IRS Issues Final Regulations under Internal Revenue Code Section 83 | Practical Law

IRS Issues Final Regulations under Internal Revenue Code Section 83 | Practical Law

On February 25, 2014, the Internal Revenue Service (IRS) issued final regulations clarifying the meaning of substantial risk of forfeiture under Section 83 of the Internal Revenue Code.

IRS Issues Final Regulations under Internal Revenue Code Section 83

Practical Law Legal Update 5-558-8865 (Approx. 4 pages)

IRS Issues Final Regulations under Internal Revenue Code Section 83

by Practical Law Employee Benefits & Executive Compensation
Published on 25 Feb 2014USA (National/Federal)
On February 25, 2014, the Internal Revenue Service (IRS) issued final regulations clarifying the meaning of substantial risk of forfeiture under Section 83 of the Internal Revenue Code.
On February 25, 2014, the IRS issued final regulations clarifying the meaning of substantial risk of forfeiture under Section 83 of the Internal Revenue Code (IRC). The regulations finalize proposed regulations that were issued in May 2012 on this topic (see Legal Update, IRS Issues Proposed Regulations under Internal Revenue Code Section 83). The final regulations are effective on February 26, 2014.
Despite one commenter's concern that the regulations narrow the circumstances that would establish a substantial risk of forfeiture under IRC Section 83, according to the Treasury and the IRS, the clarifications set out in the regulations are consistent with the IRS's historical interpretations and therefore do not represent a change.
Like the proposed regulations, the final regulations clarify that for purposes of IRC Section 83:
  • A substantial risk of forfeiture may be established only through a service condition or a condition related to the purpose of the transfer (such as a performance condition). Other conditions cannot give rise to a substantial risk of forfeiture.
  • When determining whether a substantial risk of forfeiture exists based on a condition related to the purpose of the transfer, both the likelihood that the forfeiture event will occur and the likelihood that the forfeiture will be enforced are relevant.
The proposed and final regulations also clarify that except as specifically provided in Treasury Regulation Sections 1.83-3(j) and (k), transfer restrictions (such as restrictions imposed by lock-up agreements or restrictions related to insider trading under Rule 10b-5 of the Exchange Act) do not create a substantial risk of forfeiture, even if violation of the transfer restrictions could result in the forfeiture of some or all of the property or the employee's liability for damages, penalties or fees.
Consistent with Revenue Ruling 2005-48, the proposed regulations emphasize that Section 16(b) of the Exchange Act is the only securities law provision that will delay taxation under IRC Section 83. An example in the proposed regulations illustrating the application of Section 16(b) to a stock option led certain practitioners to request clarification on whether the purchase of shares in a transaction not exempt from Section 16(b) before the exercise of a stock option that would not otherwise give rise to Section 16(b) liability would defer taxation of the option exercise. The final regulations clarify that such a non-exempt purchase of shares would not result in the deferral of taxation of the subsequent option exercise. The final regulations contain a revised example to address this situation.
The final regulations apply to property transferred on or after January 1, 2013.