When Congress passed the Tax Cuts and Jobs Act in December 2017, one of the new features introduced to the tax code was the 83(i) election.

This offers a tax break for certain stock option holders, and could significantly benefit your financial situation if you qualify for this tax break.

(Read up on other relevant changes in the new tax laws that may affect you here.)

Most financial advisors are still working out the best strategies with which to help their clients, but experts in the field are moving quickly to provide solutions.

If your advisor isn’t up to speed, first consider getting one who is. Then update yourself on what you need to know about the 83(i) election, including how you can benefit.

Understanding the 83(i) Tax Election for Non-Qualified Stock Options and Restricted Stock Units

Again, the 83(i) election offers a tax break for private company restricted stock unit (or RSU) and stock option holders. The provision allows an employee to elect to defer paying the tax in connection with the vesting of an RSU or exercise of a stock option.

This tax deferral may benefit you if you hold an RSU or non-qualified stock option (or NQSO). If you make this election in connection with the exercise of an incentive stock option (abbreviated as ISO), you lose the ISO status and are taxed in the same manner as an NQSO.

Here’s a quick overview of the benefits for the new 83(i) election:

• You can defer taxes for up to five years. This gives you time to save and prepare for your tax bill.
• You can take advantage of the potential to defer taxes until your exit — think an initial public offering (IPO) — and then have all the appreciation during your deferral period taxed as long-term capital gains, if you meet the one year holding period.
• You have the flexibility to revoke the election and choose to pay the taxes any time in the next five years.

Who Qualifies for the 83(i) Election?

To be counted as an eligible corporation, your employer must meet the following qualifications:

• It cannot be a publicly-traded company (and must meet certain other qualifications)
• It must have a written plan under which no less than 80 percent of all employees are granted stock options or RSUs.

Some employees are not eligible for this tax deferral, including anyone who owns 1 percent or more of the company’s stock. But the vast majority of employees can benefit.

If you’re considering taking advantage of the 83(i) election, it’s important to have a good plan in place. Here are a few things you should consider.

Making the 83(i) Election

You must make the election to defer the tax within 30 days of the RSU vesting or the exercise of the stock option. Your employer must notify you that you may be eligible to elect to defer income and certify that your stock is qualified.

If you work for a company that is private but contemplates an IPO in the future, this is a big benefit.

An RSU that vests prior to an IPO, for example, will be taxed at the value of the stock at the vesting date. You can elect to defer paying that tax until the IPO occurs up to five years.

If the value of the stock increases between the time you vest and the date of an IPO and you meet the one year holding period, the appreciation will be taxed at capital gain rates when you sell your stock.

The 83(i) election is usually not worth considering in connection with the exercise of ISO’s since you lose the ISO status if you make the 83(i) election.

If you make the election in connection with the exercise of ISO’s, you would avoid having to pay the AMT at time of exercise, but you lose the potential for capital gain treatment on the entire gain which is the big advantage of an ISO compared to an NQSO.

Don’t forget that it’s now easier under the new tax rules to recoup the minimum tax carryover, so you can get your AMT back.

Determining Taxable Income and Paying Taxes

The amount of taxable income will be based on the value of the stock at the date the RSU vests or the option is exercised.

If your employer stock becomes publicly tradable before the end of five years, the income becomes taxable at that time.

The 83(i) election delays the tax bill for up to five years or until an IPO, whichever occurs first. You can revoke the election anytime and pay the tax in the year that you chose to revoke.

When you pay taxes, your bill is based on the fair market value at the time the 83(i) election is made. But the taxes are paid based on your current tax rate, not the tax rate during the year of the 83(i) election.

As a result, you should take increased future income and increased future tax rates into consideration when dealing with this election.

What if your Options and RSU’s are subject to Dual Vesting

If your employer has a dual vesting requirement, taxation will look a bit different for you. Dual vesting uses a vesting schedule based on time but also requires a liquidity event to trigger vesting. If the liquidity event is an IPO, your tax is deferred until after the IPO but the tax is based on the fair market value at the later vesting date.

In other words, the tax is based on the post-IPO price with dual vesting. However, if you qualify for the 83(i) election, your tax is based on the value at the date your RSU vests or you exercise a stock option.

The 83(i) election does not apply if your RSU’s or stock options are subject to dual vesting. We suspect many companies will drop the dual vesting requirement in the future and take advantage of the 83(i) election.

Since the 83(i) election is a new feature of the tax code, it’s still an ongoing area of research for financial advisors and tax professionals. Be sure to consult tax advisor before taking advantage of the 83(i) election.

Reach out to your financial team to understand your options so you can position yourself to choose the absolute best one for you.