New Executive Compensation Rules

Published date01 October 2018
Date01 October 2018
AuthorShirley Dennis‐Escoffier
DOIhttp://doi.org/10.1002/jcaf.22361
IRS
New Executive Compensation Rules
Shirley Dennis-Escofer
DEFERRAL ELECTION
FOR PRIVATE
COMPANY STOCK
Many corpora-
tions use equity-based
compensation plans
to reward employees.
Common forms of
stock-based compen-
sation are nonquali-
ed stock options
(NQSOs), incentive
stock options (ISOs),
and restricted stock.
NQSOs are usually
taxable when exer-
cised on the excess of
the stocks fair
market value over the
exercise price. ISOs
receive more favor-
able treatment and
are generally not tax-
able until the under-
lying shares are sold (but they
are considered an alternative
minimum tax adjustment when
exercised). Restricted stock is
taxable when the employees
right to the stock is transfer-
able or is not subject to a sub-
stantial risk for forfeiture,
whichever occurs earlier. In
some cases, employer stock
may be transferred to an
employee in settlement of
restricted stock units (RSUs).
An RSU is an arrangement
under which an employee has
the right to receive at a speci-
ed future time an amount
determined by reference to the
value of one or more shares of
employer stock. The
employees right may be sub-
ject to a condition such as
remaining employed for a cer-
tain number of years or meet-
ing performance goals. The
amount included in income for
an RSU is the stocks fair mar-
ket value at the time of exercise
less the amount, if
any, that the
employee paid for
the stock.
Income from the
receipt of employer
stock may result in a
substantial tax liabil-
ity for the employee.
If the stock is
publicly traded, an
employee can sell
some of the stock to
provide funds to pay
for the tax liability
but that does not
work for a closely-
held corporation that
restricts the transfer-
ability of its stock or
whose stock is not
listed on any
exchange. Some
private companies
permit employees
who have taxable income when
the stock option is exercised or
the RSU is settled to sell back
a number of the shares to the
company sufcient to pay the
tax. If, however, the company
does not offer this option, the
employees may not have suf-
cient cash to cover their tax lia-
bility. To address this problem,
the Tax Cuts and Jobs Act
(TCJA) added a new deferral
election under IRC Section 83
(i) for private company stock
The Tax Cuts and Jobs Act (TCJA) made several
changes to the rules affecting employee compen-
sation for publicly held corporations and private
companies. These changes include both good
news and bad news. On the positive side, TCJA
added a new provision under Internal Revenue
Code (IRC) Section 83(i) allowing employees of pri-
vate companies to make an election to defer the
recognition of income for up to 5 years from cer-
tain stock options and restricted stock plans.
Unfortunately, this good news is offset by the
changes made to IRC Section 162(m) which limits
deductibility of compensation in excess of $1 mil-
lion for publicly traded corporations. The TCJA
expanded the denition of employees who are
subject to the $1 million limitation and the types of
compensation affected, including repealing the
performance-based exception. As a result, the
types of strategies that corporations used to avoid
this deduction limit in prior years may no
longer work. © 2019 Wiley Periodicals,Inc.
© 2019 Wiley Periodicals, Inc.
Published online in Wiley Online Library (wileyonlinelibrary.com).
DOI 10.1002/jcaf.22361
76

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