[Federal Register Volume 77, Number 104 (Wednesday, May 30, 2012)]
[Proposed Rules]
[Pages 31783-31786]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-12855]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-141075-09]
RIN 1545-BJ15


Property Transferred in Connection With the Performance of 
Services Under Section 83

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to 
property transferred in connection with the performance of services 
under section 83 of the Internal Revenue Code (Code). These proposed 
regulations affect certain taxpayers who received property transferred 
in connection with the performance of services.

DATES: Written or electronic comments must be received by August 28, 
2012.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-141075-09), room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
141075-09), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov/ (IRS REG-141075-09).

FOR FURTHER INFORMATION CONTACT: Concerning these proposed regulations, 
Thomas Scholz or Dara Alderman at (202) 622-6030 (not a toll-free 
number); concerning submissions of comments, and/or to request a 
hearing, Oluwafunmilayo (Fumni) Taylor, at (202) 622-7180 (not toll-
free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 83(a) of the Internal Revenue Code (Code) provides that if, 
in connection with the performance of services, property is transferred 
to any person other than the person for whom such services are 
performed, the excess of (1) the fair market value of the property 
(determined without regard to lapse restrictions) at the first time the 
rights of the person having the beneficial interest in such property 
are transferable or are not subject to a substantial risk of 
forfeiture, whichever occurs earlier, over (2) the amount (if any) paid 
for such property, is included in the gross income of the service 
provider in the first taxable year in which the rights of the person 
having the beneficial interest in such property are transferable or are 
not subject to a substantial risk of forfeiture. Section 83(c)(1) 
provides that the rights of a person in property are subject to a 
substantial risk of forfeiture if such person's rights to full 
enjoyment of such property are conditioned upon the future performance 
of substantial services by any individual.
    Section 1.83-3(c)(1) provides that, for purposes of section 83 and 
the regulations, whether a risk of forfeiture is substantial or not 
depends upon the facts and circumstances. Section 1.83-3(c)(1) further 
provides that 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. Illustrations 
provided in Sec.  1.83-3(c)(2) of the regulations demonstrate when a 
substantial risk of forfeiture will be considered to exist.
    In addition to providing that a person's rights in property are 
subject to a substantial risk of forfeiture if conditioned upon the 
future

[[Page 31784]]

performance of substantial services by any individual, the legislative 
history indicates that the drafters intended that ``in other cases the 
question of whether there is a substantial risk of forfeiture depends 
upon the facts and circumstances.'' H.R. Rep. No. 91-413 (Pt. 1), 91st 
Cong., 1st Sess. 62, 88 (1969-3 Cum. Bull. 200, 255); S. Rep. No. 91-
552, 91st Cong., 1st Sess. 119, 121 (1969-3 Cum. Bull. 423, 501). The 
current regulations adopt this approach by finding that a substantial 
risk of forfeiture may also arise if the rights to the property are 
subject to a condition related to the purpose of the transfer. Some 
confusion has arisen as to whether other conditions may also give rise 
to a substantial risk of forfeiture. See Robinson v. Commissioner, 805 
F.2d 38 (1st Cir. 1986). The proposed regulations clarify that a 
substantial risk of forfeiture may be established only through a 
service condition or a condition related to the purpose of the 
transfer.
    Similarly, confusion has arisen as to whether, in determining 
whether a substantial risk of forfeiture exists, the likelihood that a 
condition related to the purpose of the transfer will occur must be 
considered. Id. A conclusion that such likelihood need not be 
considered would lead to anomalies not intended by the statute. For 
example, assume that stock transferred by an employer to an employee 
was made nontransferable and also subject to a condition that the stock 
be forfeited if the gross receipts of the employer fell by 90% over the 
next three years. Assume further that the employer is a longstanding 
seller of a product and that there is no indication that either there 
will be a fall in demand for the product or an inability of the 
employer to sell the product, so that it is extremely unlikely that the 
forfeiture condition will occur. Although, arguably, the condition is a 
condition related to the purpose of the transfer because it would, to 
some degree, incentivize the employee to prevent such a fall in gross 
receipts, the Treasury Department and the IRS do not believe that such 
a condition was intended to defer the taxation of the stock transfer. 
Accordingly, the proposed regulations would 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 event will occur and the likelihood that the 
forfeiture will be enforced must be considered.
    Finally, the proposed regulations would clarify that, except as 
specifically provided in section 83(c)(3) and Sec.  1.83-3(j) and (k), 
transfer restrictions do not create a substantial risk of forfeiture, 
including transfer restrictions which carry the potential for 
forfeiture or disgorgement of some or all of the property, or other 
penalties, if the restriction is violated. This position is supported 
by the legislative history of section 83. The Senate Report, under the 
heading ``General reasons for change,'' provides as follows:

    The present tax treatment of restricted stock plans is 
significantly more generous than the treatment specifically provided 
in the law for other types of similarly funded deferred compensation 
arrangements. An example of this disparity can be seen by comparing 
the situation where stock is placed in a nonexempt employees' trust 
rather than given directly to the employee subject to restrictions. 
If an employer transfers stock to a trust for an employee and the 
trust provides that the employee will receive the stock at the end 
of 5 years if he is alive at that time, the employee is treated as 
receiving and is taxed on the value of the stock at the time of the 
transfer. However, if the employer, instead of contributing the 
stock to the trust, gives the stock directly to the employee subject 
to the restriction that it cannot be sold for 5 years, then the 
employee's tax is deferred until the end of the 5-year period. In 
the latter situation, the employee actually possesses the stock, can 
vote it, and receives the dividends, yet his tax is deferred. In the 
case of the trust, he may have none of these benefits, yet he is 
taxed at the time the stock is transferred to the trust.

    S. Rep. No. 91-552, 1969-3 CB 423, 500. See also H. Rep. No. 91-
413, 1969-3 CB 200, 254.
    The legislative history shows that Congress intended for section 83 
to be interpreted in such a way that precluded the use of transfer 
restrictions as a means of deferring the taxable event. If interpreted 
otherwise, section 83 would not alter the tax treatment of the 
particular transaction that Congress described as the reason for the 
statutory change.
    Moreover, Congress later added section 83(c)(3) concerning sales 
that may give rise to suit under section 16(b) of the Securities 
Exchange Act of 1934 (the ``Exchange Act''). See Public Law 97-34, sec. 
252, 1981-2 CB 256, 303. Section 83(c)(3) provides that so long as the 
sale of property at a profit could subject a person to suit under 
section 16(b) of the Exchange Act, such person's rights in such 
property are (A) subject to a substantial risk of forfeiture, and (B) 
not transferable. Section 1.83-3(j) of the regulations further provides 
that, for purposes of section 83 and the regulations, if the sale of 
property at a profit within six months after the purchase of the 
property could subject a person to suit under section 16(b) of the 
Exchange Act, the person's rights in the property are treated as 
subject to a substantial risk of forfeiture and as not transferable 
until the earlier of (i) the expiration of such six-month period, or 
(ii) the first day on which the sale of such property at a profit will 
not subject the person to suit under section 16(b) of the Exchange Act.
    Consistent with section 83(c)(3) and Sec.  1.83-3(j), Revenue 
Ruling 2005-48 (2005-2 CB 259) provides that the only provision of the 
securities law that would delay taxation under section 83 is section 
16(b) of the Exchange Act. The ruling further provides that other 
transfer restrictions (such as restrictions imposed by lock-up 
agreements or restrictions relating to insider trading under Rule 10b-5 
of the Exchange Act) do not cause rights in property taxable under 
section 83 to be substantially nonvested. Revenue Ruling 2005-48 notes 
that the Treasury Department and the IRS intend to amend the section 83 
regulations to explicitly set forth the holdings in the ruling.

Explanation of Provisions

    The proposed regulations would amend the second sentence of Sec.  
1.83-3(c)(1) of the existing regulations to add the word ``only'' to 
the phrase ``[a] substantial risk of forfeiture exists [only] where * * 
*'' The purpose of this addition is to clarify that a substantial risk 
of forfeiture may be established only through a service condition or a 
condition related to the purpose of the transfer.
    The proposed regulations would amend the second sentence of Sec.  
1.83-3(c)(1) of the existing regulations to delete the clause ``if such 
condition is not satisfied.'' The purpose of the deletion is to 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 event will occur and the likelihood that 
the forfeiture will be enforced must be considered.
    The proposed regulations would amend Sec.  1.83-3(c)(1) of the 
existing regulations to add a sentence stating that a transfer 
restriction, including a transfer restriction which carries the 
potential for forfeiture or disgorgement of some or all of the property 
or other penalties if the restriction is violated, does not create a 
substantial risk of forfeiture. The purpose of this addition is to 
incorporate the holding in Rev. Rul. 2005-48.
    Furthermore, consistent with Rev. Rul. 2005-48, the proposed 
regulations would amend Sec.  1.83-3(j)(2) to include an example 
illustrating the application of section 16(b) of the Exchange Act to

