Executive Compensation: Tax and Other …media.straffordpub.com/.../presentation.pdf2015/06/25 ·...

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Executive Compensation: Tax and Other

Considerations for Restricted Stock Awards Strategies for Navigating Substantial Risk of Forfeiture Analysis,

IRC 83(b) Elections, Interplay With Other IRC Rules and Regulations, and More

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THURSDAY, JUNE 25, 2015

Presenting a live 90-minute webinar with interactive Q&A

Stanley Baum, Of Counsel, Cary Kane, New York

Joshua M. Miller, Proskauer Rose, Washington, D.C.

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RULES AND RECENT DEVELOPMENTS

REGARDING

PROPERTY TRANSFERRED

IN CONNECTION WITH

THE PERFORMANCE OF SERVICES

UNDER

INTERNAL REVENUE CODE SECTION 83

Stanley Baum, Cary Kane LLP

Joshua M. Miller, Proskauer Rose LLP

Thursday, June 25, 2015

The information provided in this slide presentation is not, is not intended to be,

and shall not be construed to be, either the provision of legal advice or an offer

to provide legal services, nor does it necessarily reflect the opinions of the firm,

our lawyers or our clients. No client-lawyer relationship between you and the

firm is or may be created by your access to or use of this presentation or any

information contained on them. Rather, the content is intended as a general

overview of the subject matter covered. Proskauer Rose LLP (Proskauer) is not

obligated to provide updates on the information presented herein. Those

viewing this presentation are encouraged to seek direct counsel on legal

questions. © Proskauer Rose LLP. All Rights Reserved.

6

Outline

• A general overview of the rules and regulations under Section 83

• Substantial risk of forfeiture and the timing of taxation under

Section 83

• Final regulations under Section 83 issued in February 2014

• Section 83(b) elections and recent guidance from the IRS

• Comparison of restricted stock with other types of stock-based

compensation (such as RSUs and profits interests)

• How the substantial risk of forfeiture concept and the timing of

taxation under Section 83 compare and interact with other

relevant provisions of the Code

• Practical considerations, practice pointers and drafting tips for

implementing restricted stock awards

7

General Overview—Section 83 Regulations

Section 83(a):

If, in connection with the performance of services, property is transferred to any person other

than the person for whom such services are performed, the excess of—

(1) the fair market value of such property (determined without regard to any restriction

other than a restriction which by its terms will never lapse) at the first time the rights of the

person having the beneficial interest in such property are transferable or are not subject to

a substantial risk of forfeiture, whichever occurs earlier, over

(2) the amount (if any) paid for such property,

shall be included in the gross income of the person who performed such services in the first

taxable year in which the rights of the person having the beneficial interest in such property are

transferable or are not subject to a substantial risk of forfeiture, whichever is applicable

8

General Overview—Section 83 Regulations

[continued]

• The taxable amount is compensation includible as ordinary

income

• Prior to the transferred property becoming substantially vested,

any amounts received by the recipient in respect of the non-

vested property (e.g., dividends or interest on restricted stock) are

treated as additional compensation that is immediately taxable to

the recipient upon receipt at ordinary income rates.

• Reg. §1.83-1(a)

9

Property

• Reg. 1.83-3(e)

• “Property” generally includes “real and personal property other

than either money or an unfunded and unsecured promise to pay

money or property in the future”

• Section 83 does not apply to: Transactions subject to section 421 (incentive stock options and employee stock

purchase plans)

Transfers under qualified plans of deferred compensation subject to section 401(a) or

404(a)(2)

Transfers of stock options without a “readily ascertainable fair market value”

Transfers of property pursuant to the exercise of a stock option with a “readily

ascertainable fair market value”

Group-term life insurance to which section 79 applies

10

Property [continued]

Types of Compensatory Property Subject to Section 83

• Corporation: Restricted Common Stock

Most common

• Partnership/LLC taxed as Partnership: Partnership Units

Capital Interests

Profits Interests

11


Types of Compensatory Payments Not Subject to Section 83

• Cash

• Contingent rights to receive cash and/or shares in the future

Incentive stock options and most nonqualified stock options

Long-term cash incentive awards or rights to an allocation from a bonus pool

Restricted stock units

12


Brief Note on Stock Options

• Generally the grant and vesting of compensatory options do not

constitute transfers of property, unless the option itself is subject

to section 83

• This is because most compensatory options do not have a

“readily ascertainable fair market value” since the options—by

contrast to the shares underlying the options—typically are not

traded on an established market

13


General Rule

• Property is not taxable under section 83(a) until it has been

“transferred” to the employee or independent contractor (the

“recipient”) and has become “substantially vested” in that

recipient

14

Transfer of Property

• A “transfer” of property occurs when the recipient acquires a

beneficial ownership interest in the property (ignoring any

“lapse restriction”)

• Whenever a transfer has in fact occurred is based on all the facts

and circumstances

Beneficial Ownership Interest

15

• A person acquires a “beneficial ownership interest” in

property when he or she has been transferred both the right to share in an increase in the value of the property and

the obligation to share in the risk of loss in its value.

