United States: New US Tax Law Provides Tax Deferral Opportunity For Certain Private Company Equity Grants

Last Updated: March 9 2018
Article by Mary B. Hevener, Zaitun Poonja, Mims M. Zabriskie and Leslie E. DuPuy

The adoption of Internal Revenue Code Section 83(i) under recent US tax reform will allow certain private company employees to defer federal income tax on eligible stock options and restricted stock units for up to five years following their respective exercise or settlement. While additional clarification from the Internal Revenue Service is still needed, and there are a number of technical requirements under Section 83(i) that must be satisfied, Section 83(i) could be useful for bridging the gap between when an employee is subject to income tax and when the employee's shares can be liquidated.

The Tax Cuts and Jobs Act of 2017 (PL 115-97) added new Section 83(i) to the US Internal Revenue Code, which allows eligible employees of private companies the opportunity to defer US federal income taxation on eligible stock options and restricted stock units (RSUs) for up to five years following exercise of the stock options or settlement of the RSUs. The deferral treatment applies to a stock option that is exercised and RSUs that are settled after December 31, 2017.

Under current tax law, a nonqualified stock option is generally taxed upon exercise of the stock option and RSUs are generally taxed upon settlement of the RSUs. Stock of a private company cannot be readily sold by employees to cover taxes. Accordingly, Section 83(i) could be useful for bridging the gap between when an employee is subject to income tax and when the employee's shares can be liquidated. However, given the technical requirements of the new rule and some of the clarifications needed from the Internal Revenue Service (IRS), it is unclear how widely Section 83(i) will be used. On the other hand, it appears that companies cannot opt out of Section 83(i), in which case companies will have to determine whether their stock options or RSUs might be granted to enough employees to meet the 80% eligibility test described below, and then ensure that they do not inadvertently fail to comply with the requirements of Section 83(i), which could result in penalties to the company.

What Is the Tax Deferral Period?

Section 83(i) allows certain eligible employees the opportunity to defer federal income taxation attributable to "qualified stock" until the earliest of

  • five years after an employee's right in the stock is transferable or not subject to a substantial risk of forfeiture (generally, meaning five years after exercise of a stock option (for a vested option) or the settlement date of RSUs);
  • the qualified stock becoming transferable (including becoming transferable to the employer corporation);
  • the employee becoming an "excluded employee";
  • the stock becoming readily tradable on an established securities market; or
  • the employee revoking the election.

At the end of the deferral period, the amount of income that must be recognized (and subject to withholding) is based on the value of the stock at the time of exercise of the stock option or the settlement of the RSUs, even if the stock has declined in value during the deferral period. It may be difficult for the company to collect the withholding taxes from the employee (or former employee) at the end of the deferral period, even though the employee (or former employee) would have been required to agree to pay the withholding. It is also not clear how the company's withholding and reporting obligations would apply for year-end exercises or settlements where the election could be made in a subsequent year. The deferral does not apply to FICA or FUTA taxes.

Who Is Eligible to Make a Section 83(i) Election?

There are a number of eligibility requirements with respect to Section 83(i) elections, including that the employee must be a full-time employee1 who is not an "excluded employee" and who has received "qualified stock" granted by an "eligible corporation" as compensation for services.

An excluded employee is an individual who

  • is or has been the company's CEO or CFO,
  • is or was during the last 10 years (a) a 1% owner or (b) one of the four highest paid officers of the company, or
  • is a family member of the CEO or CFO.

What Is Qualified Stock?

"Qualified stock" generally means stock in an eligible corporation that is received by an eligible employee in connection with either the exercise of a stock option (including an incentive stock option or an employee stock purchase plan (ESPP) option)2 or the settlement of RSUs. Stock will not be treated as qualified stock if the employee may sell it to the corporation or otherwise receive cash from the corporation in lieu of such stock at the time the stock becomes transferable or not subject to a substantial risk of forfeiture. This would likely preclude net settlement of employment taxes.

What Is an Eligible Corporation?

An "eligible corporation" means, with respect to any calendar year, a company that (a) has never had its stock traded on an established securities market and (b) has a written plan under which at least 80% of full-time US employees (other than excluded employees) are granted stock options or RSUs, with the same rights and privileges to receive qualified stock.3 It appears that the 80% rule applies separately to RSUs; therefore, if 80% of eligible employees receive stock options, they can make a Section 83(i) election for stock options but not for RSUs, unless 80% of the eligible employees also get RSUs.

An eligible corporation is not required to give each employee the same number of shares of qualified stock, as long as the number of shares available to each employee is more than a de minimis amount.

Additionally, no election is permitted if the corporation purchased any of its outstanding stock in the prior calendar year unless (a) at least 25% of the total dollar amount of the stock purchased is stock under which there is an active Section 83(i) deferral election (deferral stock), and the determination of which individuals from whom deferral stock is purchased is made on a reasonable basis, or (b) the stock repurchased by the corporation includes all outstanding deferral stock.

When Must an Election Be Made?

A Section 83(i) election must be made within 30 days after the date the stock is transferable or no longer subject to a substantial risk of forfeiture, and cannot be made if the employee made an election under Internal Revenue Code Section 83(b).

If an employee makes a Section 83(i) election with respect to an incentive stock option (ISO) or an ESPP option, the stock option will be treated as a nonqualified stock option and will no longer be eligible for the preferential tax treatment applicable to ISOs or ESPP options, as applicable. In that case, FICA and FUTA taxes will be due upon exercise of the stock option and income tax withholding on the income recognized under the Section 83(i) timing rules.

What Are a Corporation's Notice and Reporting Obligations?

Section 83(i) imposes a notice requirement that a corporation must satisfy at the time that (or a reasonable time before) an amount attributable to such stock would first be includible in income absent the Section 83(i) election. The notice must

  • certify that the stock is qualified stock,
  • notify the employee that the employee may be eligible to make an election under Section 83(i), and
  • inform the employee of the tax consequences of the deferral.

The corporation also has a reporting obligation on Form W-2 for both the year of deferral (applicable to the reporting of FICA-taxable income and FICA tax withholding) and the year income is recognized by the employee (applicable to the reporting of "Box 1" taxable income and of income tax withholding).

The failure to provide the notice to employees results in a penalty of $100 per failure, subject to a maximum penalty of $50,000 per year for failure to provide the required notices.

Additional guidance from the IRS is needed to clarify the meaning of a number of terms used in the election and the impact on withholding obligations.

Footnotes

1 Nonemployees are not eligible to make Section 83(i) elections.

2 Section 83(i) applies to ESPP options, although private companies rarely implement such plans.

3 It appears that the rules apply to qualifying awards made prior to 2018 that are exercised or settled after 2017.

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Fredrikson & Byron, P.A.
Stroock & Stroock & Lavan LLP
Fox Rothschild LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Fredrikson & Byron, P.A.
Stroock & Stroock & Lavan LLP
Fox Rothschild LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions