House Ways and Means Committee Approves Second Amendment to Tax Cuts and Jobs Act

Today, the House Ways and Means Committee approved a new amendment to the Tax Cuts and Jobs Act (H.R. 1) (the “Bill”) offered by Chairman Brady as part of the on-going markup (the “Second Amendment”).  The Committee reported the Bill, as modified by the Brady amendment, on a partisan vote of 24-16.  This marks the second major revision to the Bill and makes changes on top of those contained in the first of which affected provisions related to dependent care assistance programs and deferred compensation (the “First Amendment,” discussed here).  For further information on the Bill, please see our series of posts highlighting provisions of the Bill affecting topics pertinent to our readers, all of which are linked in the final post in this series.

Repeal of Provisions Changing Taxation of Non-qualified Deferred Compensation.  As we discussed in our prior post, Section 3801 of the original Bill text enacted a new Code section 409B and repealed current section 409A, which would have significantly restricted the conditions that qualify as a substantial risk of forfeiture, such that non-qualified deferred compensation would have become taxable immediately unless it was subject to future performance of substantial services.  This restriction was not popular, and Chairman Brady’s amendment would eliminate Section 3801 in its entirety, meaning that current section 409A would continue to apply going forward.

In addition, Chairman Brady’s First Amendment added a new Section 3804 to the Bill that would, through the addition of a new subsection 83(i) to the Code, allow certain employees of privately-held companies the ability to defer income on shares of stock covered by options and restricted stock units (RSUs).  The Second Amendment would clarify that no provision of section 83 applies to RSUs other than section 83(i), meaning that employees cannot make section 83(b) elections with respect to RSUs.

Limited Retention of Exclusion for Employer-Paid Moving Expenses.  As discussed previously, Section 1405 of the Bill would eliminate the exclusion from income and wages available under Code section 132(a)(6) for a qualified moving expense reimbursement.  The Second Amendment would retain this exclusion for members of the U.S. Armed Forces on active duty who move pursuant to military orders.

Ways and Means Committee Approves Amendment to Tax Cuts and Jobs Act

As part of the on-going markup of the Tax Cuts and Jobs Act (H.R. 1) (the “Bill”), Chairman Brady of the House Ways and Means Committee introduced a sizeable amendment to the Bill that was approved on Monday evening, affecting the changes made to the exclusion for dependent care assistance programs (DCAP) and introducing a new rule affecting income deferral on privately-held stock options and restricted stock units (RSUs).  We have been releasing a series of posts to highlight the provisions of the Bill affecting the topics pertinent to our readers, all of which are linked in the most recent post in this series.

Elimination of Exclusion for Dependent Care Assistance Programs.  As we explained in Part I of our series on the Bill, under Code section 129, the value of employer-provided DCAP is generally excluded from an employee’s income and wages up to $5,000 per year, and employees frequently take advantage of this exclusion through a dependent care flexible spending account that is part of a cafeteria plan under Code section 125.  Previously, Section 1404 of the Bill would have repealed this exclusion in its entirety, effective for tax years beginning after 2017.  The amendment to Section 1404 of the Bill delays the effective date of this repeal, eliminating the exclusion for tax years beginning after 2022.

New Rules Regarding Income Deferral for Stock Options and Restricted Stock Units Issued by a Privately-Held Corporation.  The amendment added a new Section 3804 to the Bill, which would allow certain employees of privately-held companies the ability to defer income on shares of stock covered by options and RSUs.  Currently, pursuant to Code section 83, the value of shares covered by options without a readily-ascertainable fair market value is includable in income at the time of exercise.  Additionally, they are exempt from taxation under Code section 409A because they are generally not considered deferred compensation when the exercise price equals the fair market value at the time of grant.

