The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By Michael G. Kushner, Esq.
New York, NY
The IRS has issued proposed regulations under §83, relating to property transferred in connection with the performance of services.1 The proposed rules would clarify and narrow the definition of the term "substantial risk of forfeiture" (SRF), thereby limiting the types of restrictions that can delay the taxation of restricted property to the service provider.2
Under §83(a) if, in connection with the performance of services, property is transferred to any person other than the person for whom the services are performed, the excess of:
(1) the property's fair market value (FMV)3 when it first becomes transferable or not subject to a SRF, over
(2) any consideration paid for the property,
is included in the service provider's (employee's) gross income in the first taxable year in which the property becomes transferable or are not subject to a SRF.4
Under the statutory language, an employee's rights in property are subject to a SRF if the employee's rights to full enjoyment of the property are conditioned upon the employee's performing substantial future services.5 Whether a risk of forfeiture is a SRF depends upon the surrounding facts and circumstances.6 Under the current regulatory language, an SRF exists where rights in the property are conditioned, directly or indirectly, upon the future performance, or refraining from performance, of substantial services by the employee, or upon the occurrence of a condition that is related to a purpose of the transfer.7
Before the proposed regulations, there had been some debate over whether any other types of restrictions could give rise to a SRF.8 The proposed regulations, however, clarify that an SRF only can arise as a result of a service condition or a condition related to the transfer's purpose.
The current regulations also have caused debate over whether, in determining whether an SRF exists, the likelihood that a condition related to the transfer's purpose will occur must be considered.9 The proposed regulations clarify that, in determining whether an SRF exists based on a condition related to the transfer's purpose, both the likelihood that the forfeiture event will occur and the likelihood that the forfeiture will be enforced must be considered. Performance conditions that are unlikely to occur will not constitute a SRF. The Preamble provides an example of such an unlikely occurrence:[A]ssume that stock transferred by an employer to an employee was made nontransferable and also subject to a condition that the stock be forfeited if the gross receipts of the employer fell by 90% over the next three years. Assume further that the employer is a long-standing seller of a product and that there is no indication that either there will be a fall in demand for the product or an inability of the employer to sell the product, so that it is extremely unlikely that the forfeiture condition will occur. Although, arguably, the condition is a condition related to the purpose of the transfer because it would, to some degree, incentivize the employee to prevent such a fall in gross receipts, the Treasury Department and the IRS do not believe that such a condition was intended to defer the taxation of the stock transfer.
The proposed regulations also clarify that, except as provided in §83(c)(3) and Regs. §1.83-3(j) and (k), transfer restrictions do not create an SRF, including transfer restrictions that could trigger forfeiture or disgorgement of the property or other penalties, if the restriction is violated.10 In support of its position, Treasury noted that, by subsequently amending the statute to add §83(c)(3), which defers the taxable event on restricted stock until restrictions imposed by §16(b) of the Exchange Act expire, it can be inferred that Congress intended that other such disgorgement or penalty restrictions not qualify as SRFs, as it was necessary to add §83(c)(3) to carve out an exception for Exchange Act restrictions.11
The proposed regulations would become effective as of January 1, 2013, with respect to property transferred on or after that date. Taxpayers may rely on the proposed regulations for property transferred after the publication date of the proposed regulations (i.e., May 31, 2012).
For more information, in the Tax Management Portfolios, see Eickman, 384 T.M., Restricted Property - Section 83, and in Tax Practice Series, see ¶5710, Nonqualified Deferred Compensation.
1 REG-141075-09, 77 Fed. Reg. 31783 (5/30/12).
2 The term "substantial risk of forfeiture" (SRF) is also used in §§409A(d)(4), 457(f)(3)(B) and 3121(v)(2)(A)((ii). The IRS has issued final regulations under §409A that includes a specific, and in certain respects more narrow, definition of SRF (see Regs. §1.409A-1(d)). In addition, the IRS has announced that it intends to adopt a definition of SRF for purposes of §457(f) that is similar to the definition adopted for §409A purposes (see Notice 2077-62, 2007-32 I.R.B. 331). For purposes of §3121(v), the final regulations provide that the determination of whether a SRF exists must be made in accordance with the principles of §83 and the regulations thereunder, and therefore, the proposed regulations under §83 that were just issued should apply for §3121 purposes as well.
3 FMV, for this purpose, is determined without regard to restrictions on the transferred property which, by their terms, will eventually lapse, such as vesting restrictions. Only so-called "nonlapse" (i.e., permanent) restrictions are considered in determining FMV. An example of a nonlapse restriction would be a permanent right of first refusal in favor of the employer to repurchase the property from the employee at a set or formula price before the employee could sell the property to third parties.
4 For ease of reference, the service provider or transferee of §83 property is referred to herein as the "employee," although §83 also applies to transfers of property to independent contractors and to entities which provide services.
5 §83(c)(1). An example of such a condition would be a requirement that an employee provide a certain number of hours of consulting services for the employer after his termination of employment, provided that such consulting agreement is, in fact, enforced by the employer.
6 Regs. §1.83-3(c)(1). See also H.R. Rep. No. 91-413 (Pt. 1), 91st Cong., 1st Sess. 62, 88 (1969-3 Cum. Bull. 200, 255); S. Rep. No. 91-552, 91st Cong., 1st Sess. 119, 121 (1969-3 C.B. 423, 501).
7 Id. See Regs. §1.83-3(c)(2) for illustrations of when an SRF is deemed to exist.
8 See Robinson v. Comr., 805 F.2d 38 (1st Cir. 1986).
10 The Preamble cites support for Treasury's position in the legislative history to §83. See S. Rep. No. 91-552, 1969-3 C.B. 423, 500. See also H. Rep. No. 91-413, 1969-3 C.B. 200, 254.
11 See also Regs. §1.83-3(j). See also Rev. Rul. 2005-48, 2005-2 C.B. 259.
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