Stock transfer limits and an employer repurchase right do not defeat § 83(i) deferral

Plain-English summary

A privately held corporation wanted eligible employees to elect under IRC
§ 83(i) to defer income from exercising stock options granted before 2018.
Employees could not transfer the shares during the deferral period, while the
corporation retained a unilateral right to repurchase them at fair market
value. The IRS ruled that these restrictions and the employer's repurchase
right do not violate the rule that qualified stock cannot give an employee a
right to sell the shares back or receive cash instead. It also ruled that the
shares remain nontransferable until the earliest specified deferral-ending
event, including five years after exercise, public trading, excluded-employee
status, or the employer's exercise of its repurchase right. The IRS did not
rule that the shares otherwise qualified under § 83(i) or that the plan met
the section's remaining requirements.

Ruling snapshot

• Question: Do the transfer restrictions and unilateral employer
  repurchase right prevent the option shares from meeting § 83(i)'s qualified
  stock and nontransferability rules?
• Outcome: Approved for stock options granted under the plans before 2018
• Key authorities: IRC § 83(i); Treas. Reg. § 1.83-3(d); Notice 2018-97

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202042010 Third Party Communication: None
Release Date: 10/16/2020 Date of Communication: Not Applicable
Index Number: 83.00-00
Person To Contact:
------------- -------------------------, ID No. ---------------
----------------------------------- Telephone Number:
--------------------------------------- --------------------
------------------------------ Refer Reply To:
CC:EEE:EB:EC
PLR-104930-20
Date:
July 23, 2020

LEGEND:

Taxpayer = -----------------------------------
Plan 1 = ----------------------------------------------------------
Plan 2 = ------------------------------------------------------------------------

Dear ------------:

   This is in response to a request for a private letter ruling, dated January 30,

2020, submitted on behalf of Taxpayer by your authorized representative, requesting
rulings under section 83(i) of the Internal Revenue Code (Code). The facts, as
represented, are as follows.

   Taxpayer is a corporation that has no stock traded on an established securities

market. Taxpayer maintains two stock option plans, Plan 1 and Plan 2 (referred to
herein as the Plans), which were adopted before January 1, 2018. Taxpayer has issued
stock options to its employees under the Plans.

    Taxpayer intends to allow employees who are qualified employees under section

83(i)(3)(A) to make an election under section 83(i)(1)(A) (the Election) to defer income
tax on gain realized upon the exercise of options issued under the Plans. An employee
will be required to execute the Election before the related stock options are exercised.
The Election includes the following provisions:

•   The employee will have no right to sell, give, assign, pledge, hypothecate or
    otherwise transfer or dispose of the stock subject to the election (the
    “Transferability Restrictions”) until the earliest of (i) five (5) years from the
    exercise date of the option, (ii) the first date that any of the Taxpayer’s stock
    becomes readily traded on an established securities market within the meaning
    of section 83(i), or (iii) the date the employee becomes an excluded employee as
    defined under Section 83(i).

PLR-104930-20 2

•   The Taxpayer will have the unilateral right to repurchase any stock subject to the
    election (the “Repurchase Right”) for its fair market value at any date before the
    Transferability Restrictions lapse.

    Specifically, Taxpayer is requesting a ruling that the Transferability Restrictions

and the Repurchase Right will not prevent the shares subject to the Election from
satisfying the limitation applicable to qualified stock described in section 83(i)(2)(B).

   Taxpayer is also requesting a ruling that, as a result of the Transferability

Restrictions, the stock subject to the Election is not transferable (within the meaning of
section 83(i)(1)(B)(i)) until the earliest of (i) five (5) years from the exercise date of the
option, (ii) the first date that any of the Taxpayer’s stock becomes readily traded on an
established securities market within the meaning of section 83(i), (iii) the date the
employee becomes an excluded employee as defined under Section 83(i), or (iv) the
exercise of the Repurchase Right by the Taxpayer.

  Taxpayer is requesting the above rulings with respect to stock options that were

granted under the Plans prior to January 1, 2018.

  Section 83(i)(1)(A) provides that if qualified stock is transferred to a qualified

employee who makes an election under section 83(i) with respect to such stock, the
amount determined under section 83(a) with respect to such stock will be included in
income in the taxable year determined under section 83(i)(1)(B). Accordingly, such
income shall be included in the taxable year of the employee which includes the earliest
of:
(i) the first date such qualified stock becomes transferable (including, solely
for purposes of this clause, transferable to the employer);1
(ii) the date the employee first becomes an excluded employee;
(iii) the first date on which any stock of the issuing corporation becomes
readily tradable on an established securities market;
(iv) the date that is 5 years after the first date the rights of the employee in
such stock are transferable or not subject to a substantial risk of forfeiture,
whichever occurs earlier; or
(v) the date on which the employee revokes the election (at such time and in
such manner as the Secretary of the Treasury (Secretary) provides).

   Section 83(i)(3)(A) defines a “qualified employee” as any individual who is not an

“excluded employee” and who agrees to meet such requirements as are determined by
the Secretary to be necessary to ensure that the withholding requirements of the

1
The legislative history of section 83(i) states, in reference to this provision, “Thus, for this purpose, the
qualified stock is considered transferable if the employee has the ability to sell the stock to the employer
(or any other person).” House Conf. Rpt. 115-466, 498 (2017).
PLR-104930-20 3

corporation under chapter 24 (Collection of Income Tax at Source on Wages) with
respect to the qualified stock are met.

  An “excluded employee” is defined under section 83(i)(3)(B) as, with respect to

any corporation, any individual:

   (i)     who is a 1 percent owner at any time during the calendar year or who was
           a 1 percent owner at any time during the 10 preceding calendar years;
   (ii)    who is or has been at any prior time (I) the chief executive officer (or an
           individual acting in such capacity) or (II) the chief financial officer (or an
           individual acting in such capacity);
   (iii)   who bears a relationship described in section 318(a)(1) to any individual
           described in subclause (I) or (II) of clause (ii); or
   (iv)    who is one of the 4 highest compensated officers of the corporation for the
           taxable year, or was one of the 4 highest compensated officers of such
           corporation for any of the 10 preceding taxable years, determined on the
           basis of the shareholder disclosure rules for compensation under the
           Securities Exchange Act of 1934 (as if such rules applied to such
           corporation).

   Section 83(i)(2)(A) defines “qualified stock” as any stock in a corporation that is

the employer of a qualified employee, if such stock is received (i) in connection with the
exercise of a stock option or in settlement of a restricted stock unit (RSU), and (ii) such
stock option or RSU was granted in connection with the performance of services as an
employee and during a calendar year that the employer corporation was an eligible
corporation. Section 83(i)(5) provides that, for purposes of this subsection, all persons
treated as a single employer under section 414(b) shall be treated as one corporation.
Section 83(i)(2)(B) provides that qualified stock does not include any stock if the
employee may sell the stock to, or otherwise receive cash in lieu of stock from, the
corporation at the time that the employee’s rights to the stock first become transferable
or not subject to a substantial risk of forfeiture.

    Section 83(i)(2)(C)(i) defines an “eligible corporation” as any corporation that,

with respect to any calendar year, (i) has none of its (or any predecessor’s) stock readily
tradable on an established securities market during any preceding calendar year, and
(ii) has a written plan under which, in such calendar year, not less than 80% of all
employees who provide services to the corporation in the United States (or any
possession of the United States) are granted stock options, or are granted RSUs, with
the same rights and privileges to receive qualified stock. As provided in section
83(i)(2)(C)(iii), for purposes of section 83(i)(2)(C)(i)(II), the term “employee” does not
include any excluded employee or any employee described in section 4980E(d)(4)
(certain part-time employees).
PLR-104930-20 4

    Section 83(i)(2)(C)(ii)(I) provides that the determination of rights and privileges

shall be made in a manner similar to the determination under section 423(b)(5).
However, in accordance with section 83(i)(2)(C)(ii)(II), employees shall not fail to be
treated as having the same rights and privileges to receive qualified stock solely
because the number of shares available to all employees is not equal in amount, so
long as the number of shares available to each employee is more than a de minimis
amount. In addition, section 83(i)(2)(C)(ii)(III) provides that rights and privileges with
respect to the exercise of an option shall not be treated as the same as rights and
privileges with respect to the settlement of an RSU. Finally, in the case of any calendar
year beginning before January 1, 2018, section 83(i)(2)(C)(iv) provides that neither
stock options nor RSUs are required to have been granted with the same rights and
privileges for the stock received to be treated as qualified stock.

   Section 83(i)(4)(A) provides that an election with respect to qualified stock shall

be made no later than 30 days after the first date the rights of the employee in such
stock are transferable or are not subject to a substantial risk of forfeiture, whichever
occurs earlier, and shall be made in a manner similar to the manner in which an election
is made under section 83(b). Section 83(i)(4)(C) provides that the term “deferral stock”
is used to refer to stock with respect to which a section 83(i) election has been made.

    Section 83(i)(4)(B) provides that no election may be made under section 83(i) if

the qualified employee has made an election under section 83(b) with respect to such
qualified stock, or if any stock of the corporation which issued the qualified stock is
readily tradable on an established securities market at any time before the election is
made. In addition, no election may be made under section 83(i) with respect to any
qualified stock if the corporation that issued the stock purchased any of its outstanding
stock in the calendar year preceding the calendar year which includes the first date the
rights of the employee are transferable or are not subject to a substantial risk of
forfeiture, unless (i) not less than 25% of the total dollar amount of the stock so
purchased is deferral stock, and (ii) the determination of which individuals from whom
deferral stock is purchased is made on a reasonable basis.

   Section 1.83-3(d) provides that, for purposes of section 83 and the regulations

thereunder, the rights of a person in property are transferable if such person can
transfer any interest in the property to any person other than the transferor of the
property, but only if the rights in such property of such transferee are not subject to a
substantial risk of forfeiture. Accordingly, property is transferable if the person
performing the services or receiving the property can sell, assign, or pledge (as
collateral for a loan, or as security for the performance of an obligation, or for any other
purpose) his interest in the property to any person other than the transferor of such
property and if the transferee is not required to forfeit the property or its value in the
event the substantial risk of forfeiture materializes.
PLR-104930-20 5

    Section 83(i)(1)(A)(i) makes clear that qualified stock may not be transferable

from the employee to the employer. The legislative history of section 83(i) further
clarifies that qualified stock is considered transferable if the employee has the ability to
sell the stock to the employer. Notwithstanding the inability of the employee to sell or
transfer qualified stock to the employer, the statutory provision contemplates that the
corporation may be able to repurchase qualified stock from the employee without
causing the program to fail to meet the requirements of section 83(i). Specifically,
section 83(i)(4)(B)(iii) provides that no election may be made under section 83(i) with
respect to any qualified stock if the corporation that issued the stock purchased any of
its outstanding stock in the calendar year preceding the calendar year which includes
the first date the rights of the employee are transferable or are not subject to a
substantial risk of forfeiture, unless (i) not less than 25% of the total dollar amount of the
stock so purchased is deferral stock, and (ii) the determination of which individuals from
whom deferral stock is purchased is made on a reasonable basis. Accordingly, a
unilateral repurchase right on the part of the corporation does not make qualified stock
transferable for purposes of section 83(i)(1)(A)(i).

   The Transferability Restrictions and the Repurchase Right do not provide the

employee the unilateral right to sell the stock to, or otherwise receive cash in lieu of
stock from, the Taxpayer at the time that the employee’s rights to the stock first become
transferable or not subject to a substantial risk of forfeiture.

     Further, as a result of the Transferability Restrictions, the deferral stock is not

transferable until the earliest of (i) five (5) years from the exercise date of the option, (ii)
the first date that any of the Taxpayer’s stock becomes readily traded on an established
securities market within the meaning of section 83(i), (iii) the date the employee
becomes an excluded employee as defined under Section 83(i), or (iv) the exercise of
the Repurchase Right by the Taxpayer.

   Therefore, based solely on the facts presented, we rule as follows with respect to

stock options granted under the Plans prior to January 1, 2018:

1. The Transferability Restrictions and the Repurchase Right will not prevent the
   shares subject to the Election from satisfying the limitation applicable to qualified
   stock described in section 83(i)(2)(B).

2. As a result of the Transferability Restrictions, the stock subject to the Election is
   not transferable (within the meaning of section 83(i)(1)(B)(i)) until the earliest of
   (i) five (5) years from the exercise date of the option, (ii) the first date that any of
   the Taxpayer’s stock becomes readily traded on an established securities market
   within the meaning of section 83(i), (iii) the date the employee becomes an
   excluded employee as defined under Section 83(i), or (iv) the exercise of the
   Repurchase Right by the Taxpayer.
   PLR-104930-20 6

    Except as expressly provided herein, no opinion is expressed or implied
   

   concerning the tax consequences of any aspect of any transaction or item discussed or
   referenced in this letter. Specifically, no opinion is expressed or implied concerning
   (i) the tax consequences of any other provision of the Plans or the Election; (ii) whether
   the shares subject to the Election are qualified stock within the meaning of section
   83(i)(2) of the Code; and (iii) whether any other requirements described in section 83(i)
   or in Notice 2018-97, including the requirement to establish an escrow arrangement,
   have been satisfied.

   This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of
   the Code provides that it may not be used or cited as precedent.

   A copy of this letter must be attached to any income tax return to which it is
   relevant. Alternatively, taxpayers filing their returns electronically may satisfy this
   requirement by attaching a statement to their return that provides the date and control
   number of the letter ruling.

   This ruling is based on the information and representations submitted by your
   authorized representative and accompanied by a penalty of perjury statement executed
   by you. While this office has not verified any of the material submitted in support of the
   request for rulings, it is subject to verification on examination.

    In accordance with the Power of Attorney on file with this office, a copy of this
   

   letter is being sent to your authorized representative.

                                      Sincerely yours,
   
                                      ________________________
                                      THOMAS D. SCHOLZ
                                      Senior Counsel
                                      Executive Compensation Branch
                                      Office of the Associate Chief Counsel
                                      (Employee Benefits, Exempts Organizations,
                                      and Employment Taxes)