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Initial guidance, new tax benefit for stock options and restricted stock units

Notice 2018-97: Stock options, restricted stock units

The IRS today released an advance version of Notice 2018-97 as initial guidance on the application of section 83(i)—a provision that allows certain employees to defer the recognition of income attributable to the receipt or vesting of qualified stock.


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Section 83(i) was added to the Code by the new U.S. tax law (Pub. L. No. 115-97, dated of enactment December 22, 2017), the law that is also referred to as the “Tax Cuts and Jobs Act” (TCJA).

The new provision allows certain employees to defer federal income tax on compensation related to certain stock options and restricted stock unit (RSU) plans granted by private companies. Under this provision, if “qualified stock” is granted to a “qualified employee,” then the employee may make an election within 30 days of vesting to have the tax deferred until the earliest of: (1) the first date the stock is transferable; (2) the date the employee becomes an “excluded employee;” (3) the first date the stock become readily tradable on an established securities market; (4) the date that is five years after vesting; or (5) the date the employee revokes the election.

Also, the company must be an “eligible company”—meaning that its stock may not be readily tradable on an established securities market during any previous year; it must have a written plan during the year; and not less than 80% of all employees who provide services within the United States may be granted options and RSUs with the same rights and privileges. 

Notice 2018-97

Notice 2018-97 [PDF 287 KB] provides guidance on specific aspects of section 83(i), including:

  • The application of the requirement in section 83(i)(2)(C)(i)(II) that grants be made to not less than 80% of all employees who provide services to the corporation in the United States
  • The application of federal income tax withholding to the deferred income related to the qualified stock
  • The ability of an employer to opt out of permitting employees to elect the deferred tax treatment even if the requirements under section 83(i) are otherwise met

As further explained in a related IRS release—IR-2018-246—under section 83(i)(3)(A), executives, highly-compensated officers and those owning 1% or more of the corporation’s stock cannot make the deferral election. 

Future guidance under section 83(i) is expected to be issued in the form of proposed regulations and would incorporate the guidance provided in Notice 2018-97.

Application of 80% requirement

Notice 2018-97 provides that a determination that the corporation is an eligible corporation must be made on a calendar year basis, and whether the corporation has satisfied the 80% requirement is based solely on the stock options or the RSUs granted in that calendar year to employees who provide services to the corporation in the United States (or any possession of the United States). 

In calculating whether the 80% requirement is satisfied, the corporation must take into account the total number of individuals employed at any time during the year in question as well as the total number of employees receiving grants during the year (in each case, without regard to excluded employees or part-time employees described in section 4980E(d)(4)), regardless of whether the employees were employed by the corporation at the beginning of the calendar year or the end of the calendar year.

Employment taxes

A section 83(i) election is valid only for federal income tax purposes and does not change or defer the timing of FICA and FUTA payable with respect to qualified stock. 

Notice 2018-97 indicates that the IRS and Treasury Department expect to issue proposed regulations providing that the rate of income tax withholding under section 3402(t)(1) on deferral stock will be the maximum rate of tax in effect under Code section 1 and that withholding is to be applied: (1) without reference to any payment of regular wages; (2) without allowance for the number of allowances or other dollar amounts claimed by the employee on Form W-4, Employee’s Withholding Allowance Certificate; (3) without regard to whether the employee has requested additional withholding; and (4) without regard to the withholding method used by the employer. 

Thus, under the anticipated proposed regulations, only one rate—the maximum rate of tax under Code section 1—would be used in withholding on deferral stock under section 3402(t), and employers would not be able to increase or decrease the rate at the request of the employee. 

Pursuant to Code section 3402(t) and Notice 2018-97, and unless and until superseding guidance is issued, with respect to wages resulting from deferral stock under section 3402(t), employers must withhold taxes at the maximum rate of income tax under Code section 1 without regard to whether the employee has requested additional withholding and without regard to any withholding allowances or dollar amounts entered on the employee’s Form W-4.

The notice summarizes these points, as follows:

  • Deferral stock constitutes wages under section 3401(i) and is to be treated as received on the earliest date described in section 83(i)(1)(B) in an amount equal to the amount included in income under section 83 for the tax year that includes such date. 
  • When the wages are treated as paid under section 3401(i), the employer must make a reasonable estimate of the value of the stock and make deposits of the amount of income tax withholding liability based on that estimate. 
  • The wages included under section 3401(i) are subject to withholding at the maximum rate of tax in effect under Code section 1, and withholding is determined without regard to the employee’s Form W-4. 
  • By January 31 of the following year, the employer must determine the actual value of the deferral stock on the date it is includible in the employee’s income and report that amount and the withholding on Form W-2 and Form 941. 
  • With respect to income tax withholding for the deferral stock that the employer pays from its own funds, the employer may recover that income tax withholding from the employee until April 1 of the year following the calendar year in which the wages were paid. 
  • An employer that fails to deduct and withhold federal income tax under section 3402 is liable for the payment of the tax whether or not the employer collects it from the employee, unless section 3402(d) applies.

Escrow arrangement

In general, Notice 2018-97 requires that an employee making the section 83(i) election must agree that the stock will be held in an escrow arrangement (as described in the notice) so that the income tax withholding requirements are satisfied. If the employee does not agree, then the employee is not a “qualified employee.”  

KPMG observation 

In effect, the corporation can preclude employees from making a section 83(i) election by declining to establish an escrow arrangement consistent with the requirements of the notice. Thus, the corporation does not need to be concerned that it inadvertently created conditions that allow employees to make section 83(i) elections or that the corporation needs to comply with section 83(i) requirements.

Designation of stock as “not eligible”

The terms of a stock option or RSU may provide that no election under section 83(i) will be available with respect to stock received on exercise of the stock option or settlement of the RSU. This “not eligible” designation would inform employees that no section 83(i) election may be made—even if the stock is qualified stock.

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