Tax and Private Client Blog

The Tax Reform Act – Newly Added Section 83(i) and Tax Deferral for Private Company Equity Awards

By Jon Hughes

Private Employers Offering Equity Compensation and The Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act (the “Act”) has received considerable attention with respect to the lowering of the corporate tax rate to 21% and new tax brackets for individual filers.

What has not been as frequently discussed is newly added Section 83(i) and the impact that it may have on private employers offering equity-based compensation to employees.  More specifically, the newly added Section 83(i) permits certain employees to defer federal income tax associated with certain equity awards for as long as 5 years.

To follow is a summary of Section 83(i) that may be relevant to any private employer utilizing equity awards as compensation to its employees.

Federal Income Taxation of Equity Awards Prior to Section 83(i)

Prior to the passage of the Act, nonstatutory stock options or nonqualified stock options (“NQSOs”) granted at fair market value were generally taxable when the option was both vested and exercised.  Similarly, restricted stock or restricted stock units (“RSUs”) that were either exempt from or in compliance with Section 409A were generally not taxable until the applicable restriction(s) lapsed and fully vested stock delivered.

Eligibility for Section 83(i) Deferral of Taxation of Equity Awards

For NSOs exercised and RSUs settled subsequent to December 31, 2017, Section 83(i) permits the deferral of federal income tax for as long as 5 years by a “qualified employee” if the equity award was granted in connection with the performance of services and was granted by an “eligible corporation.”  As always, the devil is in the tax details. 

First, an employee is eligible to be a “qualified employee” if they: (i) are not an “excluded employee”; and (ii) make a timely 83(i) election.  “Excluded employees” generally include: the CFO or CEO, the top 4 compensated officers and people who are 1% owners or were 1% owners during the preceding 10 tax years. 

Second, an employer is generally an “eligible corporation” if: (i) its stock was not publicly traded during any prior calendar year; and (ii) it has adopted a written equity award plan pursuant to which not less than 80% of its US employees are granted NQSOs or RSUs with the same rights and privileges.

Duration of Federal Income Deferral Pursuant to Section 83(i)

Section 83(i) permits the deferral of federal income tax for as long as 5 years.  This 5 year period will be shortened upon the first to occur of the following events:

•  The date the “eligible employee” becomes an “excluded employee;

•  The date the employee revokes the 83(i) election;

•  The date on which the employer’s stock becomes publicly traded; or

•  The date on which the stock becomes transferable (including to the employer).

Our View

Private employers utilizing equity-based compensation for employees should review their equity-based compensation plan (if any) and their compensation objectives to determine if federal income tax deferrals permissible pursuant to Section 83(i) are desirable. This may be especially relevant to employers with employees who have expressed concerns with respect to equity-based compensation because of liquidity issues associated with the exercise of NQSOs or the settlement of RSUs because there does not exist a market for the stock. 

We welcome the opportunity to discuss any questions or concerns that you may have regarding Section 83(i), including preparing new equity incentive plans or amending or administering existing plans to permit deferral of federal income tax pursuant to Section 83(i).

Mayer Nazarian, Chair of the Tax Department - mnazarian@ckrlaw.com
Eli Akhavan, Chair of the Private Clients and Wealth Preservation Practice Group - eakhavan@ckrlaw.com       
Aman Badyal - abadyal@ckrlaw.com
Elizabeth Larrauri Chamulak - echamulak@ckrlaw.com
Elizabeth Nelson - enelson@ckrlaw.com
Farzaneh Savoji - fsavoji@ckrlaw.com
Gary Edelstone - gedelstone@ckrlaw.com
Michael Shaff - mshaff@ckrlaw.com
Jon Hughes - jhughes@ckrlaw.com
Gordon Einstein - geinstein@ckrlaw.com

DISCLAIMER: This article is not intended to provide legal advice, and no legal or business decision should be made based on its contents.