[Federal Register Volume 79, Number 38 (Wednesday, February 26, 2014)]
[Rules and Regulations]
[Pages 10663-10665]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-03988]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9659]
RIN 1545-BJ15


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

AGENCY: Internal Revenue Service, Department of the Treasury.

ACTION: Final regulations.

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

DATES: 
    Effective Date: These regulations are effective on February 26, 
2014.
    Applicability Date: For dates of applicability, see Sec.  1.83-
3(l).

FOR FURTHER INFORMATION CONTACT: Thomas Scholz or Michael Hughes at 
(202) 317-5600 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On May 30, 2012, the Department of Treasury (Treasury) and the 
Internal Revenue Service (IRS) published a notice of proposed 
rulemaking (REG-141075-09) in the Federal Register (77 FR 31783) under 
section 83 of the Code. Treasury and the IRS received two comments 
responding to the notice of proposed rulemaking. No public hearing was 
requested and no public hearing was held. After consideration of these 
comments, Treasury and the IRS adopt the proposed regulations as final 
regulations with the modifications described in this preamble.

Explanation of Provisions

    Section 83 of the Code addresses the tax consequences of the 
transfer of property in connection with the performance of services. 
These final regulations provide several clarifications regarding 
whether a substantial risk of forfeiture exists in connection with 
property subject to section 83. Specifically, the final regulations 
clarify that (1) except as specifically provided in section 83(c)(3) 
and Sec. Sec.  1.83-3(j) and (k), 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 
section 83(c)(3) and Sec. Sec.  1.83-3(j) and (k), transfer 
restrictions do not create a substantial risk of forfeiture, including 
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.

Summary of Comments

    Treasury and the IRS received two written comments on the notice of 
proposed rulemaking. The first comment was not responsive to the notice 
of proposed rulemaking. The second comment expressed concern that the 
proposed regulations result in a narrowing of the circumstances that 
would establish a substantial risk of forfeiture and requested 
clarification regarding whether an involuntary separation from service 
without cause could establish a substantial risk of forfeiture. The 
comment noted that, for purposes of section 409A, an amount that is 
payable only upon a service provider's involuntary separation from 
service without cause is subject to a substantial risk of forfeiture if 
the possibility of forfeiture is substantial, and it suggested that 
these regulations specifically state that an involuntary separation 
without cause may qualify as a substantial risk of forfeiture under 
section 83 in appropriate circumstances.
    These regulations are intended to clarify the definition of a 
substantial risk of forfeiture and are consistent with the 
interpretation that the IRS historically has applied, and therefore 
from the perspective of Treasury and the IRS they do not constitute a 
narrowing of the requirements to establish a substantial risk of 
forfeiture. See Robinson v. Commissioner, 805 F.2d 38 (1st Cir. 1986). 
Further, Treasury and the IRS believe that these regulations should not 
be modified to state that an involuntary separation from service 
without cause may qualify as a substantial risk of forfeiture under 
section 83. While a service provider's right to receive property (or an 
amount in cash) in the future upon the service provider's involuntary 
separation from service without cause may be subject to a substantial 
risk of forfeiture for purposes of section 409A if the possibility of 
forfeiture is substantial, a substantial risk of forfeiture under 
section 83 can exist only when property is actually transferred in 
connection with the performance of services. A right to receive 
property in the future is generally not property for purposes of 
section 83. See Sec.  1.83-3(e). Accordingly, an involuntary separation 
from service without cause cannot qualify as a substantial risk of 
forfeiture under section 83 if property is not transferred until after 
the separation from service occurs.
    When a transfer of property does occur, a substantial risk of 
forfeiture may be established through a substantial services condition 
or a condition related to the purpose of the transfer if the 
possibility of forfeiture is substantial. The acceleration of vesting 
upon an involuntary separation from service without cause (or 
separation from service as a result of death or disability) will not 
cause a requirement of substantial services that otherwise would be 
treated as a substantial risk of forfeiture to fail to qualify as a 
substantial risk of forfeiture, provided that facts and circumstances 
do not demonstrate that the occurrence of an involuntary separation 
from service without cause is likely to occur during the agreed upon 
service period.
    Certain practitioners informally requested clarification regarding 
the application of section 83(c)(3) to a variation of the facts set 
forth in Example 4 of proposed regulation Sec.  1.83-3(j)(2). 
Specifically, practitioners asked whether the purchase of shares in a 
transaction not exempt from section 16(b) of the Securities Exchange 
Act of 1934 prior to the exercise of a stock option that would not 
otherwise give rise to section 16(b) liability would defer taxation of 
the stock option exercise. Treasury and the IRS do not

[[Page 10664]]

believe that such a non-exempt purchase of shares would defer taxation 
of the subsequent stock option exercise. This result is consistent with 
Example 3 of Sec.  1.83-3(j)(2). In response to these requests for 
clarification, Treasury and the IRS have revised Example 4 of proposed 
regulation Sec.  1.83-3(j)(2) to address the situation raised.

