by John Anthony Castro, J.D., LL.M.
Introduction
The Tax Cuts and Jobs Act is now law, and in it is a new type of section 83 election: the 83(i) Election.
Private Company Equity Grants
The Tax Cuts and Jobs Act includes new Code section 83(i) that delays, for up to 5 years, any tax on compensation paid to employees of “eligible corporations” in the form of “qualified stock.” An “eligible corporation” is a corporation whose stock is not readily tradable on an established securities market and that has a written plan in place to grant stock options or restricted stock units (RSUs) to at least 80% of all full-time, U.S.-based employees. The term “qualified stock” means any stock:
· Received in connection with the exercise of options or settlement of RSUs
· Provided in exchange for an employee’s performance of services during a year in which the corporation was an eligible corporation
Stock is disqualified from being “qualified stock” if it can be bought back by the corporation for cash once it vests. Private sales are permitted, but it is unclear to what degree the corporation can be involved in facilitating private sales.
Employees must make an affirmative 83(i) election within 30 days of the date of an equity grant to defer income taxes on qualified stock. Without the 83(i) election, the value is subject to tax. Once this election is made, income taxes on qualified stock would be due upon the earliest of the following:
1. The date the stock is transferable, including to the employer, which encourages placing transfer restrictions
2. The date the employee first becomes an “excluded employee” (i.e., CEO, CFO, 1% owner, or one of the top four highest-paid employees for any of the 10 preceding taxable years, determined on the basis of the Securities and Exchange Commission disclosure rules for compensation, as if such rules applied to such a corporation).
3. The first date any stock of the employer becomes readily tradable on an established securities market, which encourages companies to remain private
4. 5 years after the employee’s right to the stock vests, which avoids perpetual deferral
5. The date the employee revokes the 83(i) election
For employees to be eligible to make the new 83(i) election, the corporation they work for would need to grant at least 80% of all full-time, U.S.-based employees stock options or RSUs that have the same rights and privileges, which is determined under the rules for Employee Stock Purchase Plans in Code section 423(b)(5)). To qualify under this standard, employees can receive different amounts of stock, but each participating employee must get more than a de minimis amount and cannot be granted a combination of stock options and RSUs during a year. In other words, they must be exclusively granted either stock options or RSUs for the year.
Stock for which an 83(b) election has already been made is not eligible for an 83(i) election. Additionally, the 83(i) election is generally not available if the corporation has conducted buybacks of any outstanding stock in the preceding calendar year, unless at least 25% of the total dollar amount the company bought back is stock to which an 83(i) election is in effect and the determination of which individuals from whom such stock is purchased is made on a reasonable basis. In applying this requirement, stock subject to the longest deferral election under section 83(i) must be purchased first.
Companies are required to provide notice to their employees about the right to make the 83(i) election as well as the ramification of said election. The company is subject to reporting requirements regarding stock on which employees have made an 83(i) election. Employees who make the election would pay tax on the value of the stock at vesting.
Lastly, qualified stock under 83(i) would not be treated as deferred compensation for purposes of Code section 409A.
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