Client Alert: Income Tax Deferral Opportunity for Qualified Equity Grants Under New Tax Law
The newly enacted tax bill (Public Law 115-97) creates a “qualified equity grant” (“QEG”) under new §83(i) of the Internal Revenue Code of 1986, as amended (the “Code”). A QEG allows employees of non-publicly traded corporations to defer income taxation for up to five years on the vesting of shares from: (i) exercised stock options; and (ii) settlement of a restricted stock unit (“RSU”) (each of which would otherwise be taxable upon vesting).
This deferral opportunity allows qualified employees of eligible corporations to elect to defer income taxation (but not FICA) on compensation paid in the form of qualified stock if certain election and notice requirements are met.
A “qualified employee” is any individual who (i) is not an “excluded employee” and (ii) agrees in a Code §83(i) deferral election (an “83(i) Election”) to ensure the employer’s income tax withholding requirements are met with respect to the qualified stock.
An “excluded employee” is any individual who with respect to the corporation:
- has been a 1% owner at any time during the last 10 years;
- has at any time been the CEO or CFO;
- is related to any former or current CEO or CFO under the attribution rules of Code §318; or
- has been one of the 4 highest compensated officers during the last 10 years.
“Qualified Stock” includes stock from the exercise of a stock option or the settlement of an RSU if the option or RSU was granted for the performance of services in a calendar year for which the corporation was an “eligible corporation.” If an employee makes an 83(i) Election for shares issued under an incentive stock option (“ISO”) or employment stock purchase plan under Code §423 (”ESPP”), such shares will no longer be considered shares under an ISO or ESPP.
An “eligible corporation” is one with stock not readily tradeable on an established securities market and that has a written plan under which stock options or RSUs are granted in the calendar year (with the same rights and privileges) to at least 80% of all employees who provide services to such corporation in the U.S. (excluding “excluded employees” or part-time employees who work less than 30 hours per week).
To meet the “same rights and privileges” requirement, employees may receive different amounts of stock, but each employee must get more than a de minimis amount.
If qualified stock is granted to a qualified employee, the employee can make an 83(i) Election within 30 days of vesting to have the federal income tax deferred until the earlier of:
- The first date the stock is transferable;
- The date the employee becomes an excluded employee;
- The first date the stock becomes readily tradable on an established securities market;
- The date that is five years after vesting; or
- The date the employee revokes the election.
Consistent with the regulations under Code §83(b), the qualified employee must file the 83(i) Election with the Internal Revenue Service (“IRS”), and provide a copy to the employer, containing certain information about the employee and the property subject to the election.
Note: An employee may not make an 83(i) Election with respect to any qualified stock if: (i) a Code §83(b) election was made for such stock, or (ii) in the preceding year, the corporation purchased any of its outstanding stock (unless at least 25% of the total dollar amount of stock purchased was subject to an 83(i) Election).
Employer Notice, Withholding and Reporting Requirements
For stock eligible for an 83(i) Election, the employer must provide a notice to the employee at the time (or a reasonable period before) the employee’s right to the stock vests. The notice must (i) certify that the stock is qualified stock, and (ii) notify the employee (a) that an 83(i) Election is available, and (b) that, if the employee makes an 83(i) Election, the amount of income required to be included at the end of the deferral period will be based on the value of the stock when it vested (even if the value of the stock declines afterwards). The notice requirement applies to shares from existing stock plans that vest after December 31, 2017. Thus, employers may need to provide such notice for shares that vest AS EARLY AS JANUARY 1, 2018.
Penalty – An employer is subject to a penalty of $100 for each failure to provide timely notice up to a maximum penalty of $50,000 for all failures during any calendar year.
Withholding – An 83(i) Election applies only for income tax purposes. The employer is still required to pay FICA (both employee and employer shares) and FUTA tax in the year in which the stock vests. At the end of the deferral period, the employer must remit income tax withholding at the highest rate applicable to individual taxpayers (37% as of 2018). Thus, as is the case currently with Code §83(b) elections, the employer will need to arrange with the employee for a funding source to pay the taxes on this noncash compensation.
W-2 Reporting – The employer must report on IRS Form W-2 the amount of deferred income covered by the election for the year of the deferral and for each later year until it is ultimately included in taxable income.
If you have any questions or want our help regarding Code §83(i) issues or notices, feel free to call (919-781-4000) or e-mail your Wyrick Robbins contact or either Gray Hutchison or San Parikh of our Employee Benefits & Executive Compensation group.
|Disclaimers: This Alert is intended to be summary information only, and is not written tax advice directed at the particular facts and circumstances of any person or company. Please note that not all potential details and nuances regarding 83(i) Elections have been addressed, and this Alert does not reach any conclusion regarding tax issues for any specific taxpayer. If you are interested in the subject of this Alert, we encourage you to contact us or an independent tax advisor to discuss the potential application to your particular situation.|