Section 83(i) Election: Deferring Tax on Stock

The Section 83(i) election offers a tax deferral for employees of certain private companies who receive equity compensation. Introduced as part of the Tax Cuts and Jobs Act of 2017, this provision allows qualified individuals to postpone paying federal income tax on the value of stock received from exercising stock options or the vesting of restricted stock units (RSUs). The intent behind this rule was to address a common issue for employees of private companies: owing a significant amount of tax on stock that is not yet liquid or easily sold to cover the tax liability.

Eligibility for the Deferral Election

Employee Requirements

For an employee to be eligible to make a Section 83(i) election, they must be a “qualified employee.” An individual is qualified as long as they are not an “excluded employee,” a category that prevents certain high-level individuals and significant owners from using the deferral. Specifically, an employee is excluded if they are or have ever been the company’s chief executive officer or chief financial officer.

The exclusion also applies to individuals who are 1% owners of the corporation in the current calendar year or were in any of the ten preceding calendar years. Additionally, anyone who is one of the four highest-compensated officers for the current year or any of the previous ten years is ineligible.

Company Requirements

The corporation itself must meet specific criteria to be an “eligible corporation,” which allows its stock to be considered “qualified stock.” The company must have a written plan under which it grants stock options or RSUs to at least 80% of its full-time U.S.-based employees. The grants must provide the same rights and privileges, though the number of shares granted to each employee can differ.

This “80% rule” is tested annually. The tests for stock options and RSUs are separate; a company must grant options to 80% of employees or grant RSUs to 80% of employees, not a combination of the two. Furthermore, the company’s stock cannot be publicly traded on an established securities market.

Mechanics of the Tax Deferral

When a qualified employee makes a valid Section 83(i) election, the ordinary income tax normally due upon exercising a stock option or the vesting of an RSU is deferred. The amount of deferred income is fixed based on the stock’s value at the time of vesting, regardless of future appreciation or depreciation. This deferral can last for a maximum of five years from the date the stock becomes vested.

The election only defers federal income tax. FICA taxes, which include Social Security and Medicare taxes, are not deferred and must be paid by both the employee and employer at the time of vesting. The employer remains responsible for remitting these payroll taxes in the year the stock vests.

The deferral period does not always last the full five years and will end upon the occurrence of the earliest of several specific events. The tax becomes due if:

• The qualified stock becomes transferable.
• The employee becomes an excluded employee, such as through a promotion.
• The company’s stock becomes publicly traded.
• An employee chooses to revoke their election.
• The deferral automatically ends five years after the employee’s rights in the stock have vested.

Making the Section 83(i) Election

The election must be made no later than 30 days after the employee’s rights in the stock are vested or are no longer subject to a substantial risk of forfeiture. This is a strict deadline, and failing to file within this window means the opportunity for deferral on that specific stock is lost. The employer is required to notify the employee of their potential eligibility to make the election.

There is no official IRS form for making the Section 83(i) election. Instead, the employee must prepare a written statement that affirms they are making an election under Section 83(i). This statement must include the employee’s name, address, taxpayer identification number, and a description of the qualified stock for which the election is being made.

The employee must provide this election statement to their employer. The IRS requires that the stock be held in an escrow account set up by the employer until the deferred income tax is ultimately paid. An employee cannot make an 83(i) election for stock if they have already made an 83(b) election for the same shares.