IRS extends the reach of sec. 83 to post-grant stock transfers.

• Author: Beavers, James

The IRS has ruled that in a taxable merger of corporations or a merger of corporations that qualifies as a tax-flee reorganization, Sec. 83 applies to an employee's transfer of stock in his or her employer corporation in return for stock in the remaining corporation that is subject to employment-related restrictions.

Facts

In both of the following scenarios, in exchange for A's agreement to perform services for Corporation X, in 2004, X issues 100 shares of its stock to A at a fair market value (FMV) of $10 per share. The shares of X stock transferred to A are "substantially vested" within the meaning of Regs. Sec. 1.83-3(b). For the 2004 tax year, the amount included in A's income under Sec. 83(a) is $1,000 (the FMV of the stock ($10 x 100 shares) less the amount paid ($0)). A's basis in the stock is $1,000.

Scenario 1: In the first scenario, on August 9, 2010, Corporation Y causes Corporation Z (a newly formed wholly owned subsidiary of Y) to merge into X in a transaction that qualifies as a tax-free Sec. 368(a) reorganization. In the merger, the X shareholders each receive solely 100 shares of Y voting stock in exchange for their X stock, which on that date has an FMV of $310 per share. The shares of Y stock are subject to a restriction that will cause the stock to be "substantially nonvested" within the meaning of Regs. Sec. 1.83-3(b). Under this restriction, if A's employment with X is terminated for any reason before August 9, 2013, A must sell the Y shares to Y in exchange for the lesser of $310 per share or their FMV at the time of forfeiture. In addition, the shares are nontransferable before that date. No other X shareholder receives Y stock subject to a restriction.

A timely files an election under Sec. 83(b) with respect to the Y stock received in the merger. A continues to be employed by X until August 9, 2013, at which time the FMV of the stock is $500. A sells the stock on October 31, 2014, when the FMV of the stock is $550 per share.

Scenario 2: In the second scenario, the facts are the same as in the first scenario, except that in the merger, half of the X stock is exchanged for cash and half is exchanged for Y stock, the transaction is fully taxable, and all of A's X stock is exchanged for Y stock.

Analysis

Sec. 83 provides that if, in connection with the performance of services, property is transferred to any person other than the service recipient, the excess of the property's FMV, on the first day that the rights to the...