February 2019 • Michael J. Nathanson, Joshua Nathanson, Matthew McKeown, Sean Kelly
Most people associate equity awards with public companies. Private companies, however, can also issue equity to their employees as part of an overall compensation package. While this type of compensation aligns the success of employees with that of their companies, there are drawbacks. Unlike public companies, whose stock is typically traded on public exchanges, private companies lack a ready market for their stock. Therefore, their employees who are compensated with non-qualified stock options (NSOs) or restricted stock units (RSUs) typically have to come up with the cash to pay taxes on income generated when they exercise their options or upon settlement of their units. To give employees of private companies some relief, Congress enacted Section 83(i) of the Internal Revenue Code as part of its recent overhaul, the Tax Cuts and Jobs Act. In theory, this section presents an interesting opportunity. In practice, however, the mechanics and requirements of Section 83(i) suggest that it may have only limited utility—something pointed out by critics. While there are limitations in this new provision, there still are a few circumstances in which it might be quite useful. But first, it’s important to have a basic understanding of what it does. What Does It Do? Section 83(i) provides a new deferral mechanism for taxable income that would otherwise be recognized when stock options are exercised or RSUs are settled. Generally, the fair market value of the stock received under NSOs or RSUs, less the amount paid for it, is included as ordinary income. Ideally, any money needed to pay the ensuing taxes could be raised by selling some or all of the stock. If, however, there is no way to sell the stock, then the holder could owe substantial taxes but have no cash on hand to pay for them. Congress added Section 83(i) for just such a situation, as long as certain requirements are met by the company, the stock and the employees. If an “eligible corporation” transfers “qualified stock” to an employee (other than those excluded) then that employee can possibly defer income (and the associated taxes) for up to five years, according to specific conditions. How Does It Work? Subject to certain limitations, an employee can make a Section 83(i) election within 30 days of exercising an option or settling a restricted stock unit. That election defers the ordinary income that otherwise would be part of taxable income. A person’s employment tax, however (FICA, for example) is not deferrable and must be paid, generally through withholding. Upon the eventual sale of the stock, the difference between the sale price of the stock and its fair market value when acquired should be taxed as a long-term capital gain (or loss), as long as the employee holds the stock for more than a year. For example, suppose a private company employee with restricted stock units receives 10,000 shares upon settlement, each of which is worth $10. Normally, if an employee paid nothing for the shares, he or she would be required to pay income and employment taxes on $100,000 of ordinary compensation income, even though the shares can’t be converted into cash yet. First « 1 2 3 4 » Next
Most people associate equity awards with public companies. Private companies, however, can also issue equity to their employees as part of an overall compensation package. While this type of compensation aligns the success of employees with that of their companies, there are drawbacks. Unlike public companies, whose stock is typically traded on public exchanges, private companies lack a ready market for their stock. Therefore, their employees who are compensated with non-qualified stock options (NSOs) or restricted stock units (RSUs) typically have to come up with the cash to pay taxes on income generated when they exercise their options or upon settlement of their units.
To give employees of private companies some relief, Congress enacted Section 83(i) of the Internal Revenue Code as part of its recent overhaul, the Tax Cuts and Jobs Act. In theory, this section presents an interesting opportunity. In practice, however, the mechanics and requirements of Section 83(i) suggest that it may have only limited utility—something pointed out by critics.
While there are limitations in this new provision, there still are a few circumstances in which it might be quite useful. But first, it’s important to have a basic understanding of what it does.
What Does It Do?
Section 83(i) provides a new deferral mechanism for taxable income that would otherwise be recognized when stock options are exercised or RSUs are settled. Generally, the fair market value of the stock received under NSOs or RSUs, less the amount paid for it, is included as ordinary income. Ideally, any money needed to pay the ensuing taxes could be raised by selling some or all of the stock. If, however, there is no way to sell the stock, then the holder could owe substantial taxes but have no cash on hand to pay for them.
Congress added Section 83(i) for just such a situation, as long as certain requirements are met by the company, the stock and the employees. If an “eligible corporation” transfers “qualified stock” to an employee (other than those excluded) then that employee can possibly defer income (and the associated taxes) for up to five years, according to specific conditions.
How Does It Work?
Subject to certain limitations, an employee can make a Section 83(i) election within 30 days of exercising an option or settling a restricted stock unit. That election defers the ordinary income that otherwise would be part of taxable income. A person’s employment tax, however (FICA, for example) is not deferrable and must be paid, generally through withholding. Upon the eventual sale of the stock, the difference between the sale price of the stock and its fair market value when acquired should be taxed as a long-term capital gain (or loss), as long as the employee holds the stock for more than a year.
For example, suppose a private company employee with restricted stock units receives 10,000 shares upon settlement, each of which is worth $10. Normally, if an employee paid nothing for the shares, he or she would be required to pay income and employment taxes on $100,000 of ordinary compensation income, even though the shares can’t be converted into cash yet.
Please log back in before proceeding.
There was an error logging in. Please try again.
Congrats! You are now logged in. Your exam is being submitted.