IRS Issues Final Regulations Clarifying Transfers of Stock for Services

Author: Rena Pirsos, XpertHR Legal Editor

April 9, 2014

The IRS has issued final regulations under Internal Revenue Code (IRC) § 83 clarifying when "a substantial risk of forfeiture" exists when property (e.g., stock) is transferred in connection with the performance of services by an employee. The final regulations adopt proposed regulations with minor changes. They apply to property transferred on or after January 1, 2013.

IRC § 83 addresses the tax consequences of the transfer of stock in connection with the performance of services. If the fair market value of vested, unrestricted stock provided to an employee as compensation, less any amount the employee paid for it, is subject to federal income tax (FIT) withholding, Social Security and Medicare (FICA) tax withholding and federal unemployment tax (FUTA) during the first year, then an employee's beneficial interest in the stock may be transferred. The same rule applies to stock that is subject to a restriction that will never lapse.

On the other hand, the fair market value of stock, less any amount the employee paid for it, that is subject to a substantial risk of forfeiture is subject to FIT and FICA withholding and FUTA tax when the restriction lapses.

The final regulations clarify that:

1. Except as specifically provided in § 83(c)(3) and regulation §§ 1.83-3(j) and (k), a substantial risk of forfeiture may be established only through a service condition (e.g., an employee's right to receive stock is conditioned upon him or her providing substantial services, or refraining from providing services, to the employer) or a condition related to the purpose of the transfer (e.g., stock that does not increase by a certain percentage or amount must be returned). The final regulations note that there has been some confusion as to whether other conditions may also result in a substantial risk of forfeiture.
2. In determining whether there is a substantial risk of forfeiture based on a condition related to the purpose of the transfer, both the likelihood that the forfeiture event will occur and the likelihood that it will be enforced must be considered. The final regulations note that there has been some confusion as to whether, in determining whether there is a substantial risk of forfeiture, the likelihood that a condition related to the purpose of the transfer will occur must be considered.
3. Except as provided in § 83(c)(3) and §§ 1.83-3(j) and (k), transfer restrictions do not create a substantial risk of forfeiture, including those that carry the potential for forfeiture or disgorgement of some or all of the stock, or other penalties, if the restriction is violated. The final regulations explain that the legislative history of IRC § 83 indicates that Congress intended the statute to be interpreted such that transfer restrictions could not be used to defer the taxable event.

In a revenue procedure, the IRS has created a model Section 83(b) Election Agreement (at page 9) that may be used to make an election. It also provides examples of the income tax consequences of making an election.