The NASPP Blog

Last week, the IRS issued the final version of the new Section 1.83-3 regs that were proposed back in 2012.

Background: The Proposed Regs

Section 83 provides that property transferred in exchange for services is taxable when it is transferable or no longer subject to a substantial risk of forfeiture (whichever occurs first). As explained in the preamble to the proposed regs, the purpose of this revision was to clarify that, for a substantial risk of forfeiture to exist, there has to be 1) some reasonable possibility of forfeiture (e.g., a performance goal which is certain to be met would not give rise to a substantial risk of forfeiture) and 2) there has to be some likelihood that the forfeiture provision would be enforced.

Most of us always thought this was the case, so we were surprised to see the proposed regs. Some speculated that companies would now have to estimate the likelihood of forfeiture due to failure to meet the vesting requirements to determine if taxation is delayed under Section 83. During his session at the 2012 NASPP Conference, Stephen Tackney, of the Office of Chief Counsel, at the IRS explained that this wasn’t the IRS’s intention and that they were really only concerned about situations where the likelihood of forfeiture was so infinitesimally small as to be almost nonexistent. Apparently the IRS lost a couple of enforcement actions in court due to a misunderstanding about this concept, so they decided to make the rules a little clearer.

The proposed regs also clarified that lock-up restrictions and trading black-out periods don’t delay taxation under Section 83 and codified a prior Rev. Rul. clarifying when taxation is deferred as a result of the operation of Section 16(b) (for practical purposes, virtually never).

What’s New in the Final Regs

Well, not much, really. In response to the concerns that the regulations were perhaps raising the threshold for a substantial risk of forfeiture, the IRS explains in the preamble that the new regulations are not intended to depart from the historic position that the IRS has taken with respect to Section 83. The IRS also edited the language of the regs, I think with the intention of making this clearer.

The IRS added a sentence to the regs to further clarify that it must be likely that the forfeiture restrictions would be enforced for there to be a substantial risk of forfeiture. Here again, I don’t think this represents a change in position for the IRS.

Finally, the IRS added an example to clarify that, where a Section 16 insider engages in a non-exempt purchase in the six months before an otherwise taxable acquisition under a stock option or award, the non-exempt purchase doesn’t delay taxation of the option or award (even though it does delay when the insider can sell the shares acquired under the option/award).  We had noticed there were some differences in opinion among practitioners as to whether this was the case and had asked for clarification.  Although the situation probably doesn’t come up that often, when it does come up, we thought it important to know what the correct tax treatment is. And now we know (and I think it’s the answer most of us had been assuming all along).

Read more about the final regs, including our redline comparing the proposed and final regs, in the NASPP Alert “IRS Issues Final Regs Under Section 83.”

– Barbara