New Alternative under the TCJA

Now, under the TCJA, Sec. 83(i) allows qualified employees of eligible private companies to elect to defer taxable income from vested qualified stock grants for up to five years. But three specific requirements must be met for this alternative to be available.

1. Qualified stock. This election is available only for transfers of “qualified stock.” That means stock received by a qualified employee from exercising an option, or in settlement of an RSU. The stock must be from the eligible corporation that employs the qualified employee, and the employee must have received the option or RSU for the performance of services.

   Stock isn’t considered “qualified stock” if the employee has the right to either sell it back to the employer or to receive cash in lieu of the stock immediately upon vesting.

   There are a couple of pitfalls to watch out for. First, a Sec. 83(i) election can’t be made if the corporation has — or has had — any stock that is or was readily tradable on an established securities market at any time before the election is made. Additionally, if the corporation repurchased any stock in the preceding calendar year, the Sec. 83(i) election isn’t available unless at least 25% of the total dollar amount of the repurchased stock was stock for which the Sec. 83(i) election was in effect.

2. Qualified employee. This is generally any employee who makes the Sec. 83(i) election. However, certain individuals are not considered qualified employees, including:
   • • • A 1% owner (which is anyone who directly or constructively owns more than 1% of the outstanding stock or total combined voting power of the  employer corporation) or anyone who was a 1% owner at any time during the prior 10 years.
       • Anyone who has ever been the company CEO or CFO or certain family members of such an individual.
       • The four highest compensated officers for the current year or any of the prior 10 years.
3. Eligible corporation. This is a private corporation that has a written plan under which at least 80% of full-time employees are granted stock options or RSUs. The options or RSUs must confer the same rights and privileges to receive qualified stock. However, employees can receive varying amounts of options or RSUs as long as they get the same type of grant and more than a de minimis grant.

   For purposes of the 80% rule, part-time employees (those who usually work less than 30 hours per week) and individuals who are excluded from the qualified employee definition (such as the CEO) aren’t counted.

   The 80% rule basically forces employers to grant stock options or RSUs to at least 80% of their full-time employees for the Sec. 83(i) election to be available to any employees. In many cases, that would be unacceptable except for the fact that the employer can still grant additional equity-based compensation (for example, more RSUs, ISOs or NQSOs) to a select group of employees as long as 80% of the employees receive more than de minimis stock grants. Unfortunately, we’re still awaiting guidance from the IRS on what’s considered a de minimis grant.

Making the Election

The Sec. 83(i) election must be made by the employee no later than 30 days after the earlier of:

• • The date the employee’s rights in the stock are transferable, or
  • The date the employee’s rights in the stock are no longer subject to a substantial risk of forfeiture.

While qualified employees have the choice of making the Sec. 83(i) election, the employer must meet the applicable qualification rules for the choice to be available. As of the date of this article’s publication, the IRS hadn’t yet issued guidance on making this election.

Tax Consequences

Assuming all the requirements have been met, an employee can make the Sec. 83(i) election to defer taxable income from qualified equity grants. The deferral period is five years from the vesting date. However, taxable income must be recognized earlier if any of the following occur:

• • The qualified stock becomes transferable (including back to the employer corporation).
  • The employee becomes an ineligible employee (for example, by becoming the company CFO).
  • The stock becomes publicly traded.
  • The employee revokes the Sec. 83(i) election.

The Sec. 83(i) election defers income only for income tax purposes. It doesn’t defer income for Social Security, Medicare or FUTA tax purposes. The federal employment taxes will be due when the qualified stock becomes vested based on the fair value of the shares on the vesting date. 

Should Your Company Pay Employees with Equity?

If your company is considering awarding equity-based compensation, it’s a good time to put a written plan in place, thanks to the TCJA. Consult your PDR tax advisor to make sure your plan meets all the requirements needed to make the Sec. 83(i) election available to employees.