Empowering Employees through Stock Ownership Act (EESO Act)

Senator Warner and Senator Heller

Background:
Businesses across the country offer stock options to their employees, from senior management to
administrative staff, for many reasons. Stock options allow companies to share the value of their
firms with employees, recruit and maintain talented workers, and offer compensation that goes
beyond a standard salary. For cash-strapped start-up companies, options are a way to compensate
employees and compete with more established firms.

Under current law, employees are required to pay taxes when they exercise their options or when
their Restricted Stock Units (RSUs) vest. In other words, to access their employee ownership stake,
employees are required to pay taxes on the excess of the fair market value of the stock, over the
amount they pay for the stock. The employer receives a tax deduction when the employee exercises
the option.

The Challenge:
For companies that are publicly traded, employees can sell all or a portion of their shares on the
public market to pay for their taxes. In the case of privately held companies, however, there is
generally not a market for employees to sell shares to cover their tax liability. For privately held
companies that are growing, the tax consequences for employees can be prohibitive and result in
many employees being unable to exercise their stock options. As a result, employees are missing
out on the opportunity to gain wealth as their company succeeds.

The Goal:
For employees to more easily exercise stock options and benefit from company growth while
providing employers another tool to retain and recruit workers.

The Legislation:
Creates a new election: Under the new Internal Revenue Code (IRC) Section 83(i) employees can
now elect to defer their income tax liability for an additional period of timeup to 7 years.

Reduces the barrier to exercise stock options: The legislation extends the time period in which
employees are required to pay tax upon exercise of stock options or RSUs that are settled for stock
up to 7 years. The amount of tax the employee can elect to defer is calculated in the same manner
as under current law: the excess of the fair market value of the stock, over the amount they pay for
the stock. Social security tax (subject to the social security wage base) and Medicare tax will still
be applied at exercise, and the employee is still required to pay for the underlying stock. The
employer will defer taking their tax deduction until the employee recognizes income related to the
exercise.

Promotes broad-based employee ownership: To qualify for the deferral of income tax, the
company must meet the requirements of an eligible corporation. An eligible corporation is
required to grant options to 80% or more of its employees, must offer employees stock options on
similar terms, and cannot be traded on an established market.

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This legislation is not meant to benefit highly compensated employees or the largest owners of a
company. Individuals who own 1% or more of the company and those who control the company,
such as the Chief Operating Officer, the Chief Financial Officer, and the four most highly
compensated officers, are not eligible to make the 83(i) election and benefit from tax deferral.
Family attribution rules also apply.

Requires employees to be fully informed: There may be instances where the stock price of the
company declines after the employee makes the 83(i) election. It is critical that employers provide
employees with information, through a written notice, on the tax consequences of this election.
Failure of the company to provide a notice to an employee will result in a penalty.

Provides worker flexibility: The employee can decide to revoke the 83(i) election and pay income
tax at any point.

Uses existing administrative tax rules and appropriate guardrails: Similar to other tax elections in
the stock options space, the employer will be required to report the future tax liability on the
employees Form W-2. Once the employee has the cash to pay the tax, the employee will no longer
be allowed to defer tax liability. Specifically, if stock of the company becomes readily tradable on
an established market or the employee decides to sell or transfer part or all of their shares to another
individual before the seven-year time period ends, the employee will have to pay their previously
deferred tax.

The legislation is effective for stock options exercised, or RSUs settled, after December 31, 2019.
The Secretary of the Treasury is required to issue guidance on this legislation no later than
December 31, 2018.