TC denies sec. 83 property compensation deduction.

• Author: Barton, Peter C.
• Position: Tax Court, IRC s. 83

In Venture Funding Ltd., 110 TC No. 19 (1998), a reviewed opinion, the Tax Court ruled, by a 10-7 vote, that an employer cannot deduct property transferred to employees as compensation for services unless the employees included the property in gross income. The court reached this result by distinguishing between "included" and "includible" compensation. This ruling also applies if the service providers are independent contractors instead of employees. Because property includes corporate stock and all other noncash assets, this ruling has broad application.

Sec. 83(a), enacted in 1969, requires that, in connection with the performance of services, if property is transferred to any person other than the service recipient (the person for whom the services are performed), the property shall be included in the gross income of the service provider (the employee or independent contractor who performed the services). The property is included in the first tax year in which it is not subject to a substantial risk of forfeiture. Under Sec. 83(c), there is a substantial risk of forfeiture if the full enjoyment of the property is conditioned on the future performance of substantial services.

Sec. 83(h) allows the service recipient a Sec. 162 compensation deduction equal to "the amount included" in the service provider's gross income. The service recipient is allowed the deduction for the tax year that includes the close of the tax year in which "such amount is included in the gross income" of the service provider.

Regs. Sec. 1.83-6(a)(1), in effect from 1969 to 1994 (the prior regulations), allowed the service recipient to deduct the amount includible as compensation in the service provider's gross income under Sec. 83(a), even though Sec. 83(h) allows a deduction equal to the amount included in the service provider's gross income. "Includible" means "required to be included" while "included" means "was actually or in fact included." As stated in the 1995 preamble to new Regs. Sec. 1.83-6(a), the prior regulations allowed a service recipient to claim the deduction even if the service provider failed to include the amount in income. However, if the service provider was an employee, prior Regs. Sec. 1.83-6(a)(2) required the employer to withhold taxes on the amount of the property to obtain the deduction. There was no withholding requirement if the service provider was an independent contractor. Regs. Sec. 1.83-6(a)(3), which has not been changed, allows...