the hour, week, or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor.”

See IRS Revenue Ruling 87-41 for additional information about assessing whether an individual is an employee under common law.

2.2.1 Employees of Pass-Through Entities

The ASC master glossary defines share-based payment arrangements, in part, as follows:

The term shares includes various forms of ownership interest that may not take the legal form of securities (for example, partnership interests), as well as other interests, including those that are liabilities in substance but not in form. Equity shares refers only to shares that are accounted for as equity.

Since the definition includes awards of pass-through entities (e.g., partnerships, limited liabilities corporations or limited liability partnerships), an individual is considered an employee of a pass-through entity if the individual qualifies as an employee of the entity under common law. The fact that a pass-through entity does not classify the grantee as an employee for U.S. payroll tax purposes does not, by itself, indicate that the grantee is not an employee for accounting purposes.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.