By Ricky Waldmann, Tax Manager, Falco Sult
The passing of the Tax Cuts and Jobs Act (TCJA) created Internal Revenue Code (IRC) Section 83(i), which could be a useful tool in helping certain small businesses attract, retain, and incentivize employees. Section 83(i) permits employees to elect to defer income upon the receipt of certain types of equity grants for up to 5 years and allows the capital gains holding period to begin at the time of the election. Below are a few key topics related to Section 83(i) designed to get the conversation started on whether offering an equity grant program or making an election makes sense.
An eligible corporation is any corporation if 1) no stock of such corporation is readily tradeable and 2) such corporation has a written plan under which the rules of Section 83(i)(2)(C) are met. Corporations must be privately held, meet the “80-percent requirements,” and provide the same rights and privileges under the plan as required by Section 423(b)(5), which relates to qualified employee stock purchase plans.
Only qualified employees are eligible to receive qualified equity grants. A qualified employee is not an “excluded employee” and agrees to make the election under section 83(i) to meet the requirements for proper federal income tax withholding by the eligible corporation. An excludable employee is any individual who is a 1% owner or who is or has been the CEO, CFO, bears any relationship to the CEO or CFO, or is one of the 4 highest compensated officers of such corporation. Independent contractors are not considered qualified employees.
Qualified stock is any stock in a corporation that 1) is received in connection with the exercise of an option or restricted stock unit (RSU) and 2) such unit was granted by the corporation in connection with the performance of a service as an employee and during a calendar year in which the granting corporation was an eligible corporation. Essentially, it is an option or RSU received by an employee for services performed for an eligible corporation.
Making the Election
The election needs to be made within 30 days of vesting or transferability (whichever occurs sooner). Federal income tax withholding on the IRC Section 83(i) election is mandatory and occurs in the same tax year income subject to the inclusion deferral is included in income by the employee. The withholding will generally occur at the highest income tax rate to applicable individual taxpayers. Employers are required to provide notice to their employees that this election may apply to their qualified stock grants before the stock substantially vests as outlined in Section 83(i)(6). Failure to notify employees will result in fines of up to $50,000.
The nuances of IRC Section 83(i) can be quite confusing, and you should always consult with professionals when making any election. If you think you may benefit from this new code section, please contact our office to schedule a consultation.