Proposed regulations clarify when there is a substantial risk of forfeiture under Code section 83

Code section 83 sets forth the rules for the taxation of property that is transferred in connection with the performance of services. In general, if property is transferred to an employee or other service provider, the employee recognizes income when the property is no longer subject to a substantial risk of forfeiture, or when the employee can freely transfer the property, if earlier. At that time, the employee will recognize income equal to the fair market value of the property less any amount that the employee has paid for the property.

Section 83 most commonly applies to stock-based compensation arrangements, such as grants of restricted stock, transfers of stock upon the exercise of a nonqualified stock option and transfers of stock under a restricted stock unit award. A stock option is generally not treated as property; rather, section 83 applies to stock transferred upon exercise of an option.

Under recently released proposed regulations, the IRS clarifies that a substantial risk of forfeiture may be established only through a service condition or a condition related to the purpose of the transfer. The proposed regulations also require companies to take into account the likelihood that a condition related to the purpose of the transfer will occur.