Meaning
Tax election that allows employees of private corporations to delay paying income tax on the value of qualified stock for up to five years. The section 83i deferral was designed to help workers at startups who receive equity that is valuable on paper but cannot be sold for cash. It prevents a situation where a person owes a massive tax bill but has no liquidity to pay it.
Qualification Criteria
Only specific types of companies and employees can use this benefit. The corporation must have a written plan and must grant stock options or restricted stock units to at least eighty percent of its full time US workers. This broad based requirement prevents the section 83i deferral from being a perk only for the chief executive or the board of directors.
If the company becomes public, the eligibility for new grants ends immediately.
Deferral Period
Tax payments are postponed until the earliest of several events occurs. These events include the stock becoming transferable, the company going public, five years passing since the shares vested, or the employee revoking the election. The section 83i deferral does not eliminate the tax but simply moves the due date.
This gives the employee time to wait for a secondary market sale or an acquisition of the business.
Risk Profile
Opting into this plan requires careful record keeping by both the worker and the employer. If the value of the stock drops significantly during the five year window, the tax is still based on the value at the time of the original vest. This means a person could end up paying tax on wealth that has disappeared.
Because of this danger, the section 83i deferral is often compared to a long term bet on the stability of the startup valuation.
