On February 25, 2014,the Internal Revenue Service (“IRS”) issued final regulations regarding property transferred in connection with the performance of services under Internal Revenue Code Section 83 (“Section 83”).  As a reminder, Section 83 controls the timing and amount of income that must be included with respect to property transferred to an employee or other service provider subject to restrictions and forfeiture provisions, such as restricted stock. The final regulations confirm previous IRS guidance regarding what constitutes a “substantial risk of forfeiture” under Section 83, as discussed in our previous client alert

Under Section 83, when property is transferred in connection with the performance of services, the service provider must include, in gross income, (i) the fair market value of the property as of the first time the property is transferable or no longer "subject to a substantial risk of forfeiture," over (ii) the amount (if any) paid for the property.  This amount must be included in gross income in the first year that the property is transferable or is no longer subject to a substantial risk of forfeiture (unless an election is made under Section 83(b) to include the fair market value of the property in gross income at the time of transfer). Whether or not a substantial risk of forfeiture exists depends on the facts and circumstances.

Consistent with the proposed regulations, the final regulations confirm that, except as otherwise provided in certain very limited exceptions under Section 83, a “substantial risk of forfeiture” may be established only through (i) a service condition or (ii) a condition related to the purpose of the transfer.  The final regulations also confirm that, in determining whether a condition related to the purpose of the transfer creates a substantial risk of forfeiture, the likelihood both that the condition will occur and that the forfeiture will be enforced must be considered. 

In response to comments on the proposed regulations, the final regulations also clarify that the definition of a “substantial risk of forfeiture” under Section 83 differs the definition of that term for purposes of Internal Revenue Code Section 409A (“Section 409A”).  Under Section 409A, a right to receive property in the future upon a service provider’s involuntary separation of service without cause qualifies as a “substantial risk of forfeiture.”  However, the final regulations highlight that an involuntary termination without cause would not constitute a “substantial risk of forfeiture” under Section 83 as the right to receive a transfer of property in the future is generally not “property” for Section 83 purposes.  The preamble goes on to confirm that the acceleration of vesting of property upon a service provider’s involuntary separation from service without cause will not cause a service condition to fail to qualify as a substantial risk of forfeiture for Section 83 purposes.

The final regulations become effective February 26th for transfers of property on or after January 1, 2013.  A copy of the final regulations can be obtained by clicking here.