The Tax Cuts and Jobs Act added a new tax deferral to encourage private corporations to grant more equity awards. If you’re thinking about it, consider whether the juice is worth the squeeze.

The Juice

One reason private companies don’t grant equity awards is that many employees are unable or unwilling to write a check for the taxes due when shares are issued. Employees with stock options usually prefer waiting until the company is sold or goes public, when their options can be cashed out with taxes deducted from the payment—i.e., at no out-of-pocket cost.

Playing the waiting game, however, has disadvantages. If an employee terminates employment, an equity award might expire or be forfeited before the company is sold or goes public—and waiting until the eve of a sale or an IPO to cash out usually results in any payment being taxed as ordinary income. Whereas exercising options more than one year before selling shares results in long-term capital gain, which is taxed at a lower rate.

To address this issue, new Section 83(i) of the Internal Revenue Code creates the “qualified equity grant.”

With a qualified equity grant, an employee can elect to defer income taxes—but not FICA—for up to five years from when compensation would have otherwise been included in income. In theory, this creates time for the employee to save money to pay the income taxes or for the company to be sold or go public.

But it’s doubtful that many employees will save money over five years just to pay income taxes for option shares. So qualified equity grants are more attractive to companies expecting to be sold or go public in five years.

The Squeeze

If qualified equity grants make sense for your company, consider the many requirements.

Only private corporations can make qualified equity grants, which must be in the form of nonqualified stock options or restricted stock units. Incentive stock options and restricted stock don’t qualify.

Qualified equity grants must be made under a written plan to at least 80% of eligible employees. But certain employees must be excluded, including the CEO, the CFO, the four highest compensated officers, and 1% owners. Grants must have the same rights and privileges, although the number of shares can vary by employee.

A notice describing the deferral election must be furnished when shares are issued. Failure to provide notice merits a $100 penalty per failure, up to $50,000 per calendar year. The deferral election must be made within 30 days after issuance of shares. Reporting on Form W-2 is required in both the year when the deferral is elected and the year when compensation is eventually included in income.

Being a blog post, this is just a summary of a new tax provision that’s sometimes too detailed and often unclear. Consult an undaunted tax professional before making qualified equity grants.

Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. The author has provided the links referenced above for information purposes only and by doing so, does not adopt or incorporate the contents. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.

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