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IRS Proposed Regulations Address Substantial Risk of Forfeiture Under IRC Section 83

The Internal Revenue Code (IRC) Section 83 governs property transferred to an employee in connection with the performance of services. Currently, the section states that such transfers of property (typically restricted stock or stock options) are subject to federal income tax when the property is no longer subject to a substantial risk of forfeiture; however, new regulations will go into effect on January 1, 2013.

By Alice Cheng

On May 29, 2012, the Internal Revenue Service (IRS) issued proposed regulations (REG-141075-09) under Section 83 to refine and narrow the concept of the substantial risk of forfeiture. Whether a substantial risk of forfeiture exists is based on the facts and conditions of a property transfer arrangement. The proposed regulations will address the confusion over the appropriate elements of what constitutes a substantial risk of forfeiture.

The Internal Revenue Code (IRC) Section 83 governs property transferred to an employee in connection with the performance of services. Currently, the section states that such transfers of property (typically restricted stock or stock options) are subject to federal income tax when the property is no longer subject to a substantial risk of forfeiture.

The proposed regulations will make clarifications in the following three areas:

  1. Under current regulations, a substantial risk of forfeiture exists subject to the performance (or non-performance) of substantial services of the employee, or to the occurrence of a condition related to the purpose of the transfer. The proposed regulation clarifies that a substantial risk of forfeiture arises only through a future service condition or a condition relating to the purpose of the transfer.
  2. Two issues will be considered to determine whether a substantial risk of forfeiture exists—the likelihood that the forfeiture event will occur, and the likelihood that the forfeiture will be enforced.
  3. A transfer restriction (such as lock-up provisions, buyback provisions, and blackout periods) generally does not create a substantial risk of forfeiture for the purposes of the Section. However, there is an exception if the sale of property at profit could subject a person to suit under Section 16(b) of the Securities and Exchange Act of 1943.

The proposed regulations are to go into effect on January 1, 2013, and will apply to property transfers on or after that date.