On February 26, 2014, the Internal Revenue Service released final regulations regarding all property that is transferred to service providers for transfers on or after January 1, 2013 (click here for the complete document). Pursuant to the final regulations, the IRS has revised paragraph (c)(1) of Section 1.83–3 to clarify the following:
- property that is subject to a condition that is unlikely to be enforced is not subject to a "substantial risk of forfeiture" and
- property that is merely subject to a contractual or legal restriction on transfer is not subject to a "substantial risk of forfeiture" unless the transfer restriction is described in paragraph (j) or (k) of Section 1.83–3.
In regards to (1) above, the IRS explained that if the transfer of property is conditioned on the service provider's continued substantial services to the Company, the property is subject to a substantial risk of forfeiture only if the possibility of forfeiture is substantial. Therefore, if that same service provider is entitled to the acceleration of vesting in the event of a "qualified termination" (such as termination without cause, death, or disability), the property would only be considered subject to a substantial risk of forfeiture if the occurrence of the "qualified termination" is unlikely to occur. This clarification by the IRS is unlikely to be considered a substantial deviation from the general understanding of Section 83 by most practitioners. However, it is worth noting that the determination of whether a "substantial risk of forfeiture" exists should consider both the likelihood that the forfeiture event will occur and the likelihood that the forfeiture will be enforced. Note—We do not believe that an agreement previously entered into that provides for acceleration of vesting in the event of a qualified termination should create a presumption that a substantial risk of forfeiture is not likely to be enforced. We believe that a substantial risk of forfeiture exists if the facts and circumstances of that agreement indicate that a risk of forfeiture is substantial pursuant to the terms of that agreement and there is a substantial likelihood that the terms of that agreement will be enforced.
In regards to (2) above, the IRS added Example 6 and Example 7 to paragraph (c)(4) of Section 1.83–3, which describe contractual and legal transfer restrictions that do not result in a substantial risk of forfeiture. As summarized above, the only contractual and legal transfer restrictions that will subject property to a substantial risk of forfeiture are those transfer restriction described in paragraph (j) (related to sales which may give rise to suit under Section 16(b) of the Securities Exchange Act of 1934) or paragraph (k) (related to Special Rules for certain accounting rules) of Section 1.83–3. For clarity, the IRS added Example 4 to paragraph (j)(2) of Section 1.83–3, which provides an example of when property is subject to a substantial risk of forfeiture as a result of a transfer restriction under Section 16(b). It should be noted that the revised language of paragraph (c)(1) of Section 1.83.3 makes clear that even contractual or legal transfer restrictions that may subject the transferor to penalties or the loss of the property will not be considered to subject the property to a substantial risk of forfeiture unless those contractual or legal transfer restrictions are those described in paragraph (j) or (k) of Section 1.83–3.
The final regulations are effective January 1, 2013.
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.
