The 2017 tax reform legislation created a new provision that allows certain employees to defer recognizing gain on certain employer-issued stock options and restricted stock units (RSUs) for up to five years following issuance.
The new provision contains several important restrictions, including rules that require the employer to issue options with similar features to at least 80 percent of employees and continue to withhold employment-related taxes based on the value of the benefits. Because many of the details in the law were vague, the IRS has recently released guidance designed to provide clarity for employers who wish to take advantage of the new deferral option.
The new guidance provides details on both the 80 percent requirement and the employer’s withholding obligations, and requires that the employer create an escrow arrangement in which the stock or RSUs must be held throughout the deferral period. The guidance has been initially received with mixed opinions, and we asked Professors Robert Bloink and William Byrnes, who are affiliated with ALM’s Tax Facts, and hold opposing political viewpoints, to weigh in on the new rules.
Below is a summary of the debate that ensued between the two professors.
Byrnes: This is one area that tax reform impacted where we really needed additional clarity and guidance from the IRS and Treasury. Employers have been reluctant to take advantage of the deferral option because of uncertainty, and this guidance is a very positive step in the right direction—the clarity should encourage more employers to take advantage of this tax deferral benefit.
Bloink: The new guidance created additional problems and complexities for employers who were already on the fence about the strict requirements of the new Section 83(i) deferral option. Offering stock options to at least 80 percent of employees was already a steep ask for many of the start-up type employers that would benefit most from this new compensation option, and the IRS guidance made this hurdle much more difficult to cross.
Byrnes: The guidance provides specific and detailed rules for what employers have to do to satisfy the 80 percent requirement. The rule isn’t bad just because it isn’t necessarily the easiest to satisfy—and it’s designed to make sure that the deferral option is offered to a broad range of employees within an offering company.
Bloink: The administrative difficulties imposed by the rules the IRS created make it nearly impossible for smaller, start-up businesses to offer equity grants under Section 83(i). The rules don’t allow the company to look at equity grants made over past years when considering whether the 80 percent requirement is met in any given year. Imagine companies who are trying to expand, and want to offer grants to all new employees over time—they’d have to offer options to 80 percent of all employees each year, which can be very unattractive for a small start-up. We’re cutting out exactly the companies that the rule was supposed to benefit.
Byrnes: But this rule is designed to protect all employees, not just those higher level executives who got in on the ground floor.
Bloink: I agree with Professor Byrnes that the deferral option should encourage equity grants for all employees, but the administrative difficulties of how the 80 percent rule has been interpreted will make it so that only larger private companies can offer these grants. Additionally, the employer can’t use a single day “snapshot” approach to determining how many employees it has for the year—making it necessary to constantly monitor the number of employees to make sure that the 80 percent requirement is satisfied for the overall one-year period.
Byrnes: It shouldn’t be impractical for a company to know how many employees that it has at any given time during the year. I don’t think that the administrative burdens outweigh the potentially powerful benefits of tax deferral on this one—the new rule transforms these equity grants into an actual benefit for the employee, who may not have had the resources to cover the tax liability the way things stood in the past. Employers should look to this value when evaluating whether the administrative requirements are worth taking on.
Bloink: I think that employers will conduct the cost-benefit analysis and determine that the 80 percent requirement makes it administratively impossible to continue to offer equity grants under this new rule in many circumstances. Maybe they’ll consider it for a single year, but then determine it’s too difficult to continue to offer the benefit to newer employees—considering that each year, 80 percent of employees would have to be offered the benefit if a single new hire is given access in a later year. The continuous monitoring requirement is just one more piece in the puzzle that I believe will tip the scale against offering the 83(i) deferral benefit.
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