The Internal Revenue Service (“IRS”) has provided new guidance, in the form of proposed regulations, on the timing of income inclusion under section 83 when property has been transferred in connection with the provision of services.
By way of background, in general under section 83(a), if property is transferred in connection with the provision of services, the fair market value of the property is included in the recipient’s gross income on the first date on which either the recipient’s rights in the property are transferable or are not subject to a substantial risk of forfeiture. Under section 83(c)(1), the rights of a person in property is subject to a substantial risk of forfeiture, if such person’s rights to the full enjoyment of the property are conditioned on the future performance of substantial services by any individual. Treas. Reg. Sec. 1.83-3(c)(1) elaborates on this rule.
The IRS’s proposed regulations would amend sec. 1.83-3(c)(1) to clarify whether a substantial risk of forfeiture exists. Under the proposed regulations:
–a substantial risk of forfeiture may be established only through a service condition or a condition related to the purpose of the transfer;
–in determining whether a substantial risk of forfeiture exists based on a condition related to the purpose of the transfer, both the likelihood that the forfeiture event will occur and the likelihood that the forfeiture will be enforced must be considered; and
–a restriction on transferring the property- including a restriction which carries the potential for forfeiture, disgorgement of some or all of the property or other penalties if the restriction is violated- does not create a substantial risk of forfeiture.
The change in the regulations is proposed to apply as of January 1, 2013, and will apply to property transferred after that date. However, taxpayers may rely on the change for property transferred on or after May 30, 2012.