IRS Issues Final Regulations under Internal Revenue Code Section 83 Regarding Substantial Risk of Forfeiture Analysis

by Proskauer - Employee Benefits & Executive Compensation Blog
Contact

Companies that compensate their employees with annual or long-term awards of restricted property such as restricted stock grants should take note of the final regulations relating to property transferred in connection with the performance of services under Internal Revenue Code Section 83 issued by the Internal Revenue Service on February 25, 2014 (the “Final Regulations”). These rules impact the timing of taxation of restricted stock grants and other compensatory transfers of property.

The Final Regulations are substantially similar to the proposed regulations issued by the IRS in May 2012, which we discussed in our June 2012 Client Alert, “IRS Issues Proposed Regulations under Internal Revenue Code Section 83 Regarding Substantial Risk of Forfeiture Analysis,” available here, but further clarify the impact of insider trading restrictions under Section 16(b) of the Securities Exchange Act of 1934 and involuntary separations from service on the Section 83 “substantial risk of forfeiture” analysis.

*               *               *

Generally, Section 83 requires the inclusion in gross income of property transferred in connection with the performance of services when the property is no longer “subject to a substantial risk of forfeiture.” Section 83 regulations provide that whether a risk of forfeiture is “substantial” depends upon the particular facts and circumstances. Under these regulations, a substantial risk of forfeiture may exist where vesting of property is subject to (i) a service condition (e.g., employee must work for a specified period to become vested) or (ii) a condition related to the purpose of the transfer (e.g., a performance-based condition).

The Final Regulations make three important clarifications relevant to “substantial risk of forfeiture” analysis:

  • A substantial risk of forfeiture generally may only be established through a service condition or a condition related to the purpose of the transfer (except as otherwise specifically provided in the Section 83 regulations with regard to a sale or other transfer of securities that could subject the seller to a suit under Section 16(b) of the Securities Exchange Act of 1934).
  • In determining whether a substantial risk of forfeiture exists, both (1) the likelihood that a forfeiture condition will occur and (2) the likelihood that the forfeiture condition will be enforced must be taken into consideration.
  • Transfer restrictions on securities (such as lock-up provisions, buyback provisions, blackout periods and limited trading windows insider trading compliance programs) generally do not create a substantial risk of forfeiture; however, a substantial risk of forfeiture would exist for so long as the sale or other transfer of the property not exempt from Securities Exchange Act Section 16(b) could subject the seller to a suit under Section 16(b).

The Final Regulations make clear that, although Section 16(b) liability may constitute a substantial risk of forfeiture, the purchase of stock subject to Section 16(b) in an open market transaction separate from the exercise of an option cannot create a substantial risk of forfeiture as to the shares acquired upon the exercise of the option. Taxation of compensatory stock options ordinarily occurs upon the exercise of the option, but such taxation could be delayed for so long as the underlying shares remain subject to a substantial risk of forfeiture by virtue of potential Section 16(b) insider trading liability. 

While most companies make exempt stock option grants, if an option was not granted pursuant to an exemption, then the shares underlying the option generally would be subject to Section 16(b) restrictions for six months from the date of grant. This is because the “purchase” of the option shares (which, for Section 16(b) purposes, occurs on the date of grant of the option) could be matched for Section 16(b) purposes with any non-exempt sales occurring within six months of the option grant date. By adding a new example, the Final Regulations highlight than an option holder may not use a non-exempt open market purchase of stock after the date of a non-exempt option grant to defer taxation of option shares subsequently acquired upon the exercise of the option on the grounds that there is Section 16(b) risk from the “match” of the future sale of such option shares against the open market purchase. Instead for purposes of 83(b) and stock options, the relevant Section 16(b) six-month time frame commences on the date of grant of the non-exempt option, and the period during which option shares acquired upon exercise remain subject to a substantial risk of forfeiture by virtue of Section 16(b) risk is limited to this six-month period.

Finally, in response to comments received on the Proposed Rules, the preamble to the Final Regulations restates the principle that the right to receive property or cash in the future is not “property” for purposes of Section 83, and thus cannot be taxable unless and until the property is received. As a result, a right to receive property or cash in the future, such as upon an involuntary termination of employment without cause, does not give rise to a substantial risk of forfeiture under Section 83. The preamble acknowledges that this is the case under Section 83 notwithstanding the fact that a right to receive property in the future (such as a share-settled restricted stock unit) might otherwise be deemed to be subject to a substantial risk of forfeiture for purposes of Section 409A regarding nonqualified deferred compensation.

The Final Regulations do not change the principle that property that is conditioned upon refraining from service, such as a covenant not to compete, can constitute a service condition establishing a substantial risk of forfeiture under Section 83. Under the Section 83 regulations, whether a covenant not to complete constitutes a substantial risk of forfeiture depends upon such factors as the employee’s age, health and skill set, the availability of other obtainable employment opportunities and the likelihood that the restrictive covenant will be enforced.

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.

© Proskauer - Employee Benefits & Executive Compensation Blog | Attorney Advertising

Written by:

Proskauer - Employee Benefits & Executive Compensation Blog
Contact
more
less

Proskauer - Employee Benefits & Executive Compensation Blog on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.