Buried deep in the Tax Cuts and Jobs Act of 2017 is a brand new tax incentive for employees who work at privately-held companies and receive equity compensation.
The Tax Cuts and Jobs Act added a new incentive under section 83(i) of Internal Revenue Code called an “inclusion deferral” election. This 83(i) election offers employees the opportunity to defer for up to five years the income related to their stock options, employee stock purchase plans, and restricted stock units.
Deferring income related to employer stock sounds like a good deal. But based on a preliminary analysis conducted by the tax advisors at Visor, there might be just three situations when making this election would actually benefit the taxpayer.
An Overview of the 83(i) Inclusion Deferral Election
Employees who work at privately-owned companies and who receive stock in their employer’s company as the result of:
- exercising incentive stock options,
- exercising non-qualified stock options,
- receiving stock settled from Restricted Stock Units, or
- purchasing stock through Employee Stock Purchase Plans.
The 83(i) election is not available for:
- Post-IPO companies where their stock already trades on an exchange;
- RSUs settled in cash rather than stock;
- Independent contractors, since they are not employees; or
- Excluded employees.
Certain employees are not eligible to make the 83(i) election if they:
- Own 1% or more of the company at any time during the current year or past ten years;
- Serve (or previously served) as the Chief Executive Officer or Chief Financial Officer; or are the family members (spouse, children, grandchildren, and parents) of someone who served/served in these roles; or
- Are among the four highest compensated officers for the year or in the previous ten years.
What the 83(i) Election Does
The new 83(i) election offers employees the opportunity to delay the recognition of income resulting from their stock options, RSUs, or ESPP. This pushes off the tax impact to a later tax year. Making the 83(i) election:
- Defers income equal to the difference between the fair market value of the stock on the date of vesting and the price paid to acquire the stock.
- Treats this deferred income as wages subject to income tax at the ordinary rates, plus Social Security tax and Medicare tax.
- After the election, the stock stops being treated as an ISO, ESPP or RSU and instead is treated similar to regular stock.
Events that Trigger the End of the Deferral Period
Of course, the 83(i) election does not defer income forever, as eventually the tax obligation must be paid. The deferral is capped at five years from the vesting date, but the deferred income will become taxable as soon as any of the following takes place:
- the employer’s stock begins trading on an established securities market (e.g. an initial public offering);
- the employee becomes an excluded employee (see above);
- the employee can transfer ownership of the stock to someone else, including transferring the stock back to the employer;
- the employee chooses to revoke the 83(i) election; or
- five years after the vesting date.
Time Frame to Make the Election
The election must be made within 30 days of the earlier of two events:
- Vesting date of the stock options
- Purchase date of the underlying stock
To complete the election, the employee mails a written statement to the Internal Revenue Service.
What Three Situations Benefit from the 83(i) Election?
After analyzing various scenarios, we at Visor believe there are three primary situations where making the 83(i) election could be beneficial.
- An employee has recently vested non-qualified stock options that he/she wants to exercise.
- An employee is receiving restricted stock units settled in stock that vests based on time instead of event-based vesting.
- An employee is receiving incentive stock options, and wants to exercise this year and then sell the stock when the company goes public in the near future.
The 83(i) election (also known as the inclusion deferral election) is a brand new tax planning move that can be deployed starting in 2018. The IRS has not issued any guidance interpreting this new law. Accordingly, we acknowledge that our understanding of this new election could be flawed or incomplete.
Additionally, companies might need to modify their equity compensation plans so that employees are eligible to make this new 83(i) election.
Due to these additional complexities, we urge people to seek advice from a tax professional before attempting to take advantage of the new deferral opportunity found in section 83(i) of the tax code.
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