Under tax code Section 83, you don’t tax employees who receive company stock, stock options or other property that is subject to a substantial risk of forfeiture until the risk lapses and the property vests. Final regulations issued in February, which closely follow proposed regs, clarify what counts as a substantial risk of forfeiture.
The regs also incorporate a 2005 revenue ruling in which the IRS concluded that the only provision of the securities law that qualifies as a substantial risk of forfeiture is Section 16(b) of the Exchange Act. These final regs apply to property transferred to employees beginning Jan. 1, 2013. (79 F.R. 10663, 2-26-14)
No risk, no reward. Under the regs, a substantial risk of forfeiture may be established only through a service condition (e.g., an employee must work for five years before the stock vests) or through a condition related to the purpose of the transfer (e.g., the employee must return the stock if it drops in value over a set time period). The regs further clarify that, in 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 will occur and the likelihood that the forfeiture will be enforced must be considered.
RISKY BUSINESS: Employees’ rights to receive property in the future based upon their involuntary termination without cause may be subject to a substantial risk of forfeiture under the rules that apply to nonqualified deferred compensation (NQDC). But these final regs specify that a substantial risk of forfeiture for NQDC purposes doesn’t qualify as a risk under Section 83. According to the regs, a substantial risk of forfeiture under Section 83 exists only when the property is actually transferred in connection with the current performance of services.
Killer (b). Finally, the regs confirm Rev. Rul. 2005-48, in which the IRS concluded that trading restrictions imposed by the securities laws, which prevented employees from trading company stock during lock-up periods or restricted trading to specific trading windows, don’t qualify as a substantial risk of forfeiture. Under the regs, the only trading restriction that qualifies as a substantial risk of forfeiture is Section 16(b) of the Securities Exchange Act of 1934.