IRS offers guidance on 5-year tax deferral for stock options

The Internal Revenue Service provided initial guidance Friday on a provision of last December’s tax overhaul enabling qualified employees of private corporations to defer paying income taxes for up to five years on the value of qualified stock options and restricted stock units granted by their employers.

Sign in front of IRS building in Washington, D.C.
The IRS building in Washington, D.C.

However, the provision of the Tax Cuts and Jobs Act comes with a catch. In general, executives, highly compensated officers and those owning 1 percent or more of the corporation’s stock can’t make the deferral election. The IRS noted that Federal Insurance Contributions Act tax and Federal Unemployment Tax Act tax payable on the value of qualified stock cannot be deferred.

Notice 2018-97 spells out the initial guidance taxpayers can rely on until the IRS and the Treasury Department issue proposed regulations and ask for public comment on any other issues that need to be addressed in the final regulations.

Stakeholders have indicated to the IRS that they would benefit from initial guidance on:

  • The application of the requirement that grants be made to no less than 80 percent of all employees who provide services to the corporation in the U.S.;
  • The application of federal income tax withholding to the deferred income related to the qualified stock; and,
  • The ability of an employer to opt out of permitting employees to elect the deferred tax treatment even if the requirements in Section 83(i) of the Tax Code are otherwise met.

In response, the notice addresses these three issues.

Section 83 of the Tax Code generally provides for the federal tax treatment of property transferred in connection with the performance of services. Section 83(i) allows some employees to elect to defer income that would otherwise be included under Section 83(a) upon the exercise of a stock option or settlement of a stock-settled restricted stock unit, or RSU. Income subject to such an election may be deferred for up to five years, subject to certain limitations.

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