[[Page 31785]]

an option. The regulations are not intended to provide guidance on the 
application of section 16(b) of the Exchange Act. Rather, for purposes 
of the examples it is assumed that the period of liability is 
determined in accordance with the applicable law, including any 
applicable court decisions. See, for example, Stella v. Graham-Paige 
Motors, 132 Fed. Supp. 100, 103 (S.D.N.Y. 1955), rev'd other grounds, 
232 F.2d 299 (2d Cir.), cert. denied, 352 U.S. 831 (1956). The proposed 
regulations also would add two additional examples to Sec.  1.83-
3(c)(4) illustrating that a substantial risk of forfeiture is not 
created solely as a result of potential liability under Rule 10b-5 of 
the Exchange Act or a lock-up agreement. Rev. Rul. 2005-48 will be 
obsoleted when the proposed regulations are published as final 
regulations. See Sec.  601.601(d)(2).

Proposed Effective Date

    These regulations under section 83 are proposed to apply as of 
January 1, 2013, and will apply to property transferred on or after 
that date. Taxpayers may rely on the proposed regulations for property 
transferred after publication of these proposed regulations in the 
Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
the regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, these regulations have 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are timely submitted to the 
IRS. The IRS and the Treasury Department request comments on the 
clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying. A public hearing will be scheduled if requested in writing by 
any person that timely submits written or electronic comments. If a 
public hearing is scheduled, notice of the date, time, and place for 
the hearing will be published in the Federal Register.

Drafting Information

    The principal authors of these proposed regulations are Thomas 
Scholz and Dara Alderman, Office of the Division Counsel/Associate 
Chief Counsel (Tax Exempt and Government Entities). However, other 
personnel from the IRS and the Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for Part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805.

    Par. 2. Section 1.83-3 is amended by:
    1. Revising paragraph (c)(1).
    2. Adding Example 6 and Example 7 to paragraph (c)(4).
    3. Adding Example 4 to paragraph (j)(2).
    4. Removing paragraph (j)(3).
    5. Redesignating paragraph (k)(1) as paragraph (k).
    6. Removing paragraph (k)(2).
    7. Adding paragraph (l).
    The additions and revisions read as follows:


Sec.  1.83-3  Meaning and use of certain terms.

* * * * *
    (c) Substantial risk of forfeiture--(1) In general. For purposes of 
section 83 and the regulations, whether a risk of forfeiture is 
substantial or not depends upon the facts and circumstances. A 
substantial risk of forfeiture exists only 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 upon the occurrence of a condition related 
to a purpose of the transfer if the possibility of forfeiture is 
substantial. Property is not transferred subject to a substantial risk 
of forfeiture to the extent that the employer is required to pay the 
fair market value of a portion of such property to the employee upon 
the return of such property. The risk that the value of property will 
decline during a certain period of time does not constitute a 
substantial risk of forfeiture. A nonlapse restriction, standing by 
itself, will not result in a substantial risk of forfeiture. Except as 
set forth in paragraphs (j) and (k) of this section, restrictions on 
the transfer of property, whether contractual or by operation of 
applicable law, will not result in a substantial risk of forfeiture. 
For this purpose, transfer restrictions that will not result in a 
substantial risk of forfeiture include, but are not limited to, 
restrictions that if violated, whether by transfer or attempted 
transfer of the property, would result in the forfeiture of some or all 
of the property, or liability by the employee for any damages, 
penalties, fees or other amount.
* * * * *
    (4) * * *
    Example 6. On January 3, 2013, Y corporation grants to Q, an 
officer of Y, a nonstatutory option to purchase Y common stock. 
Although the option is immediately exercisable, it has no readily 
ascertainable fair market value when it is granted. Under the 
option, Q has the right to purchase 100 shares of Y common stock for 
$10 per share, which is the fair market value of a Y share on the 
date of grant of the option. On May 1, 2013, Y sells its common 
stock in an initial public offering. Pursuant to an underwriting 
agreement entered into in connection with the initial public 
offering, Q agrees not to sell, otherwise dispose of, or hedge any Y 
common stock from May 1 through November 1 of 2013 (``the lock-up 
period''). Q exercises the option and Y shares are transferred to Q 
on August 15, 2013, during the lock-up period. The underwriting 
agreement does not impose a substantial risk of forfeiture on the Y 
shares acquired by Q because the provisions of the agreement do not 
condition Q's rights in the shares upon anyone's future performance 
(or refraining from performance) of substantial services or on the 
occurrence of a condition related to the purpose of the transfer of 
shares to Q. Accordingly, neither section 83(c)(3) nor the 
imposition of the lock-up period by the underwriting agreement 
preclude taxation under section 83 when the shares resulting from 
exercise of the option are transferred to Q.
    Example 7. Assume the same facts as in Example 6, except that on 
May 1, 2013, Y also adopts an insider trading compliance program, 
under which, as applied to 2013, insiders (such as Q) may trade Y 
shares only between November 5 and November 30 of that year (``the 
trading window''). Under the program, if Q trades Y shares outside 
the trading window without Y's permission, Y has the right to 
terminate Q's employment. However, the exercise of the nonstatutory 
options outside the trading window for the Y shares is not 
prohibited under the insider trading compliance program. As of 
August 15, 2013 (the date Q fully exercises the option), Q is in 
possession of material nonpublic information concerning Y that would 
subject him to liability under Rule

