The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By Sharon L. Klingelsmith, Esq., Mona Ghude, Esq.
and Sharde Armstrong, Esq.
Drinker Biddle & Reath LLP, Philadelphia, PA and Chicago,
The Treasury Department (Treasury) and Internal Revenue Service
(IRS) have issued final regulations clarifying the forfeiture
provisions under §83 for transactions occurring after January 1,
2013. The regulations were issued on February 25, 2014.
Section 83 provides that property transferred to an employee as
compensation (such as the issuance of employer stock or property
other than cash) is not taxable until the property is no longer
subject to a substantial risk of forfeiture or until the property
is freely transferable, whichever is earlier. The regulations are
consistent with prior guidance, but offer several clarifications on
what constitutes a "substantial risk of forfeiture." Employers who
did not evaluate the impact of the regulations when they were
originally proposed in 2012 will need to consider how the final
regulations affect existing arrangements.
The Final Regulations confirm that a "substantial risk of
forfeiture" may be established only if a recipient's
rights in transferred property are either (1) conditioned on the
performance, or refraining from performance (e.g., as a result of a
non-compete agreement), of substantial services, or (2) are subject
to a condition related to the purpose of the transfer (e.g.,
recipient must achieve a certain level of performance, such as
maintaining specified revenue levels). Additionally, the facts and
circumstances at the time of the property transfer must establish
the likelihood that a forfeiture event will occur and that the
forfeiture condition will be enforced.
The Final Regulations clarify that, subject to certain
exceptions, transfer restrictions on securities (such as lock-up
arrangements, blackout periods, and insider-trading restrictions)
alone do not create a substantial risk of forfeiture because rights
in these securities are not subject to future service conditions or
conditions related to the purpose of the transfer. This is true
even if a violation of the transfer restriction carries the
potential for forfeiture or disgorgement of some of the property,
or other damages, penalties, or fees.
An exception to this rule arises if an insider may not sell
shares of stock previously acquired in a non-exempt transaction
within the past six-months due to potential liability under §16(b)
of the Securities Exchange Act. Under the Final Regulations, unless
the taxpayer has made a §83(b) election - i.e., an election to be
taxed at the time of the stock issuance - the stock is subject to a
substantial risk of forfeiture and is not taxable until six months
after the acquisition date; this period is not tolled if there is a
subsequent non-exempt acquisition.
While a non-compete clause never constitutes a substantial risk
of forfeiture with respect to deferred compensation subject to
§409A (which does not consider refraining from performance a
service condition), the Final Regulations retain the possibility
that a non-compete clause may constitute a substantial risk of
forfeiture under §83 depending on factors such as an employee's
age, health, other employment opportunities, and the likelihood
that the restrictive condition will be enforced.
Finally, the preamble to the Final Regulations addresses a
comment requesting that an involuntary termination without cause be
treated as a substantial risk of forfeiture, similar to the §409A
rule. The IRS and Treasury concluded that a right to receive
property in the future, such as upon an involuntary termination
without cause, is not "property" for purposes of §83 and does not
give rise to a substantial risk of forfeiture under §83.
For more information, in the Tax Management Portfolios, see
Eickman, 384 T.M., Restricted Property - Section 83, and
Brisendine, Drigotas and Pevarnik, 385 T.M., Deferred
Compensation Arrangements, and in Tax Practice Series,
see ¶5710, Deferred compensation Tax Concepts and Structures, and
¶5810, Nonstatutory Stock Options.
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