Recent tax law changes include a new income tax deferral opportunity for Qualified Equity Grants available to some “qualified employees” of “eligible corporations” under the new Internal Revenue Code Section 83(i). San Parikh and Tom Cook spoke with Bloomberg Tax’s Lydia O’Neal about how and when the law applies, and discuss concerns over ambiguity in some of the rule’s terms. From the article:
Employees of startups who get paid in restricted stock units are now allowed to delay paying taxes on it, but tax professionals think doing so might pose more risk than benefit.
While employees of these fledgling businesses can avoid paying income taxes on their restricted stock units for five years under new code Section 83(i) in the 2017 tax law, they are still essentially betting on a startup’s success, practitioners said.
Additionally, employment law and tax attorneys told Bloomberg Tax, widespread use of the deferral may be limited by the code section’s narrow real-world application, the need for IRS guidance, and the likelihood that many new and small businesses don’t know about it.
“We don’t think that these smaller companies, unless they’re advised by larger accounting firms or law firms, will know about this ability to defer tax under 83(i),” said Sanyam Parikh, an attorney at the Raleigh-based law firm Wyrick, Robbins Yates & Ponton LLP, who specializes in employee benefits and equity compensation.
“To the extent that they are advised and do know about it, it’s still not clear that employees will take advantage of the deferral election, just because of the risk.”
How It Works
Under Section 83(a) of the code, which existed before Section 83(i) was added in the tax law (Pub. L. No. 115-97), the value of property transferred in exchange for performed services is included in income when it vests, meaning the employee has become fully entitled to and able to sell it.
Section 83(b), which also existed prior to the new law, allows employees with private company restricted stock units to elect within 30 days of the transfer to have the fair market value of the stock taxed as income, so that, as the value of the stock ideally rises over time, they can maximize the amount of share value later taxed at the capital gains rate rather than the much higher income tax rate. Otherwise, employees would pay income tax on the restricted stock units when they vest—potentially a much higher value than when it was transferred.
For low- to mid-level employees at a young startup, paying income tax on a stock they can’t sell, even when the shares hold much lower value when they’re transferred than when they vest, is far from ideal.
The new Section 83(i), which practitioners said was likely intended to benefit nascent tech, biotech, and pharmaceutical firms, defers the income tax obligation on qualified equity transfers for five years. It must be provided to at least 80 percent of employees and exclude: chief executive officers; chief financial officers and their spouses, children, grandchildren, and parents; one percent owners of the company; and the four highest-compensated company officers.
To help employees make the most of Section 83(i), a company within half a decade of a liquidity event would give the equity grants to low- and mid-level personnel so they can wait until after the stock can be sold on a securities marketplace to pay the income tax on the value at which it was initially transferred to them, and capital gains tax on any increase in value since then. Practitioners said what sounds great in theory may in reality still tie employees to the risk that the company will bottom out. The provision may be little used—or worse, used inadvertently at the risk of penalty, they said.
Read the rest of the article here.
Read more about the 83(i) Election in Qualified Equity Grants in our client alert here.