Part of Our Series on the Tax Cuts and Jobs Act of 2017
When an employee exercises a stock option or receives shares of stock from the settlement of a restricted stock unit (or “RSU”), generally the employee has income based on the value of the stock received. Income tax and Social Security and Medicare (“FICA”) taxes are due, and the employer must withhold and report these taxes.
Employees of publicly traded companies usually can sell shares in the public market to cover the cost of their taxes. However, there is typically no market for shares of privately held companies, such as start-ups. As a result, employees receiving shares of a private company through a stock option exercise or RSU settlement usually must come up with the cash to pay the IRS.
The Tax Cuts and Jobs Act of 2017 (the “Act”) adds a new section 83(i) to the Code that allows certain employees of private corporations that broadly grant stock options or RSUs to elect to defer income tax for up to five years. This is referred to as an “83(i) election”.
Section 83(i) was billed as a way to make it easier for employees of start-ups and other private companies to share in their employers’ success. However, as we explore in this post, the benefits of an 83(i) election may be limited. As discussed in more detail below, private employers face a number of questions about how they can — and whether they will want to — offer an equity program that is eligible under section 83(i).