[[Page 31786]]

10b-5 under the Securities Exchange Act of 1934 if Q sold the Y 
shares while in possession of such information. Neither the insider 
trading compliance program nor the potential liability under Rule 
10b-5 impose a substantial risk of forfeiture on the Y shares 
acquired by Q, because the provisions of the program and Rule 10b-5 
do not condition Q's rights in the shares upon anyone's future 
performance (or refraining from performance) of substantial services 
or on the occurrence of a condition related to the purpose of the 
transfer of shares to Q. Accordingly, none of section 83(c)(3), the 
imposition of the trading window by the insider trading compliance 
program and the potential liability under Rule 10b-5 preclude 
taxation under section 83 when the shares resulting from exercise of 
the option are transferred to Q.
* * * * *
    (j) * * *
    (2) * * *
    Example 4. On January 3, 2013, Y corporation grants to Q, an 
officer of Y, a nonstatutory option to purchase Y common stock. Y 
stock is traded on an established securities market. Although the 
option is immediately exercisable, it has no readily ascertainable 
fair market value when it is granted. Under the option, Q has the 
right to purchase 100 shares of Y common stock for $10 per share, 
which is the fair market value of a Y share on the date of grant of 
the option. The grant of the option is not a transaction exempt from 
section 16(b) of the Securities Exchange Act of 1934. On August 15, 
2013, Y stock is trading at more than $10 per share. On that date, Q 
fully exercises the option, paying the exercise price in cash, and 
receives 100 Y shares. Q's rights in the shares received as a result 
of the exercise are not conditioned upon the future performance of 
substantial services. Because no exemption from section 16(b) was 
available for the January 3, 2013 grant of the option, the section 
16(b) liability period expires on July 1, 2013. Accordingly, the 
section 16(b) liability period expires before the date that Q 
exercises the option and the Y common stock is transferred to Q. 
Thus, the shares acquired by Q pursuant to the exercise of the 
option are not subject to a substantial risk of forfeiture under 
section 83(c)(3) as a result of section 16(b). As a result, section 
83(c)(3) does not preclude taxation under section 83 when the shares 
acquired pursuant to the August 15, 2013 exercise of the option are 
transferred to Q. If, instead, Q exercises the nonstatutory option 
on May 30, 2013 when Y stock is trading at more than $10 per share, 
the shares acquired are subject to a substantial risk of forfeiture 
under section 83(c)(3) as a result of section 16(b) through July 1, 
2013.
* * * * *
    (l) Effective/applicability date. Paragraphs (j) and (k) of this 
section apply to property transferred after December 31, 1981. 
Paragraph (c)(1), Example 6 and 7 of paragraph (c)(4), and Example 4 of 
paragraph (j)(2) of this section apply to property transferred on or 
after January 1, 2013.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2012-12855 Filed 5-29-12; 8:45 am]
BILLING CODE 4830-01-P