Employees usually sell their stock awards as soon as they can. Here, you’re asking them to do the opposite, essentially deferring to pay the tax, holding the shares, and then paying a (presumably) lower amount of tax later. However, you run the risk of repeating the problem from the dot-com boom, as employees may not be able to sell until the value of the shares has already declined. If the value of the shares drops from the date they exercise, they still owe the tax on the amount that was due at the time of exercise.
And then there’s the FICA (Federal Insurance Contribution Act) problem. If I exercise an ISO as part of an 83(i) plan, it immediately becomes a non-qualified stock option, which doesn’t change its value but does change the way it’s treated under the tax code. For tax purposes, unlike ISOs, the spread between the strike price and fair-market value for non-qualified stock options count as ordinary income. Section 83(i) allows employees to defer paying income tax, but not FICA tax, which includes Social Security and Medicare. So the employee and the employer will both owe FICA at the time that the election is made.
There’s one other problem, too. The tax deferral ends on the date of an IPO. So employees would owe the tax on any options they exercised under 83(i) that day. It’s the employer’s responsibility to collect and remit the tax payments to the IRS, also that day. But there’s no liquidity at that point because the employees can’t sell their stock for another six months. So, how is the company going to collect and remit the tax payment?
Facebook faced a similar problem when it went public. Vested RSUs were due to employees at the IPO. That was a taxable event, except those employees, couldn’t sell the stock right away because they were subject to a six-month lockup. Facebook had to go to the bank and take out billions of dollars in loans to pay the tax on behalf of the employees, who then repaid those loans when the six-month lockup period had ended.
With all these headaches, it’s hard to see many companies deciding to offer 83(i) programs.