Sec. 83: uncertainty of transfers and nonlapse restrictions.

• Author: Zarzar, Robert
• Position: Taxation of property transferred in connection with performance of services

For purposes of Sec. 83 taxation of property transferred in connection with the performance of services, a "transfer" does not occur unless the transferee acquires a beneficial ownership interest in the property (Regs. Sec. 1.83-3(a)(1)). Generally, this requires that the employee hold the property subject to a risk of loss (Regs. Sec. 1.83-3(a)(6)).

To determine whether a compensatory "transfer" of property has occurred, lapse restrictions (such as risks of forfeiture) are not considered; however, nonlapse restrictions must be considered. Nonlapse restrictions frequently are used by privately held companies to set a formula for establishing the stock's fair market value (FMV) while the company is privately held. Under Sec. 83(d)(1), if a nonlapse restriction allows the transferee to sell the property only at a reasonable price determined under a formula, the price so determined generally is deemed to be the property's FMV, to be used in determining whether a "transfer" has occurred.

A lapse restriction is not considered in determining whether a transfer has occurred. A lapse restriction occurs, for example, when an employer sells stock to an employee, with the restriction that the employee must forfeit the shares if he does not perform two additional years of service. If the employer promises it will return to the employee any amount the employee paid for the stock if he forfeits the shares, this generally is considered part of the lapse restriction, as it lapses on vesting. Accordingly, this refund feature also should be disregarded in determining whether a transfer has occurred.

However, if the employer promises to pay the employee, in any event, the greater of the amount the employee paid for the shares or their FMV at the time of disposition, the provision is a nonlapse restriction and considered in determining whether a transfer has occurred. In this situation, because there is no risk to the employee that the stock will decline substantially in value, no transfer occurs. Thus, no taxable event will occur until the employee disposes of the stock. At that point, the employee recognizes compensatory income on the difference between the amount he received for the stock and the amount he paid for it, and the employer is allowed a corresponding deduction.

Nonlapse Restrictions

A nonlapse restriction must be permanent. Generally, if the recipient of the property has the ability to resell the property later at FMV, rather than the formula...