New Code Section 83(i) Equity for Private Employers: More Headache Than Benefit?

Recently, the IRS issued guidance on the election to defer compensation under section 83(i). However, there is still much question, especially for smaller operations, regarding the administrative headache, as compared to the benefits, of setting up deferred compensation. Indeed, many businesses are electing to simply avoid 83(i) by amending their equity plans altogether.

In short, section 83(i) permits private businesses to adopt qualified equity grant plans designed to issue either stock options or restricted stock to eligible employees in exchange for their services. These grant plans provide employees with two tax advantages. When the qualified equity grant vests, the employee can elect at that time to defer income taxes for up to five years or until another qualifying event occurs. Further, when the employee chooses to defer such taxes, the deferred stock begins the holding period for long-term capital gains and its advantaged tax treatment, despite the fact that the employee has yet to pay income tax on the stock.

Headache?

Offering an 83(i) election means the business must follow a specific sequence of steps before making the offering.

  • A private corporation must grant either options or restricted stock to at least 80 percent of employees within the calendar year. While startups often choose, or are required by negotiation to offer equity when someone is hired, timing those offerings, and further stock grants as the company grows, may mean continuing to offer stock to employees. Further, the offering must be the same to all 80 percent.
  • Highly compensated employees (HCEs) are excluded from making this deferral election, including people who are or were an owner of more than 1% of the company, so companies who offer equity compensation larger than that amount will be excluded from this section. And if more than 20% of the employees fall into this category, then the company will become excluded.
  • With certain exceptions, if the business has repurchased stock in the previous year, then they cannot offer the election. The exceptions involve repurchases of stock made with the 83(i) election.
  • 83(i) election plans are not compatible with other types of stock incentive plans such as incentive stock options (ISOs) and employee stock purchase plans (ESPPs). Each of these types of stock plans has different taxation and withholding requirements and a business would need to study each option to determine the right path forward.
  • At the end of the deferral period of either 5 years or when another event happens to end the deferral period, the employer must withhold income tax equivalent to the tax on the value of the stock at vesting in escrow. This applies even if the value of the stock has decreased over the deferral period.

Benefits?

For small businesses looking to grant employees stock in order to give them additional financial compensation and align their financial interests with the business, section 83(i) is a way to offer benefits while pushing off the tax consequences until, hopefully, the company has grown or employees are ready to pay taxes on the stock.

Other options are available for employees who want to offer tax-advantaged stock to employees. Incentive stock options and employee stock purchase plans may be better options for your business. The experienced team at Hall Benefits Law can help your business sort through the different options and create a program that is both tax savvy and meets your goals. Reach out to learn more by calling 678-439-6236 or visiting the Hall Benefits Law website.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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