The IRS has provided two important pieces of new guidance regarding Code Section 83, which governs the taxation of property (e.g., stock and stock options) transferred in exchange for the performance of services.
First, new regulations have been proposed that would revise or clarify the standards on when property is subject to a "substantial risk of forfeiture" for purposes of Section 83. (This is a key consideration, because property transferred in connection with the performance of services generally is not taxable so long as it is subject to a substantial risk of forfeiture.)
- Conditions Other Than Service or Performance. The proposed regulations would clarify that a substantial risk of forfeiture may be established only through a service condition (e.g., a vesting schedule) or a condition related to the purpose of the transfer (e.g., a performance-based condition). For example, an obligation to sell property back to the employer in lieu of transferring it to a third party would not qualify as a substantial risk of forfeiture.
- Likelihood That Condition Will Occur. The proposed regulations would clarify that, in determining whether a performance-based condition is a substantial risk of forfeiture, the likelihood that the condition will occur must be considered, in addition to considering the likelihood that the condition will be enforced. For example, if stock transferred to an employee will be forfeited if the employer's gross receipts fall by 90% over the three-year period after the transfer, the likelihood that gross receipts actually will fall by that amount must be considered in determining whether the forfeiture condition is a substantial risk of forfeiture.
- Transfer Restrictions. The proposed regulations would clarify that transfer restrictions other than a restriction under Section 16(b) of the Securities Exchange Act would not constitute a substantial risk of forfeiture. For example, if stock is transferred to an employee subject to a lock-up agreement or a sale restriction based on an insider-trading policy, those restrictions will not be considered substantial risks of forfeiture.
Of interest, these proposed regulations would not disturb the provision in the existing Section 83 regulations that allows a covenant not to compete to qualify as a substantial risk of forfeiture in certain circumstances.
The new regulations are proposed to be effective for property transferred on or after January 1, 2013, and may be relied on for property transfers occurring after the date the regulations were published in the Federal Register (May 30, 2012).
Second, the IRS has published a sample election form that may be used in making an election under Section 83(b). The 83(b) election is an election made within 30 days after non-vested property is transferred to an individual. The election causes the individual to be taxable on the current value of the property, even though it remains subject to a risk of forfeiture. If the election is made and the property subsequently vests, there is no tax consequence upon the later vesting event. But if the property is forfeited, there is no refund of the taxes paid (if any) in connection with the 83(b) election.
This is the first time the IRS has provided a sample 83(b) election form. The accompanying Revenue Procedure provides additional information and background on the requirements and consequences of making an 83(b) election.