Stock Options Under the Tax Cuts and Jobs Act

This guest post was written by Kevin P. Martin, Jr., CPA and managing director of KPM.

The start of a new year, the first heavy snow, the first parking ban, the first grilled cheese and tomato soup of the winter…often invokes memories of years past. Having worked with start-ups and emerging growth companies for my entire career, so many reflections come to mind.

Entrepreneurs oftentimes put the “accounting stuff” on the back burner - the bookkeeping, entity structure, writing down “the deal,” fringe benefit plans, trying to figure out whether team members are employees or independent contractors...but I can’t tell you how many times I’ve almost been bowled over in a hallway by an entrepreneur trying to make a timely 83(b) election. 

So now the new tax legislation includes Code Section 83(i), which would delay for “up to five years” the taxation of compensation paid to employees of “eligible corporations” in the form of “qualified stock.” The election applies only for income tax purposes - FICA and FUTA are not affected.

An “eligible corporation” is one with stock that is “not readily tradable”on an established securities market and that has a “written plan” in place to grant stock options or restricted stock units (RSUs) to at least 80% of all of its full-time, U.S.-based employees. For the most part, that’s the majority of start-up and growth companies that sit to our left and right at the community table and with whom we share the same refrigerator.

The new law is generally effective for options exercised or RSUs settled after December 31, 2017 (subject to a transition rule). Here we go again...the election must be made no later than 30 days after the “first time” the employee's right to the stock is substantially vested or is transferable, whichever occurs earlier. Please don’t tackle me in the hallway!

Now, for sure, there’s some complexity and interpretation here. When are we really picking up the income? It might simply be five years after the first date the employee's right to the stock becomes substantially vested.  It might be the first date the qualified stock becomes transferable to the employer.  It might be the first date on which any stock of the employer becomes readily tradable on an “established” securities market.  It could be the date on which the employee revokes his or her election, for whatever reason he or she might want to do that.

And, then, you might have a taxable event on the date you become an “excluded employee.” An excluded employee is one (a) who is a one-percent owner of the corporation at any time during the 10 preceding calendar years; (b) who is, or has been at any prior time, the chief executive officer or chief financial officer of the corporation or an individual acting in either capacity; (c) who is a family member of an individual described in (a) or (b); or (d) who has been one of the four highest compensated officers of the corporation for any of the 10 preceding tax years. Nothing’s easy!

Just as the employee may have a deferred income inclusion, the employer's deduction is deferred until the employer's tax year “in which”or “with which” ends the tax year of the employee for which the amount is included in the employee's income as described above.  If you’ve got lots of employees, good date tracking is going to be very important.

There are lots of defined terms under the new code section – qualified stock, readily tradable, written plan, restricted stock units, et al.  We can work with you to figure those out as it applies to your company and strategic needs.

“Settlements made after December 31, 2017” – that’s the triggering date.  But, like everything, there are some transition rules and until the IRS issues some detailed regulations or other guidance on the 80% and employer notice requirements, a company will be treated as complying with those requirements if it complies with a reasonable, good faith interpretation of them.

And one of my new reflections? Start-ups and their employees are mostly breathing a sigh of relief as to how options will be taxed going forward. Earlier versions of the law threatened to damage a start-up’s ability to compensate its earliest employees...making it harder to attract employees…more likely causing potential team members to go to incumbent companies that can pay higher salaries…and that caused a vast amount of lobbying and educating legislators about the importance of the entrepreneurial ecosystem.  The final law isn’t perfect, nothing ever is…but we look forward to working with you as you, too, move your American dream forward while you create jobs and contribute to the economic power offered by our innovation companies.

Kevin P. Martin, Jr. is the Managing Director of Kevin P. Martin & Associates, P.C, a Boston-based CPA and consulting firm specializing in start-up and early stage tech, biotech and life sciences companies. Kevin spends most of his time advising clients, growing companies, putting business ideas to work, giving lectures and can be reached always at