United States: IRS Issues New Guidance On Section 83(i)

Last Updated: December 27 2018
Article by Gerald Audant

The Internal Revenue Service issued Notice 2018-97 on December 7, providing initial guidance for the new Section 83(i) of the Internal Revenue Code (Section 83(i)) enacted by the Tax Cuts and Jobs Act. The notice principally addressed guidance on the 80 percent requirement under the act, a new mandatory withholding tax mechanism and an opt-out opportunity for employers.


Section 83(i) allows certain "qualified employees" of "eligible corporations" an opportunity to elect to defer federal income taxes from the exercise of stock options and/or settlement of restricted stock units (RSUs) for up to five years. By making a Section 83(i) election within 30 days of the exercise of the option or the settlement of the RSU, employees defer federal income taxes with respect to the stock received upon exercise or settlement (deferral stock) until the earliest of the following dates when:

  • The stock becomes transferable (including transferable back to the employer)
  • The employee becomes an "excluded employee"
  • The stock becomes tradable on an established securities market (an IPO)
  • Five years after the exercise / settlement, or
  • The employee revokes the election

Each date above is referred to as a "payment date."

Under the Tax Cuts and Jobs Act, a "qualified employee" is any employee of an "eligible corporation" who: (1) is not an "excluded employee" and (2) agrees to certain requirements that ensure that proper withholding of federal income taxes will be met in connection with a Section 83(i) election.

An "excluded employee" is anyone who:

  • Is or has ever been the CEO or CFO of the employer, (or a family member of such person under constructive ownership rules)
  • Is a one percent owner of the employer during the current calendar year or any of the 10 preceding calendar years (or a family member of such person under constructive ownership rules)
  • Is one of the four highest compensated officers of the employer during the current taxable year or any of the 10 preceding taxable years

An "eligible corporation" is a private company that has a written equity incentive plan, under which at least 80 percent of all employees who provide services in the U.S. are granted stock options or RSUs in a calendar year, with the same equal rights and privileges.

The 80 Percent Requirement

The notice clarifies that the determination of whether an employer satisfies the 80 percent requirement must be made on a calendar-year basis, without regard to awards granted in prior calendar years. An employer must consider all the employees employed at any time during the calendar year (disregarding part-time employees and excluded employees) and determine whether at least 80 percent of those employees received options or RSUs. The tests for options and RSUs are separate, meaning 80 percent must have received options, or 80 percent must have received RSUs. The test is not whether 80 percent received either options or RSUs.


  • Employers will not know until the end of a calendar year whether they qualify as an "eligible corporation" by satisfying the 80 percent requirement.
  • Employers would be required to provide most employees annual refresh awards, instead of providing refresh awards only after the initial new hire awards are nearly or fully vested.
    • As an alternative, employers could consider changing their grant practices all together. For example, rather than issuing a large initial new hire award, they could grant smaller awards annually. This, however, could result in different (potentially higher) exercise prices for subsequent awards, and could impact hiring and retaining employees.

Withholding Requirements

General Guidance
The notice provides guidance and clarification on the requirements with respect to withholding federal income taxes relating to deferral stock received in connection with a Section 83(i) election:

  • Although the amount of federal income recognized on the deferral stock is locked in at the time of exercise or settlement, the income is treated as paid on the earliest of the five payment dates listed above.
  • An employer is obligated to withhold at the then-maximum current tax rate (currently 37 percent in 2018), without regard to an employee's Form W-4 (Withholding Allowance Certificate). This means there is no reduction for any withholding allowances. Depending on the employee's tax bracket, the employer could withhold more taxes than is ultimately owed by the employee.
  • By January 31 of the year following the payment date, the employer must determine the actual value of the deferral stock on the payment date, and report that amount and the withholding on the employee's Form W-2 (Wage and Tax Statement), and the employer's Form 941 (Quarterly Federal Tax Return).
  • If the employer pays the income tax withholding for the deferral stock from its own funds, it may recover that amount from the employee until April 1 of the calendar year following the payment date. The notice also provides a reminder that only federal income taxes are deferred under a Section 83(i) election. FICA and FUTA taxes are unaffected and remain due at the time of exercise of the option or settlement of the RSUs for both the employee and employer.

Escrow Arrangement
In an effort to solve the withholding requirements, the IRS is mandating that an employee making a Section 83(i) election agree in the election form that all deferral stock will be held in an escrow arrangement until the employer recovers from the employee the income tax withholding obligation. At any time between the payment date and March 31 of the calendar year following the payment date, the employer may retain a number of shares with a fair market value (FMV) equal to the income tax withholding obligation that has not been recovered from the employee by other means. For this purpose, the FMV is determined using the regulations of Section 409A, as of the date the shares of deferral stock are retained by the employer. This is different than the FMV of the deferral stock used to calculate the amount of income, which is as of the date of the exercise of the option or the settlement of the RSU.

After the income tax withholding obligation has been met, any shares of deferral stock remaining must be delivered by the employer to the employee as soon as reasonably practicable. If the employee does not agree to deposit the deferral stock into the escrow established by the employer, the employee will not meet the requirements of a "qualified employee" and may not make a Section 83(i) election.


  • Unless an employee provides cash directly to his/her employer, the company will be forced to use its own cash to satisfy the withholding obligation, which depending on the employer, could be due as soon as one business day following the payment date.
  • For any company whose preference is not to repurchase its own shares at then FMV, this escrow arrangement could force them to do so. Further, although the intent of the escrow arrangement is to ensure that the withholding obligation will be satisfied, if the FMV of the shares goes down (or potentially becomes worthless), it is possible that even if a company retains all the shares of deferral stock, the company will not be completely reimbursed for the withholding obligation, and would bear the tax risk for the withholding value.

Opportunity to Opt-Out

Companies that are concerned about the administrative complexities involved with Section 83(i) can now "opt-out." If the employer does not establish an escrow arrangement, it can preclude its employees from making a Section 83(i) election, even if the employer would otherwise qualify as an "eligible corporation." An employer may inform its employees that the stock is not eligible for a Section 83(i) election, as a result of not having an escrow arrangement.


  • Opting out places the burden on the company to prevent employees from making a Section 83(i) election.
  • Another alternative would be for employers not to qualify as an "eligible corporation" by either failing to satisfy the 80 percent requirement, or granting awards without equal rights and privileges.
    • This notice did not provide any guidance on what constitutes equal rights and privileges. We anticipate that the IRS will release further guidance on this topic, among others.

We encourage you to reach out to any lawyer in the employee benefits group at Fenwick & West regarding Section 83(i).

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.

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