Proposed regulations soften consequences of failure to withhold in sec. 83 transactions.

• Author: Wagman, Rich
• Position: Brief Article

Employers generally must withhold on any compensation paid to employees, or face payroll tax penalties. This rule applies to noncash transfers, such as the exercise of nonqualified stock options. As an added penalty, Regs. Sec. 1.83-6(a) provides that employers are not permitted a deduction if they fail to withhold at the required time, even when the employee has reported the income and paid the tax.

This added penalty for failure to withhold in the Sec. 83 context has always been controversial. In response to extensive criticism, the IRS has issued Prop. Regs. Sec. 1.83-6, repealing the requirement that an employer withhold income tax as a prerequisite for claiming a deduction for property transferred to an employee in connection with the performance of services. Payroll tax penalties for failure to withhold are still applicable.

Under Prop. Regs. Sec. 1.83-6(a)(2), if the service recipients timely comply with applicable Form W-2 or Form 1099 reporting requirements, they will be permitted the deduction without demonstrating that the service provider actually included the amount...