3615 / What is the escrow requirement that employers must satisfy in order to give employees the option of deferring tax on certain stock options and RSUs under Section 83(i)?

IRS guidance interpreting the Section 83(i) tax deferral option requires employers to establish an escrow arrangement if they wish to provide employees with the opportunity to defer taxes under the code section. This escrow arrangement is designed to solve potential income tax withholding issues associated with the new rules. If the employee and employer do not agree to the escrow arrangement, the employee is not a qualified employee for purposes of the Section 83(i) deferral option.

All deferral stock must be deposited in the escrow account before the end of the calendar year in which the Section 83(i) election is made, and must remain in the account until the employer recovers the income tax withholding obligation from the employer. At any time between the date of income inclusion under Section 83(i)(1)(B) and March 31 of the following year, the employer is permitted to remove from escrow and retain the number of shares of deferral stock with a fair market value equal to the income tax withholding obligation that has not been otherwise received from the employee.

Planning Point: Practically, this escrow arrangement could force corporations to repurchase their own stock in order to satisfy the employee’s income tax withholding obligations, potentially making the Section 83(i) deferral option less attractive for employers who may not wish to use their own funds to satisfy these obligations.

Fair market value, for purposes of these rules, means the fair market value as determined under the Section 409A regulations, and is the fair market value of the shares at the time the corporations retains the shares held in escrow to satisfy the employee’s income tax withholding obligations.

After the employee has satisfied his or her income tax withholding obligations, the shares held in escrow must be delivered to the employee as soon as reasonably practicable.¹