Initial guidance issued on Sec. 83(i) deferral election for private company equity grants

By Sally P. Schreiber, J.D.

In response to requests from taxpayers and employers, the IRS issued Notice 2018-97 on Friday to provide initial guidance on new Sec. 83(i), which was added to the Code by the law known as the Tax Cuts and Jobs Act, P.L. 115-97. New Sec. 83(i) permits eligible private company employees to elect to defer for up to five years the recognition of income from private company stock acquired by exercising a stock option or settling a restricted stock unit (RSU), provided the employee received the stock as part of a qualified equity grant. The income-deferral election applies to stock received due to options exercised or RSUs settled after Dec. 31, 2017.

The requirements to be a qualified equity grant include that the employer must issue the grant according to a written plan under which, in that calendar year, not less than 80% of all U.S.-based employees who provide services to that corporation receive grants of stock options or RSUs.

The IRS is responding to requests it received to provide guidance on the following issues under Sec. 83(i) until it issues proposed regulations:

  1. How does the Sec. 83(i)(2)(C)(i)(II) requirement that grants be made to not less than 80% of all employees who provide services to the corporation in the United States apply?
  2. What are the federal income tax withholding requirements for the deferred income related to the qualified stock?
  3. Can an employer opt out of permitting employees to elect deferred tax treatment even if the requirements under Sec. 83(i) are otherwise met?

Stakeholders have asked whether the 80% requirement in issue (1) above applies on a cumulative basis so that employers can take into account stock options issued in previous years. The IRS believes that the statutory language requires employers to meet the 80% requirement in the calendar year in which the stock options or RSUs are issued, finding that the interpretation that options issued in previous years can be counted on a cumulative basis with options granted in the current calendar year to be contrary to the statutory language and not a reasonable good-faith interpretation of the 80% requirement.

As for the income tax withholding requirements of stock options or RSUs in the year they are includible in the employee's income, the notice provides that the employer should withhold at the maximum rate of tax in effect under Sec. 1. Withholding is determined without regard to the employee's Form W-4, Employee's Withholding Allowance Certificate, meaning there is no reduction for any withholding allowances. By Jan. 31 of the following year, the employer must determine the actual value of the deferral stock on the date it is includible in the employee's income and report that amount and the withholding on Form W-2, Wage and Tax Statement, and Form 941, Employer's Quarterly Federal Tax Return. If the employer pays the income tax withholding for the deferral stock from its own funds, it may recover that withholding from the employee until April 1 of the year following the calendar year in which the wages were paid.

To ensure that the withholding requirements are met, in order to be a qualified employee for purposes of the election, an employee making a Sec. 83(i) election with respect to qualified stock must agree in the election that all deferral stock will be held in an escrow arrangement until certain conditions are met.

Finally, the IRS provided that employers may opt out of permitting employees to elect deferred tax treatment by either declining to provide an escrow arrangement for deferral stock or otherwise creating conditions that will not allow an employee to make the Sec. 83(i) election. If the corporation intends to do this, the terms of a stock option or RSU may provide that no election under Sec. 83(i) will be available for stock received upon the exercise of the stock option or the settlement of the RSU. This would inform employees that no Sec. 83(i) election may be made for stock received upon exercise of the option or settlement of the RSU even if the stock is qualified stock.

— Sally P. Schreiber, J.D., (Sally.Schreiber@aicpa-cima.com) is a JofA senior editor.

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