United States: Enough To Get Exercised About?

Tax Reform Offers Limited Deferral on Certain Private Company Equity Compensation

On December 22, 2017, the President signed into law the tax reform bill (the "Act"), informally referred to as the Tax Cuts and Jobs Act. The Act contains a new provision, Section 83(i) of the Internal Revenue Code of 1986, as amended (the "Code"),1 that would allow eligible employees of certain private companies to elect to defer U.S. Federal income tax with respect to "qualified equity grants" for up to five years. The change to the potential tax treatment of stock transferred upon exercise of a stock option or settlement of a restricted stock unit ("RSU") applies to stock options exercised, or RSUs settled, after December 31, 2017.

The provision is ostensibly targeted to start-up and other venture stage companies, and designed to promote broad-based employee ownership and "upside" in such new companies. Notably, the provision is clear that the election (or ability to elect) to defer under Section 83(i) does not result in the arrangement becoming nonqualified deferred compensation under Section 409A of the Code. To qualify for the deferral opportunity under Section 83(i), several limitations and requirements must be met. Put simply, the deferral opportunity is limited to "qualified stock" transferred to "qualified employees" of "eligible corporations."

First, to be a "qualified employee" the employee needs to be employed by a private company, and cannot be (i) the chief executive officer or chief financial officer of the company (either at the time of the election or at any time prior); (ii) one of the four highest compensated officers for the taxable year (or any of the prior ten years); or (iii) a one percent owner of the company in the calendar year (or any of the prior ten years).

Second, to meet the requirements of "qualified stock" the stock must be received upon exercise of a stock option or settlement of a RSU and the stock option or RSU must have been granted in connection with the performance of services by an eligible corporation. In addition, if the employee can sell the stock to (or otherwise receive cash in lieu of stock from) the employer at the time the stock first becomes transferable or is not subject to a substantial risk of forfeiture, the stock will not constitute qualified stock.

Third, the election is not available if the company has repurchased its stock in the preceding year unless at least 25 percent of the dollar amount of such repurchased stock had previously been deferred by employees pursuant to the provision.

Fourth, the election can only be made if the company's stock is not readily tradeable on an established securities market — either at the time of the election or at any time prior to such election — and the company has a written plan under which, in the applicable year, not less than 80 percent of its full time employees in the United States (or a possession of the United States) are granted stock options or RSUs (with the same rights and privileges – and, it seems, either RSUs or options, but not both). The "same rights and privileges" requirement is tested in accordance with the rules for employee stock purchase plans under Section 423(b)(5) of the Code. Although Section 83(i) allows grants of different amounts to different qualified employees, each employee that is intended to count for the 80 percent test must receive more than a "de minimis" amount. Further, these requirements are applied on a controlled group basis (as determined under Section 414(b) of the Code).

A qualified employee who receives an award of stock options or RSUs that is eligible under Section 83(i), can elect within 30 days of exercise or settlement, as applicable, to defer U.S. Federal income tax that would otherwise have been due upon exercise or settlement. The deferral is generally for five years, or, if earlier, the date the underlying stock is (or becomes) readily tradeable on an established securities market, the stock becomes transferrable (including to the company), the employee is no longer eligible for the deferral or the employee revokes the election. Note that the provision calls merely for a deferral of U.S. Federal income tax that would have been recognized at the time of exercise of the option or delivery of the RSU: the value of the amount to be recognized does not "float" with the value of the shares underlying such awards during the deferral period. The employer's deduction follows the employee's inclusion, so that the employee's revocation of the deferral will then trigger the deduction from the employer.

Employers are required to provide notice to qualified employees who receive such qualified stock of their ability to elect to defer income under Section 83(i). Failure to provide such notice, unless due to reasonable cause, will subject companies to a fine of $100 per failure (not to exceed $50,000 in a calendar year).

With all of the limitations and restrictions contained in the provision, it remains to be seen how many employees will be able to take advantage of this new deferral feature. In addition to the tax related issues, companies will also need to consider any U.S. Federal (and State) securities requirements and applicable exemptions. Depending on the size of the employee base and the amounts at stake in respect of stock option and RSUs, some companies may have additional challenges in complying with these conditions, particularly if the employees are not "accredited investors," the company has limited assets, and/or a substantial portion of the shares underlying such awards are in fact granted to employees.

Footnote

1 Curiously, the Conference Report notes that "[t]he provision clarifies that Section 83 (other than the provision), including subsection (b), shall not apply to RSUs. Therefore, RSUs are not eligible for a section 83(b) election. This is because, absent this provision, RSUs are nonqualified deferred compensation and therefore subject to the rules that apply to nonqualified deferred compensation."

Most (if not all) practitioners have traditionally regarded RSUs as unfunded, unsecured promises to deliver shares (or their equivalent) on a date specified in the underlying governing documents of the award. Because traditional tax principles under Section 83 have indicated that neither cash nor the mere promise to pay at a point in the future are considered "property" within the meaning of Section 83, it is uncertain what this language was intended to add.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Shearman & Sterling LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Shearman & Sterling LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions