Compensation and Benefits Insights: Additional Lifetime Income Guidance

by King & Spalding

[author: Laura Westfall, New York, +1 212 556 2263,]

On May 30, 2012, the Internal Revenue Service (the “IRS”) issued proposed regulations clarifying what constitutes a “substantial risk of forfeiture” for purposes of the timing of income related to property transferred in connection with the performance of services under Section 83 of the U.S. Internal Revenue Code of 1986, as amended (the “Code”) (the “Proposed Regulations”) and certain other requirements.

Substantial risk of forfeiture  

Code Section 83 sets forth the rules for the taxation of property that is transferred to an employee or other service provider in connection with the performance of services (such as grants of restricted stock and transfers of stock upon the exercise of an option or under a restricted stock unit award). If property is transferred to an employee (or other service provider) in connection with his or her performance of services, the employee recognizes income when the property is no longer subject to a “substantial risk of forfeiture,” or when the employee can freely transfer the property, if earlier.  Section 1.83–3(c)(1) of the existing regulations provides that a “substantial risk of forfeiture” exists where rights in property are conditioned, directly or indirectly, upon either (i) the future performance (or refraining from performance) of substantial services by any person (a “service-based condition”), or (ii) the occurrence of a “condition related to a purpose of the transfer” (where the possibility of forfeiture is substantial if such condition is not satisfied). 

The Proposed Regulations provide that a substantial risk of forfeiture may be established only through a “service-based restriction” or a “condition related to the purpose of the transfer.” The IRS indicated in the preamble to the Proposed Regulations (the “Preamble”) that this change is intended to clarify that no other conditions (such as transfer restrictions) may be treated as a substantial risk of forfeiture that would delay taxation under Code Section 83.

INSIGHT: This amendment would make Code Section 83’s definition of “substantial risk of forfeiture” more similar to the definition of that phrase for purposes of Code Section 409A. Under Code Section 409A, a “substantial risk of forfeiture” exists where “entitlement to an amount is conditioned on the performance of substantial future services by any person or the occurrence of a condition related to a purpose of the compensation, and the possibility of forfeiture is substantial.”  However, unlike the Section 83 regulations, the Section 409A regulations expressly provide that refraining from performing services (for example, a non-competition agreement) is not a substantial risk of forfeiture.  26 C.F.R. §1.409A-1(d)(1).

The Proposed Regulations also clarify that in determining whether a “substantial risk of forfeiture” exists based on a “condition related to the purpose of the transfer,” both (i) the likelihood that the forfeiture event will occur and (ii) the likelihood that the forfeiture condition will be enforced must be considered, at the time the arrangement is established. The Preamble provides the example of a plan under which stock transferred to an employee would be forfeited if gross receipts of the employer fell by 90% over the next three years, but where there was no indication based on the employer’s past profitability that such a drop in profits would occur.  The IRS stated that no “substantial risk of forfeiture” would exist for purposes of Code Section 83 because it was extremely unlikely that the forfeiture condition (decline of gross receipts by 90%) would occur.

INSIGHT: Given the emphasis placed by the IRS in the Proposed Regulations on the requirement that an employer consider both the likelihood that the forfeiture event will occur and the likelihood that the forfeiture will be enforced at the time an arrangement is established, an employer may want to document its decision-making process when establishing the arrangement, to show that both likelihoods were taken into consideration.

Restrictions on Stock Transfers  

As stated above, the general rule under Code Section 83 is that a person recognizes income related to property transferred in connection with the performance of services when the property is no longer subject to a “substantial risk of forfeiture,” or when the person can freely transfer the property, if earlier. However, where a sale of property at a profit could subject a person to suit under Section 16(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Code Section 83(c)(3) provides that such person’s rights in such property are treated as subject to a substantial risk of forfeiture and as not transferable (and, therefore, such person does not recognize income during that period). Further, Section 1.83–3(j) of the existing Treasury Regulations provides that if the sale of property at a profit within 6 months after its purchase could subject a person to suit under Section 16(b) of the Exchange Act, such person’s rights in the property are treated as subject to a substantial risk of forfeiture and as not transferable until the earlier of (i) the expiration of such 6-month period, or (ii) the first day on which the sale of such property at a profit will not subject the person to suit under Section 16(b) of the Exchange Act.

In IRS Revenue Ruling 2005-48, the IRS provided guidance on Code Section 83(c)(3), holding that Section 16(b) of the Exchange Act is the only provision of the U.S. securities law that would delay taxation under Code Section 83. The Proposed Regulations incorporate the holding of that Revenue Ruling, by adding an example to the existing Treasury Regulations illustrating this limitation.

INSIGHT: The Proposed Regulations reiterate the IRS’s long-held view, stated in Revenue Ruling 2005-48, that other transfer restrictions under U.S. securities law, such as insider trading restrictions under Rule 10b-5 of the Exchange Act or lock-up provisions after an initial public offering, will not delay taxation under Code Section 83.

Effective Date

The Proposed Regulations, if finalized as proposed, will apply to transfers of property made on or after January 1, 2013. Comments on the Proposed Regulations must be submitted to the IRS by August 28, 2012.

As always, King & Spalding is happy to assist employers and employees in understanding the impact of the Proposed Regulations (and Code Section 83 in general) on their equity compensation programs. Feel free to contact any member of our Executive Compensation and Employee Benefits Practice with your questions.

Upcoming Filing and Notice Deadlines for Qualified Retirement and Health and Welfare Plans

The table below sets forth key filing and notice deadlines common to calendar year retirement and health and welfare plans for July and August. Please note that the deadlines will be different if your plan year is not the calendar year. For a look at the key filing and notice deadlines for the entire year, please see the March edition of the K&S Compensation and Benefits Insights.


July 1, 2012

Receipt of Fee Disclosures from Covered Service Providers

Deadline for covered service providers to provide certain fee information to responsible plan fiduciary.


Retirement Plans**

July 28 (no later than 210 days after the end of the plan year in which the change was effective)

Summary of Material Modifications

Deadline for plan administrator to distribute summary of material modifications  reflecting any changes to the plan summary description arising from any plan amendments adopted during prior year.


Retirement Plans

July 31 (within 210 days after the close of the plan year)


Form 5500

Deadline for plan administrator to file Form 5500 for prior year. This deadline is extended to September 15th if plan sponsor’s corporate tax return is extended, and is extended to October 15th if plan sponsor files Form 5558 for extension.


Generally required for all ERISA plans with 100 or more participants.

- Retirement Plans

- Health and Welfare Plans


July 31

(The last day of the seventh (7th) month of the following plan year)

Form 8955-SSA


Deadline for plan administrator to File Form 8955-SSA (replaced the Form SSA).  


Note that Form 5558 may be used to obtain an extension.

Retirement Plans

August 30

Annual Fee and Investment Disclosure to Participants 

Deadline for plan administrator to make initial disclosure of certain fees and investment information for participant directed individual account plans to be provided to participants and beneficiaries.


Defined Contribution Plans that allow participants to direct investments


** Retirement Plans means all employee pension benefit plans as defined in ERISA §3(2).


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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