Press Room: Tax Release

July 11, 2012

Clarification of “Substantial Risk of Forfeiture” May Make Tax Deferral for Certain Compensation More Difficult

Recently, the Treasury Department issued new proposed regulations clarifying the meaning of substantial risk of forfeiture under Sec. 83 of the Internal Revenue Code of 1986, as amended. This may affect companies that grant equity interests to employees and other service providers. While the proposed regulations apply to property transferred after December 31, 2012, they can be relied on for property transferred after May 30, 2012.

Sec. 83 governs the taxation of property transferred to a service provider in connection with the performance of services and applies most often to the transfer of restricted company stock to a service provider. The relevant provisions in Sec. 83 apply specifically when “in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed.” When such a transaction has occurred, the service provider is required to include in gross income the excess of the fair market value of the property, at the time it becomes transferable or no longer subject to a substantial risk of forfeiture, less the amount paid for the property. The proposed regulations have the effect of narrowing the definition of a substantial risk of forfeiture and thereby triggering earlier recognition of taxable income when property is transferred to service providers.

The proposed regulations clarify that for purposes of Sec. 83:

  • A substantial risk of forfeiture may be established only through a service condition or a condition related to the purpose of the transfer.
  • Whether a substantial risk of forfeiture exists depends on the likelihood the forfeiture event will occur and the forfeiture will be enforced.
  • Transfer restrictions, such as lock-up agreements, and insider trading under Rule 10b-5 of the Securities Exchange Act of 1934 (Exchange Act), do not create a substantial risk of forfeiture even if there is a potential for forfeiture or disgorgement of some or all of the property, or other penalties, if the restriction is violated. The only exception is the sale of property at a profit that could subject the service provider to suit under Section 16(b) of the Exchange Act.

The proposed regulations include three new examples illustrating when transfer restrictions will and will not constitute a substantial risk of forfeiture. 

For further information, please contact your WTAS advisor or Dennis Minich at 312.357.3940 or at