Applicability Date

    These regulations apply to property transferred on or after January 
1, 2013.

Effect on Other Documents

    Rev. Rul. 2005-48 (2005-2 CB 259) is obsolete as of February 26, 
2014.

Special Analyses

    It has been determined that this final regulation is not a 
significant regulatory action as defined in Executive Order 12866, as 
supplemented by Executive Order 13653. 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, the notice of proposed rule making 
preceding these final regulations was submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on their 
impact on small business.

Drafting Information

    The principal authors of these final regulations are Thomas Scholz 
and Michael Hughes, Office of the Division Counsel/Associate Chief 
Counsel (Tax Exempt and Government Entities). Other personnel from 
Treasury and the IRS also participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR Part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for Part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 1.83-3 is amended by:
0
1. Revising paragraph (c)(1).
0
2. Adding Example 6 and Example 7 to paragraph (c)(4).
0
3. Adding Example 4 to paragraph (j)(2).
0
4. Removing paragraph (j)(3).
0
5. Removing paragraph (k).
0
6. Redesignating paragraph (k)(1) as paragraph (k).
0
7. Adding paragraph (l).
    The revisions and additions 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 these regulations, whether a risk of forfeiture is 
substantial or not depends upon the facts and circumstances. Except as 
set forth in paragraphs (j) and (k) of this section, a substantial risk 
of forfeiture exists only if 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 if at the 
time of transfer the facts and circumstances demonstrate that the 
forfeiture condition is unlikely to be enforced. Further, 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. A restriction on the transfer of 
property, whether contractual or by operation of applicable law, will 
result in a substantial risk of forfeiture only if and to the extent 
that the restriction is described in paragraph (j) or (k) of this 
section. 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 April 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 August 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 August 1 through February 1 of 2014 (``the lock-up 
period''). Q exercises the option and Y shares are transferred to Q 
on November 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 
precludes 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 
August 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 during a limited number of days following each quarterly 
earnings release (``a trading window''). Under the program, if Q 
trades Y shares outside a trading window without Y's permission, Y 
has the right to terminate Q's employment. However, the exercise of 
the nonstatutory options outside a trading window for Y shares is 
not prohibited under the insider trading compliance program. Q fully 
exercises the option, and Y shares are transferred to Q, on November 
15, 2013. The exercise of the option occurs outside a trading 
window, and, on the date of exercise, Q is in possession of material 
nonpublic information concerning Y that would subject him to 
liability under Rule 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 windows 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. (i) On June 3, 2013, Y corporation grants to Q, an 
officer of Y, a nonstatutory option to purchase Y common

[[Page 10665]]

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 one that 
satisfies the requirements for a transaction that is exempt from 
section 16(b) of the Securities Exchange Act of 1934. On December 
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 June 3, 2013 grant of the 
option, the section 16(b) liability period expires on December 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 December 15, 2013 exercise 
of the option are transferred to Q.
    (ii) Assume the same facts as in paragraph (i) of this Example 4 
except that Q exercises the nonstatutory option on October 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 December 1, 
2013.
    (iii) Assume the same facts as in paragraph (i) of this Example 
4 except that on November 5, 2013, Q also purchases 100 shares of Y 
common stock on the public market. The purchase of the shares is not 
a transaction exempt from section 16(b) of the Securities Exchange 
Act of 1934. Because no exemption from section 16(b) was available 
for the November 5, 2013 purchase of shares, the section 16(b) 
liability period with respect to such shares will last for a period 
of six months after the November 5, 2013 purchase of shares. 
Notwithstanding the non-exempt purchase of Y common stock on 
November 5, 2013, the shares acquired by Q pursuant to the December 
15, 2013 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 December 
15, 2013 exercise of the option are transferred to Q.
* * * * *
    (l) Effective/applicability date. This section applies to property 
transferred on or after January 1, 2013. For rules relating to property 
transferred before that date, see Sec.  1.83-3 as contained in 26 CFR 
part 1 (as of April 1, 2012).

John Dalrymple,
 Deputy Commissioner for Services and Enforcement.
    Approved: January 31, 2014.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2014-03988 Filed 2-25-14; 8:45 am]
BILLING CODE 4830-01-P