Planning considerations for cross-border compensatory equity.

AuthorFoley, Sean

Non-U.S.-headquartered entities (inbound employers) seeking global expansion of business operations will often look to U.S. markets and bring employees into the United States in search of growth. While it may seem that a decision to expand business operations or send employees to the United States would be based on a straightforward cost/benefit analysis from a business perspective, the complex U.S. tax consequences associated with certain compensation arrangements are frequently overlooked. In particular, compensatory equity, such as company stock, held by employees that was acquired in connection with the performance of services may result in unexpected issues.

For ease of reference, this item refers to employers and employees; however, the same rules and issues may be relevant to other types of service recipients and service providers. Further, this item focuses only on U.S. federal income tax issues associated with inbound employers and employees (other than U.S. citizens or green-card holders) and is not intended to address other potential U.S. tax and reporting consequences.

General property transfer rules

Under Sec. 83, property transferred to an employee in connection with the performance of services generally results in taxable compensation for the employee when the employee vests in the property and in a corresponding compensation deduction for the employer. The amount of taxable compensation is the fair market value (FMV) of the property at vesting, less any amount paid by the employee for the property. However, if a Sec. 83(b) election is made by the employee within 30 days of the initial transfer of the restricted (unvested) property, then the taxable compensation is equal to the FMV of the property less the amount paid at the time of the initial transfer.

Property for these purposes includes real and personal property, but it does not include money or an unfunded promise to pay money or property in the future (Regs. Sec. 1.83-3(e)). Property becomes vested when it is no longer subject to a substantial risk of forfeiture. For Sec. 83 purposes, a substantial risk of forfeiture exists only if the rights in the property are conditioned, directly or indirectly, either on the future performance (or refraining from performance) of substantial services or on the occurrence of a condition related to a purpose of the transfer, if the possibility of forfeiture is substantial (Regs. Sec. 1.83-3(c)(1)). A classic example of a substantial risk of forfeiture is a service-based vesting provision under which the right to full ownership does not occur until a service period is completed and the property is forfeited if employment is terminated at any point before the end of the service period.

Common issues for inbound employers and employees that become U.S. taxpayers

Is it property?: One starting point for any Sec. 83 analysis is to ask whether property has been transferred. Often, property transfers involve the issuance of company stock to an employee. Careful review of the award agreement or plan document is often necessary, however, to determine whether the employee has been granted a current beneficial ownership in property as opposed to a right to receive something in the future that is more properly characterized at grant as an unfunded, unsecured obligation to pay deferred compensation.

For example, under a virtual share plan or a deferred share plan, it may appear that the employee acquires a right to receive company stock upon grant; however, a more thorough review may indicate that, from a U.S. tax perspective, the employee acquires only a promise to be paid company shares in the future (see, e.g., IRS Letter Ruling 9308022). As a result, consideration of the Sec. 409A nonqualified deferred compensation rules, which may result in additional U.S. tax, is necessary.

Is there a substantial risk of forfeiture?: Non-U.S. equity-based plans frequently include "good," "bad," and "intermediate" leaver provisions. Although there are many variations, these provisions often require compulsory transfer of property to the employer or other shareholders at a specified price (which may not be FMV) on the occurrence of certain leaver events (e.g., termination due to death, disability, voluntary resignation, or termination with or without cause). The employee may be entitled to retain a certain percentage of shares based on the reason for the termination.

Whether these leaver provisions create a substantial risk of forfeiture for Sec. 83 purposes and when that risk lapses depend on how the provisions are drafted. For example, although forfeiture in the event of termination due to the commission of a crime or fraud is generally not considered a substantial risk of forfeiture, a broadly drafted "bad" leaver provision may include voluntary resignation. In Austin, 141 T.C. 551 (2013), the Tax Court concluded that a broadly drafted "for cause" provision created a substantial risk of forfeiture.

Thus, reviewing leaver provisions before the performance of services in the United States--to determine (1) the extent to which a substantial risk of forfeiture exists, and (2) whether they would continue to apply while services are performed in the United States--provides an opportunity to mitigate any potential unexpected U.S. federal tax consequences under Sec. 83. After services are performed in the United States and while property is unvested, it is often too late to mitigate the application of Sec. 83. Note that U.S. citizens and green-card holders are generally taxable on worldwide income, and, therefore, they may be subject to U.S. taxation regardless of where services are performed.

What if no Sec. 83(b) election was made?: While an inbound employer and its employees may be familiar with the relevant income tax elections in their home country (e.g., a U.K. Section 431 election), they may not...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT