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New Section 83(i) Election Provides Income Deferral for Certain Stock Option and Restricted Stock Transactions

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Rödl & Partner Tax Matters Vol 2018 – 10, published in November 2018

 

TAXATION OF EQUITY-BASED COMPENSATION

Companies will often use equity-based compensation such as stock options and restricted stock units to incentivize and motivate employees. Stock options may be in the form of Incentive Stock Options (ISOs) or Nonqualified Stock Options (NQSOs). ISOs are generally taxable to the employee when the underlying shares are sold, whereas NQSOs are generally taxable to the employee when exercised. Restricted stock units (“RSUs”) are usually taxable to the employee when there is no longer a substantial risk of forfeiture or the employee’s right to the stock becomes transferable.

 

A special election under IRC §83(b) allows the recipient of RSUs to recognize taxable income equal to the excess of the fair market value of the property over the amount paid upon receipt, even though the units are subject to a substantial risk of forfeiture at that time. The gamble with an §83(b) election is that the stock value will appreciate. The employee chooses to pay tax on the fair market value of the stock immediately, as opposed to waiting until the restrictions lapse. Without an §83(b) election, the employee is taxed on the value of the stock when the restrictions lapse, which could be higher than on the grant date.


NEW §83(i) ELECTION

Individuals receiving equity-based compensation may find that they need to sell some of the stock to cover the tax due. However, this may not be possible for stock of a privately held company. The inability to pay the tax due could cause an individual to forfeit his or her rightful compensation by allowing the stock options to expire. In order to alleviate this problem, the Tax Cuts and Jobs Act that was signed into law in December 2017 created a new election under §83(i) which allows an individual to defer recognition of taxable income from receipt of stock attributable to the exercise of an option or the settlement of a restricted stock unit. If the election is made, the individual may defer income recognition for no longer than five years from the date on which the employee’s right to receive the stock becomes substantially vested.

 

The election is effective for stock options exercised or RSUs settled after December 31, 2017.

 

In order to make the election, there must be a transfer of qualified stock to a qualified employee for the performance of services for an eligible corporation.
  • QUALIFIED STOCK is stock received in connection with the exercise of an option or the settlement of restricted stock units from the individual’s employer in connection with the performance of services. Note that when the employee has the right to sell the stock back to the employer or receive cash in lieu of stock immediately upon vesting, the stock is not qualified for this election.
  • A QUALIFIED EMPLOYEE is any employee other than the following:
    • An individual who owns more than 1% of the outstanding stock or total combined voting power of the corporation (including anyone who met this threshold at any time within the last 10 years)
    • Anyone who has ever been the company’s CEO or CFO (including certain family members)
    • The four highest compensated officers for the current year and any of the previous 10 years
  • AN ELIGIBLE CORPORATION is one whose shares are not traded on an established securities market and which has a written plan under which at least 80% of full-time employees are granted stock options or RSUs.

 
The election must be made within 30 days from the earlier of the date on which the employee’s rights in the stock become transferable or are no longer subject to a substantial risk of forfeiture.


Certain limitations and special rules apply. If you have any questions or would like further information, please contact your Rödl & Partner representative.

 

 

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