On December 7th, the IRS issued Notice 2018-97 to provide initial guidance on the new private company income inclusion deferral regime enacted under Code Section 83(i) as part of the 2017 Tax Cuts and Jobs Act (“Section 83(i)”). Under the deferral regime, eligible employees of eligible privately-held companies may elect to defer payment of federal income taxes due on exercise of stock options or settlement of restricted stock units (“RSUs”) for up to five years from when the employee’s right to the stock is vested, as described in our December 2017 alert. Although guidance before year-end is indeed welcome, in many ways, the Notice serves as validation of the widely-held sense that the risks and complexities of the deferral regime outweigh any potential benefits – particularly for employers.

In Notice 2018-97, the IRS provides guidance on the following aspects of Section 83(i):

  1. The 80% Employee Coverage Requirement – Section 83(i) is available only where options or RSUs are granted under a written plan to not less than 80% of all employees who provide services in the United States, with the same rights and privileges. The Notice clarifies that to meet the 80% coverage requirement with respect to a calendar year, an eligible corporation must have granted options, or RSUs (or both), to 80% of its employees in such calendar year (not counting employees who are ineligible for the deferral, such as the CEO, CFO or four highest compensated officers). Awards granted in prior years may not be taken into account in determining whether the 80% requirement is met. Further, the 80% test is calculated based on the total number of individuals employed at any time during the applicable year, as well as the total number of employees receiving awards during the year, regardless of whether the employees were employed at the beginning or end of the calendar year.
  2. Tax Withholding on Deferred Income – Withholding of income taxes on awards subject to deferral under Section 83(i) is required at the end of the permitted deferral period, based on the taxable amount (and share value) as of the option exercise date or RSU settlement date. Withholding is required to be applied at the maximum rate in effect (currently, 37%). The Notice states that the IRS expects that proposed regulations on Section 83(i) will require that such withholding be applied without reference to (i) any payment of regular wages, (ii) an employee’s Form W-4 or request for additional withholding or (iii) the withholding method used by the employer.

    Additionally, in order to facilitate collection of such withholding taxes, potentially years after the issuance of shares to the employee, the Notice requires employees to agree that their deferred stock will be held in an escrow arrangement until the withholding obligations are satisfied, and specifies that such obligations may be satisfied by withholding from the shares of stock held in escrow. Although an escrow arrangement may help with compliance with the withholding obligations, it will be of limited practical utility if the share value has decreased between the option exercise or RSU settlement and the end of the deferral period, such that the value of the shares held in escrow may be insufficient to cover the withholding tax liability.

  3. Employers’ Ability to Opt Out of the Regime – A recurring question since the enactment of Section 83(i) is whether employers can avoid application of the regime entirely, given its withholding complexities and administrative burdens, noting also that penalties apply where an employer fails to notify employees that their equity awards qualify for deferral. Fortunately, the Notice confirms that employers may preclude their employees from making Section 83(i) elections by declining to establish the required escrow arrangement. Companies may also avoid the application of Section 83(i) by providing in the terms of the options or RSUs that no election under Section 83(i) will be available with respect to the shares issued upon the exercise of options or settlement of RSUs.

The terms of Notice 2018-97 will be incorporated into future regulations and will apply to any taxable year ending on or after December 7, 2018. Through February 5, 2019, the IRS requests comments on additional issues that future Section 83(i) guidance should address, as well as on any other guidance or clarifications that may be helpful.



Victor Flores is a partner in Baker McKenzie’s Employment & Compensation Practice, with a focus on Executive Compensation and Employee Benefits. Victor advises global US and non-US companies – both public and private – on all aspects of executive compensation and benefits matters, including the corporate, securities and tax law, and ERISA issues arising in the implementation and administration of compensation programs. He regularly helps clients with the design and implementation of equity and non-equity based incentive compensation programs and nonqualified deferred compensation programs. Victor also has extensive experience advising on compensations and benefits issues in mergers and acquisitions, corporate reorganizations, private equity and other corporate transactions.


Sinead Kelly is a partner in Baker McKenzie’s Compensation practice in San Francisco. She advises on U.S. executive compensation and global equity and has practiced in the compensation field since 2005. In her practice, Sinead counsels U.S. and non-U.S. public and private companies on all aspects of equity and executive compensation plans and arrangements, including plan design, drafting, administration and governance. In this regard, Sinead advises on and assists companies with compliance with U.S. federal and state securities and tax laws relating to compensation arrangements, as well as with preparing SEC disclosures, complying with stock exchange rules and addressing non-U.S. tax and regulatory requirements. She has been repeatedly recognized by Legal 500 as a leading lawyer for Executive Compensation and Employee Benefits.