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Final IRS Regulations May Make Deferring Tax on Compensatory Property Transfers More Difficult


3/26/14

Synopsis
 
Taxpayers should be aware of final regulations issued by the IRS which make it more complex for taxpayers receiving property in connection with the performance of services to defer the tax on the value of property received. The final regulations tighten certain rules related to a taxpayer’s rights to property that is subject to a “substantial risk of forfeiture.”
 
Issue
 
Background
Generally, if property is transferred to a taxpayer in connection with the performance of services, the excess of the fair market value of the property over the amount paid for the property, is included in the taxpayer’s gross income in the first tax year in which the taxpayer’s rights in the property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier.
 
The rights of a person in property are subject to a substantial risk of forfeiture if the person’s rights to full enjoyment of the property are conditioned upon the future performance of substantial services by any individual. Whether a risk of forfeiture is “substantial” generally depends upon the specific facts and circumstances.
 
Final Regulations
On February 26, 2014, the IRS published final regulations which affect certain taxpayers who receive property transferred in connection with the performance of services.
 
The final regulations clarify preexisting regulations related to whether a substantial risk of forfeiture exists. Under the final regulations, a substantial risk of forfeiture exists only if rights in property that are transferred are conditioned, directly or indirectly, on the future performance (or refraining from performance) of substantial services by any person, or upon the occurrence of a condition related to a purpose of the transfer if the possibility of forfeiture is substantial. 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.
 
Transfer restrictions that do not result in a substantial risk of forfeiture include, but are not limited to, those that, if violated, would result in the forfeiture of some or all of the property, or other liability by the employee for any damages, penalties, fees, or other amounts.
 
What Does CohnReznick Think?
Taxpayers and their advisors should be careful. Although the IRS has commented that the change in the regulation is not a narrowing of the circumstances in which a substantial risk of forfeiture exists, under the previous regulation the IRS did not use the word “only.” By not using the word “only” in the previous regulation, some taxpayers and planners might have argued that the circumstances described there were not the exclusive circumstances necessary for a substantial risk of forfeiture to exist. In addition, when determining if a condition related to the purpose of the transfer gives rise to a substantial risk of forfeiture, both the likelihood that the forfeiture event will occur and that the forfeiture will be enforced will be considered by the IRS.

 
To learn more about CohnReznick’s Tax Practice, please visit our webpage.


Circular 230 Notice: In compliance with U.S. Treasury Regulations, the information included herein (or in any attachment) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of i) avoiding penalties the IRS and others may impose on the taxpayer or ii) promoting, marketing, or recommending to another party any tax related matters.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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