By Wei Wei, Tax Senior
As you have been made aware from our series of webinars, e-mail updates and blog posts, President Trump signed the Tax Cuts and Jobs Act just in time for the new year and the Act includes new rules for the taxation of “qualified equity grants”. Internal Revenue Code Section 83(i) allows “eligible employees” to elect to defer taxation on the exercise of certain stock options or the settlement of restricted stock units for up to 5 years. Employees must make the election no later than 30 days after the employee’s rights in “qualified stock” are transferrable or vested. The election only defers income tax, the stock-based compensation received by the employee is still subject to employee and employer payroll taxes when vested.
If the election is made, the amount of income required to be included at the end of the deferral period will be based on the value of the stock at the time the stock becomes transferrable or vested, regardless of whether the stock value had decreased during the deferral period.
Under prior tax law, employees generally recognized taxable income at the time their stock vested.
Employees must work for an eligible corporation to qualify for this new tax benefit.
“Eligible corporations” are private companies that have a written plan under which at least 80% of all US employees (excluding part-time employees) are granted options or restricted stock units, with the same rights and privileges. All employees do not need to receive the same number of shares, but all must receive more than a de minimis amount.
All employees are eligible except those that:
- are or were at any time the corporation’s CEO or CFO;
- are or were one of the 4 highest compensated officers in the current or preceding 10 taxable years;
- are or were a 1% owner in the current or preceding 10 calendar years; or
- are a family member of the CEO or CFO.
The recognition of taxable income can be deferred until the earlier of:
- the date the qualified stock becomes transferrable (including transferable to the employer);
- the date the stock becomes readily tradeable on an established securities market, such as upon an IPO;
- the date that is 5 years after the employee’s right in the stock is vested;
- the date the employee becomes an “excluded employee” (defined above); or
- the date the employee revokes his or her election.
Qualified Equity Grant and Qualified Stock
Two requirements must be met:
- the option or restricted stock unit must be granted by an employer in connection with the performance of services during a calendar year in which the employer was an “eligible corporation”;
- stock must be received in connection with the exercise of an option or settlement of a restricted stock unit; and
certain restrictions apply if the employee, at time of vesting, may sell their stock back to the Company or if the Company had stock redemptions in the preceding calendar year.
A written election statement must be filed with the employer and the IRS.
Employers are required to notify “eligible employees” when they receive “qualified stock”. A penalty of $100 for each failure to notify may be assessed by the IRS.
Making the election provides an excellent tax deferral opportunity for employees of qualifying privately held companies. Under prior law a tax liability would be incurred upon receipt of equity-based compensation but the opportunity to sell shares to generate cash to pay the tax was not available. Beginning Jan. 1, 2018 the tax may be deferred until the stock received can be sold to generate funds to pay the employee’s tax liability.