When the Tax Cuts and Jobs Act went into effect in December 2017, so did an IRS tax code provision, Section 83(i), that allows the deferral for up to five years of federal income tax by employees who exercise a company’s stock options or vest restricted stock units, also known as RSUs, if the options or RSUs were offered to 80 percent of eligible workers.
However, as the IRS works on guidance to clarify aspects of Section 83(i), few companies are taking advantage of the provision, thanks to burdensome administrative obligations and a requirement that the employer continue to withhold Federal Insurance Contributions Act, or FICA, taxes. Additionally, the provision bars CEOs, CFOs, the four highest paid executives and select others from deferring income tax.
Pillsbury Tax partner Michael Kosnitzky tells Law360 that another drawback of Section 83(i), particularly for startups, is timing. For instance, if a company doesn’t pursue an IPO within five years of offering the stock options or RSUs, employees are still liable for the deferred income tax but cannot cash in the asset to pay it. Furthermore, if the value of the stock declines, the employee is obligated to pay taxes on the higher value when it was issued initially. And in addition to withholding FICA, the company is required to also withhold federal unemployment taxes, or FUTA.
“If you want to make it user-friendly, make it 10 years, not five years,” Kosnitzky said. “I’ve got one … Silicon Valley client that has adopted this. But it’s a small company, and they believe they’ll have an IPO within five years. Nobody else is doing this that I have seen.”
Kosnitzky also says the IRS should remove the exclusion of the CEO, CFO and four highest paid executives from the provision to make the program more attractive. However, he says, that language is in the Tax Cuts and Jobs Act and would have to be addressed by lawmakers, as opposed to a clarification in IRS guidance.
“I’d also get away from the recordkeeping requirements and the other obligations, including having FICA and FUTA due at the time of either the IPO or 10 years,” he added. “Just make it easier for people.”