The Tax Cuts and Jobs Act (Tax Reform) includes a new deferral election for employees receiving stock-based compensation from privately-held corporations. The new Section 83(i) election allows employees to defer the recognition of income attributable to stock received on exercise of an option or settlement of a restricted stock unit (RSUs) for a maximum of five years. The election is only permitted with respect to a transfer of “qualified stock” to a “qualified employee” of an “eligible corporation.”
In order to be qualified stock, the qualified employee must receive the option or RSU in connection with the performance of services. A qualified employee is generally any employee that is not: (1) an individual who owns more than 1% of the company during the year (or at any time during the last 10 years); (2) anyone who has ever been the CFO or CEO (an employee can also be disqualified under this exception due to the family attribution rules); (3) the four highest compensated officers of the corporation during the current year or any of the ten prior years. An eligible corporation is a privately-held corporation that has a written plan where at least 80% of full-time employees receive more than a de minimis amount of stock options or RSUs. The IRS has not yet defined what is considered to be a de minimis amount.
The election cannot be made if (1) a Section 83(b) election was previously filed; (2) the corporation’s stock was previously traded on an established securities market at any time before the election; (3) or the corporation repurchased certain amounts of its stock in the previous calendar year.
The Section 83(i) election is required to be made by the employee within 30 days after vesting in the stock. When the election is made, the employee may defer income from an option or an RSU for a maximum of five years from the vesting date. The income must be recognized earlier upon the occurrence of certain events, such as the employee becoming an excluded employee, the employee revoking the election, or an IPO.
At the end of the deferral period (five years or earlier as explained above), the amount included in income is based on the fair market value of the stock on the date the employee’s right to the stock first becomes substantially vested. The amount included in income is subject to withholding at 37%. It should be noted that only income taxes can be deferred by making the election. As a result, the election does not affect social security and Medicare taxes and unemployment taxes.
The Section 83(i) election can be made for options exercised or RSUs settled after December 31, 2017. Contact your Warren Averett advisor to discuss how this election could affect you and your business or to learn more about Tax Reform.