The Tax Cuts and Jobs Act includes new provision that can delay the taxation of compensation paid to employees of “eligible corporations” in the form of “qualified stock” for up to five years. The provision is set forth in new Internal Revenue Code (Code) section 83(i).
An “eligible corporation” is one that is privately held and has a written plan in place to grant stock options or restricted stock units (RSUs) to at least 80% of all full-time, U.S.-based employees. “Qualified stock” must be:
- Received in connection with the exercise of stock options or the settlement of RSUs; and
- Provided for an employee’s performance of services during a calendar year in which the corporation was an eligible corporation.
An election to defer income inclusion must made by the employee in a manner similar to a section 83(b) election no later than 30 days after the first time the employee’s right to the stock is substantially vested or transferable, whichever occurs earlier. As a practical matter, this means that ordinarily the election must be made within 30 days of the issuance of stock following exercise of a stock option or stock settlement of an RSU.
Ordinarily, once a stock option is exercised or RSU is settled, the award becomes subject to income taxes in the year in which the underlying stock is received (or, if later, the first year for which the stock ceases to be “substantially nonvested”). However, if the election is made, income taxes on qualified stock are due upon the earliest of the following:
- The date the stock is transferrable, including to the employer.
- The date the employee first becomes an “excluded employee” (i.e., (i) an individual who is or has been a 1% owner at any time during the 10 prior calendar years; (ii) the chief executive officer or chief financial officer (or an individual acting in either capacity); (iii) a family member of an individual described in (i) or (ii); or (iv) one of the highest four compensated officers for any of the 10 prior taxable years).
- The first date any stock of the employer becomes readily tradable on an established securities market.
- The date five years after the date the employee’s right to the stock is not subject to a substantial risk of forfeiture.
- The date on which the employee revokes a deferral election.
For employees to be eligible to make a Code section 83(i) election, an eligible corporation must grant at least 80% of all full-time, U.S.-based employees stock options or RSUs that have the same rights and privileges (determined under the rules for employee stock purchase plans in Code section 423(b)(5)). To meet this standard, employees may receive different amounts of stock, but each participant must get more than a de minimis amount; employees cannot be granted a combination of stock options and RSUs during a year (i.e., they must be granted stock options or RSUs for the year).
Employees that have made Code section 83(b) elections with respect to any stock options are not eligible to make elections under Code section 83(i). Additionally, the deferral election is generally not available if the corporation has bought back any outstanding stock in the preceding calendar year, unless at least 25% of the total dollar amount the company bought back is stock to which a Code section 83(i) deferral election is in effect and the determination of which individuals from whom such stock is purchased is made on a reasonable basis. In applying this requirement, stock subject to the longest deferral election under Code section 83(i) must be purchased first.
The employer is subject to reporting requirements regarding stock on which employees have deferred income tax. It is required to provide notice to employees about their right to defer income tax on the stock as well as the consequences of the deferral. Employees who make the election pay tax on the share value at vesting, which could decline over the deferral period. Qualified stock under Code section 83(i) is not be treated as deferred compensation for purposes of Code section 409A. Finally, this deferral opportunity only relates to income taxes—not FICA taxes.
The new qualified equity grant deferral feature requires a broad-based plan that is available to 80% of employees. This may make the plan less attractive to some employers. However, for employers that want to provide a broad-based deferral opportunity for equity grants, this could be a significant benefit to employees.