Qualified Equity Grants: Tax Deferral for Illiquid Employer Stock

Journal of Taxation, Vol. 129, No. 4, October 28

8 Pages Posted: 7 Nov 2018

Date Written: October 1, 2018


Stock received on the exercise of a nonstatutory stock option may create liquidity problems for a recipient employee. The employee must generally pay tax on the bargain element in the stock when the stock is received or later when it vests. However, the employee may not have the cash to pay the tax, particularly if the stock received is not a source of liquid funds because it is not then readily tradable or transferable. This problem is most frequently associated with start-up corporations that have not yet gone public.

Fortunately, Congress has provided a potential solution. For stock vesting after 2017, a “qualified employee” may elect to defer tax on the bargain element in “qualified stock” issued pursuant to an equity grant awarded by an “eligible corporation.” Such equity grants consist of either stock options or restricted stock units (RSUs).

If qualified stock is received under such a grant, an employee may be able to defer payment of tax on the bargain element for as long five years from the date of receipt or vesting. When the deferral period ends, the bargain element in the stock becomes subject to tax as compensation, with any remaining appreciation in the stock taxed on subsequent disposition.

An employee electing to defer gain on qualified stock need not be one of the employees under an equity grant plan necessary to qualify the employer as an “eligible corporation.” Nor does the employee’s option or RSU need to be granted pursuant to the equity grant plan. It is enough that the employee is a qualified employee, and the employer was an eligible corporation in the calendar year the employer granted the option or RSU.

Independently of the qualified equity grant provisions, the Code imposes taxes, penalties, and interest on nonqualified deferred compensation plans that do not satisfy the deferral and distribution requirements of Section 409A. Fortunately, statutory stock options are exempt from the requirements of 409A. Nonstatutory stock options may also be exempt if certain conditions are satisfied. RSUs are exempt if they are settled by transferring unvested stock. In any event, if a qualified equity grant is exempt from the requirements of Section 409A, an election to defer tax on the receipt of qualified stock will not subject the arrangement to the section.

Note: “Reprinted from the Journal of Taxation, with permission of Thomson Reuters. Copyright © 2018.”

Suggested Citation

Blankenship, Vorris J., Qualified Equity Grants: Tax Deferral for Illiquid Employer Stock (October 1, 2018). Journal of Taxation, Vol. 129, No. 4, October 28. Available at SSRN: https://ssrn.com/abstract=3279684

Vorris J. Blankenship (Contact Author)

Tax Planning for Retirees ( email )

3120 Texas Hill Rd
Placerville, CA 95667
United States

HOME PAGE: http://www.retirement-taxplanning.com/index.html

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