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For some things, later is just better. And paying taxes is one of them.

Thanks to the Tax Cuts and Jobs Act, that truism extends to certain private company employees who were granted stock options or restricted stock units (RSUs) by their employers.

If you are a qualified employee and exercise stock options or settle restricted stock units in return for vested stock, you may be able to defer the resulting income for up to five years.

Background

Typically the federal tax rules under Section 83 of the Internal Revenue Code require that you, as an employee, must report income if you receive employer stock (or other property) from your employer in connection with the performance of services.

You report the income for the tax year in which your right to the stock is not subject to a substantial risk of forfeiture — i.e., when it vests or becomes transferable.

The amount of income you report is equal to the fair market value of the stock when it vested less the amount you paid for the stock.

SEE ALSO Been Granted Stock Options? Maximize the Benefit

The 83(i) Election for Options and RSUs

Under the Act, you may be able to delay reporting income for federal income tax purposes — and thus defer taxes — on the income that otherwise results when you receive vested stock from your employer after exercising stock options or settling RSUs.

To defer reporting the income for federal tax purposes, you must make an 83(i) election within 30 days of the date your right to the stock first becomes substantially vested.*

Importantly, the 83(i) election applies only to federal income taxes. It does not apply to payroll taxes, including Social Security (FICA) and federal unemployment (FUTA).

Under the election, the date you receive the stock starts the holding period required for long-term capital gain tax treatment. In other words, your holding period is not delayed just because you elected to defer the taxes.

The 83(i) deferral election is effective for stock options that you exercise and RSUs that you settle after 2017, subject to transition rules.

Deferral Period

Generally, your deferral period ends five years from the date your stock was substantially vested. However, the income may be taxable at an earlier date if any of the following become true.

The qualified stock becomes transferable.

You (employee) become an ineligible excluded employee.

Any stock of your employer becomes publicly traded.

You (employee) revoke the 83(i) election.

Qualified Employees

To be considered a qualified employee and therefore eligible for the deferral, you must agree to withholding requirements. Further, you can’t be an excluded employee, which consists of any of the following:

a one percent owner, either during the year or in any of the prior ten calendar years

a current, former or acting CEO or CFO

a family member of any of the above

an officer of the employer company who is among the four highest paid officers during the year or in any of the prior ten calendar years

Eligible Corporate Employers

Eligible corporate employers must be private companies— including S corporations and limited liability companies that elect to be taxed as corporations.

They also must have adopted a written qualified equity grant plan that provides stock options or RSUs to 80 percent or more of their U.S. employees.

Finally, they must provide notice to their employees that includes the following information:

information about withholdings — including the fact that the income recognized at the end of the deferral period will be subject to withholding and be based on the stock’s value when it first becomes substantially vested, even if the stock declines in value during the deferral period

an explanation that employees may elect to defer recognizing income under 83(i)

a certification that the stock the employee will receive is qualified

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*  You cannot make an 83(i) election if you’ve made an 83(b) election. In general, an 83(b) election allows you to pay taxes on your stock based on its fair market value when the stock is granted, rather than the value when it is later vested. If you assume the stock will increase in value, the 83(b) election can provide for a significantly lower tax liability, although you must pay the tax earlier.

 

SEE ALSO Got Incentive Stock Options? Timing is Everything

SEE ALSO Exercising ISOs? How to Minimize the Investment and Tax Risks in Selling the Stock

 

 

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KELLY NELSON
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ANGELA BAILOR
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