Section 3804 of the Bill would add a new subsection 83(i) to the Code, which would allow “qualified” employees to elect to defer income related to stock of a privately-held corporation received upon stock option exercise or RSU settlement by making an election no later than 30 days after the first time the employee’s rights in such stock are transferrable or no longer subject to a substantial risk of forfeiture.  Following such an election, the stock would be includable in income on: (i) the first date the stock becomes transferrable; (ii) the date the recipient first becomes an excluded employee (generally, a 1% owner, an officer, or a highly-compensated employee); (iii) the first date any stock of the corporation becomes readily tradeable on an established securities market; (iv) five years after the earlier of the date the recipient’s rights are not transferable or are not subject to a substantial risk of forfeiture; or (v) the date on which the employee revokes his or her election.  This change to section 83, in conjunction with the fact that the Bill would specifically include stock options within the definition of deferred compensation for purposes of what would be new section 409B (previously discussed here), suggests that Congress may intend to make stock options taxable upon vesting, even if the options do not yet have a readily-ascertainable fair market value.  Another issue raised by this new subsection 83(i) relates to whether section 83(b) elections, which currently permit unvested property to be includable in income in the year of transfer, should be expanded to allow such elections for stock options.  Indeed, section 83(i) seems to envision such a change: the new election provided for under section 83(i) is explicitly barred for any stock options with respect to which an employee has already made a section 83(b) election.

IRS Simplifies Filing Requirements for Section 83(b) Elections

On July 25, the IRS released final regulations eliminating the requirement that taxpayers making a Section 83(b) election file a copy of the election notice with their federal income tax return.  Under Section 83, the fair market value of property received (less any basis in the property) for the performance of services is generally included in income when the property is no longer subject to a substantial risk of forfeiture or when the taxpayer’s interest in the property is transferable.  However, taxpayers may elect under Section 83(b) to include the property’s fair market value (less any basis in it) as of the date of transfer in income in the year of transfer.  Despite the upfront tax liability, this election may actually defer taxation on the appreciated value of the property and subject the appreciation to capital gains rates rather than ordinary income rates.  Under the prior regulations, taxpayers who make an 83(b) election must submit to the IRS a copy of the election notice not only within 30 days after the date of the transfer, but also with their federal income tax return for the year of the transfer.  Last summer, the Treasury and the IRS proposed to eliminate the latter filing requirement, and after receiving no comments, adopted the final regulations without modification.

The requirement to file an election notice with the annual return was duplicative and easy to miss because taxpayers making an 83(b) election were already required to submit to the IRS the election notice within 30 days after the date of the transfer.  Further, as the IRS explained in the preambles to the proposed regulations, this requirement had become an obstacle to electronic filing of returns for certain taxpayers, since commercial e-filing software does not consistently allow for submitting an 83(b) election notice with the return.  The final regulations apply to transfers on or after January 1, 2016, and taxpayers can also rely on these regulations for transfers in 2015.  As a result, taxpayers are not required to file a copy of any 83(b) election made in 2015 with their 2015 tax returns.

Significantly, the final regulations ease compliance for non-resident alien employees of multinational companies.  Although foreign tax consequences can make transfers of restricted stock to such employees undesirable from the employee’s perspective, it may be desirable for the employee to make a section 83(b) election when restricted stock is transferred.  This is particularly true for start-ups and other companies where the value of the shares is small when granted and is likely to increase.  (It is often undesirable to make an 83(b) election for a mature company where the value of the stock is high at transfer and may decline.)

When nonresident alien employees working outside of the United States receive non-vested equity compensation, they may have no obligation to file a U.S. tax return, and could easily neglect to file a return for purposes of filing the election notice.  (Because the employees are nonresident aliens working outside the United States, the income from their 83(b) elections would presumably be foreign source income resulting in no U.S. income tax due in the year of transfer.)  But if these employees become U.S. residents between the grant and vesting dates, their failure to file nonresident returns and attach the 83(b) election notices would invalidate their 83(b) elections, thereby subjecting the value of the property to U.S. income tax upon vesting based on their U.S. resident status at the time of vesting.  Under the final regulations, these employees – and any other service providers – must simply file an election notice with the IRS within 30 days after the date of the transfer.

Although the final regulations simplified filing obligations under Section 83(b), the IRS emphasized taxpayers’ recordkeeping responsibilities under Section 6001, especially to show the basis of property reported on taxpayers’ returns.  Thus, to protect themselves from tax-return audit liability, executives and other service providers who receive restricted property under an 83(b) election must be careful to keep records of the original cost of the property received, and retain the records until at least the period of the limitations for the returns expires.