The IRS recently proposed regulations (REG-141075-09) under Section 83 to clarify and make changes to the current regulations.

Section 83 provides rules regarding the recognition of income when property (e.g., stock) is transferred to a service provider in connection with the performance of services. In general, the service provider recognizes income in the first taxable year that the property has been transferred to the service provider, and the property is either transferrable or not subject to a substantial risk of forfeiture (i.e., the property is vested).

The current regulations provide 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 the condition is not satisfied. A condition related to a purpose of the transfer includes, for example, reaching certain revenue or net income targets. 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, two issues must be considered: the likelihood that the forfeiture event will occur and the likelihood that the forfeiture will be enforced.

In addition, the proposed regulations would provide that, in general, a transfer restriction (including a transfer restriction that 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. For example, an employer stipulates that an employee may not sell or transfer shares of stock granted to the employee even after the stock becomes nonforfeitable. This transfer restriction is not a substantial risk of forfeiture for purposes of Section 83. Section 83 and the current regulations, however, provide one exception to this general rule: Section 83(c)(3) provides that as long as the sale of property at a profit could subject a person to suit under section 16(b) of the Securities and Exchange Act of 1943 (the Exchange Act), the person's rights in the property are subject to a substantial risk of forfeiture and are not transferable. The proposed regulations provide a new example that clarifies that the exception under Section 83(c)(3) applies to only section 16(b) of the Exchange Act and not to other provisions of the Exchange Act that may restrict an employee's ability to sell or transfer shares of stock.

These regulations are proposed to apply as of Jan. 1, 2013, and will apply to property transfers on or after that date. Taxpayers may rely on these proposed regulations before they become final.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.