Rev. Ruling 2004-37

• Under Reg. 1.83-3(a)(3), a transfer may not have

occurred if the property is transferred under conditions

that require its return upon the happening of an event

that is certain to occur, such as the termination of

employment

16

Substantially Vested

• Property becomes “substantially vested” when it either ceases to

be subject to a “substantial risk of forfeiture” or it is

“transferable.” Reg. § 1.83-3(b)

• Property is “substantially non-vested” when it is subject to a

“substantial risk of forfeiture” and is “nontransferable.” Reg. §

1.83-3(b)

17

Transferable

• The rights of a recipient in property are “transferable” if the recipient can

transfer any interest in the property to any person (other than the initial

transferor of the property), but only if the rights in the property of the

transferee are not subject to a substantial risk of forfeiture, i.e., the

transfer is made on a fully vested basis

• Accordingly, property is transferable if the recipient can sell, assign, or

pledge (as collateral for a loan, or as security for the performance of an

obligation, or for any other purpose) his interest in the property to any

person (other than the initial transferor), and if the transferee is not

required to give up the property or its value in the event the substantial

risk of forfeiture materializes. Reg. § 1.83-3(d)

18

Risk of Substantial Forfeiture

• Whether a “risk of forfeiture is substantial” or not depends upon

the facts and circumstances

• A substantial risk of forfeiture exists where rights in property that

are transferred are conditioned, directly or indirectly, upon:

(1) the future performance (or refraining from performance) of

substantial services by recipient, or

(2) the occurrence of a condition related to a purpose of the transfer,

and the possibility of forfeiture is substantial if such condition is not

satisfied.

• Reg. § 1.83-3(c)

Risk of Substantial Forfeiture [continued]

19

• Property is not transferred subject to a substantial risk of forfeiture

to the extent that the employer is required to pay the fair market

value of a portion of such property to the employee upon the

return of such property

• The risk that the value of property will decline during a certain

period of time does not constitute a substantial risk of forfeiture

• A “nonlapse restriction,” standing by itself, will not result in a

substantial risk of forfeiture

20


• Examples

If the property is subject to a vesting schedule, under which a portion of the

property vests for each year that the recipient remains in employment, such

property is subject to a substantial risk of forfeiture

If an employee receives property from an employer subject to a requirement

that it be returned if the total earnings of the employer do not increase, such

property is subject to a substantial risk of forfeiture

A requirement that the property be returned to the employer if the employee is

discharged for cause or for committing a crime generally will not be treated as

a substantial risk of forfeiture

21


• Examples [continued]

Rights in property transferred to a retiring employee subject to the sole requirement

that it be returned unless he renders consulting services upon the request of his

former employer will not be considered subject to a substantial risk of forfeiture

unless he is in fact expected to perform substantial services

A requirement that the recipient cannot engage in competition with the employer

(that is, a noncompetition agreement) is normally not a substantial risk of forfeiture,

but could be treated as such depending on the recipient’s age, the availability of

alternate employment opportunities, the likelihood of securing other employment,

the recipient’s job skills and health, and the employer’s practice of enforcing such

requirement

22

Purchase of Property with a Loan

• “Notably” the purchase of property with a nonrecourse note secured only by the

property may not be a transfer of such property

In such a case, Reg. 1.83-3(a)(2) treats the property like an option – thus no transfer -

since there is no personal liability to pay all or a substantial portion of the “indebtedness”

• Also “note” that reduction in principal or forgiveness of a recourse debt would be

treated as compensation income

Section 1.83-4(c) provides that if indebtedness treated as an “amount paid” for purposes

of section 83 is later cancelled, forgiven or satisfied for an amount that is less than the

outstanding indebtedness, the amount of indebtedness that is cancelled, forgiven or not

paid is included in the gross income of the purchaser in the year that such cancellation,

forgiveness or satisfaction occurs

23

Compensation Element

• The transfer of property is subject to section 83 whether such transfer is

in respect of past, present, or future services

• Property transferred to an employee or an independent contractor (or

beneficiary thereof) in recognition of the performance of, or the

refraining from performance of, services is considered transferred in

connection with the performance of services within the meaning of

section 83

• The existence of other persons entitled to buy stock on the same terms

and conditions as an employee, whether pursuant to a public or private

offering may, however, indicate that in such circumstances a transfer to

the employee is not in recognition of the performance of, or the refraining

from performance of, services

24

Compensation Element [continued]

