Final rules on substantial risk of forfeiture are released


The IRS finalized regulations that clarify when a substantial risk of forfeiture exists on the transfer of stock to an employee that is treated as compensation under Sec. 83. If a substantial risk of forfeiture exists, the employee does not have to recognize the income at the time of the transfer.

The regulations adopt proposed rules issued in May 2012, with a few clarifications (REG-141075-09).

Under prior Regs. Sec. 1.83-3(c)(1), “a substantial risk of forfeiture exists where rights in property that are transferred are conditioned, directly or indirectly, upon the future performance (or refraining from performance) of substantial services by any person, or the occurrence of a condition related to a purpose of the transfer, and the possibility of forfeiture is substantial if such condition is not satisfied.”

The new regulations clarify that (1) except as specifically provided in Sec. 83(c)(3) and Regs. Secs. 1.83-3(j) (sales that may give rise to suits under Section 16(b) of the Securities Exchange Act of 1934) and 1.83-3(k) (transfer restrictions under the pooling-of-interests accounting rule), a substantial risk of forfeiture may be established only through a service condition or a condition related to the purpose of the transfer; (2) 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 event will occur and the likelihood that the forfeiture will be enforced must be considered; and (3) except as specifically provided in Sec. 83(c)(3) and Regs. Secs. 1.83-3(j) and 1.83-3(k), transfer restrictions do not create a substantial risk of forfeiture. This includes transfer restrictions that carry the potential for forfeiture or disgorgement of some or all of the property, or other penalties, if the restriction is violated (Regs. Sec. 1.83-3(c)(1)).

Another change from the proposed rules is in the last example in the regulations in response to practitioners who asked whether the purchase of shares in a transaction that was 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 stock option’s exercise. The IRS amended the example to clarify its position that a nonexempt purchase of shares would not defer taxation of the subsequent stock option exercise (Regs. Sec. 1.83-3(j)(2), Example (4)).

The regulations apply to property transferred on or after Jan. 1, 2013.

 T.D. 9659

By Sally P. Schreiber, J.D., a JofA senior editor.


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