• Once restricted property becomes “substantially vested,” the

amount taxed generally equals the property’s fair market value at

the time of substantial vesting, less any amount paid for the

property

• The taxable amount is compensation includible as ordinary

income

• Prior to the transferred property becoming substantially vested,

however, any amounts received by the recipient in respect of the

non-vested property (e.g., dividends or interest) are treated as

additional compensation that is immediately taxable to the

recipient upon receipt at ordinary income rates. Reg. §1.83-1(a)

25

Subsequent Sale, Forfeiture, or Other

Disposition of Non-Vested Property

• Section 83(a) provides, in part, that the general rules “shall not apply if

such person sells or otherwise disposes of such property in an arm’s

length transaction before his rights in such property become transferable

or not subject to a substantial risk of forfeiture”

• If substantially non-vested property is exchanged for other non-vested

property, there is generally no gain on the exchange, and the section 83

rules will apply to the non-vested property received

• If a recipient of a transfer of compensatory property subsequently sells or

otherwise disposes of that property while substantially non-vested, then

treatment under section 83 depends on the nature of the sale or other

disposition

26


Disposition of Non-Vested Property [continued]

• If pursuant to an arm's length transaction, then the sale closes the compensation element and

the recipient realizes taxable income, treated as ordinary income compensation, equal to the

amount realized in such sale or disposition, over the amount (if any) paid for the property.

Following the sale, Section 83 no longer applies to the property

• If pursuant to a non-arm's length transaction (e.g., a gift or discounted sale to a relative), the

recipient realizes taxable income, treated as compensation, equal to the sum of (x) any

money received in the sale/disposition plus (y) the fair market value of any substantially

vested property received, but not in excess of the fair market value of the property sold or

disposed of (ignoring any “lapse restriction”) minus any amount paid for the property. Further,

section 83 continues to apply to the property until the restrictions lapse (except that any

amounts previously includible in gross income are treated thereafter as amounts paid for the

property)

• If upon the recipient’s death, the property goes to his or her estate or beneficiary, then the

income realized on or after death with respect to the property is income in respect of the

decedent and generally taxable to the estate or beneficiary under the section 691 rules and in

accordance with section 83 rules

27


Disposition of Non-Vested Property [continued]

• Example:

If in 2011 an employee pays $50 for a share of stock which has a fair market

value of $100 and is substantially non-vested at that time and later in 2011 (at

a time when the property still has a fair market value of $100 and is still

substantially non-vested) the employee disposes of, in a transaction not at

arm's length, the share of stock to his wife for $10, the employee realizes

compensation of $10 in 2011.

If in 2012, when the share of stock has a fair market value of $120, it becomes

substantially vested, the employee realizes additional compensation in 2012 in

the amount of $60 (the $120 fair market value of the stock less both the $50

price paid for the stock and the $10 taxed as compensation in 2011).

Reg. 1.83-1(c)

28

Sale or Transfer of Substantially Vested

Property

• Assuming compensation element closed upon vesting (and taxes

on the compensation includible in income):

Once substantially vested (or if a section 83(b) election was made), sale

generally results in recipient recognizing capital gain or loss equal to

difference between amount received and basis

The recipient’s basis in the property is equal to the amount paid plus the

compensation included in income upon vesting (or an 83(b) election)

Holding period for determining whether the sale results in long- or short-term

capital gain/loss begins when compensation element closes

29

Forfeiture of Unvested Property

If no section 83(b) election has been made:

If property is forfeited while still substantially unvested as a result of the

applicable service or other forfeiture restrictions and no section 83(b) election

(as described below) has been made, then the recipient generally recognizes

ordinary loss or gain, equal to the difference (if any) between the amount

paid for the property (if any) and the amount received upon forfeiture

If a section 83(b) election has been made:

Under Reg. 1.83-2(a), if the property for which a section 83(b) election is in

effect is forfeited while substantially non-vested, the forfeiture is treated as a

sale or exchange upon which there is realized a capital loss equal to the

excess (if any) of the amount paid (if any) for the property (including any tax

paid when the section 83(b) election was made), over the amount realized (if

any) upon the forfeiture

30

Forfeiture of Vested Property

Under Reg. §1.83-1(e)

- if the recipient is taxable under section 83(a) when the property transferred

becomes substantially vested, and

- subsequently the property is nonetheless forfeited pursuant to a lapse restriction,

then any loss incurred by the recipient (but not a beneficiary) is treated as an

ordinary loss to the extent the basis in the property has been increased as a result of

the recognition of income under section 83(a)

31

Section 83(b) Election

• Under Reg. § 1.83-2, if property is transferred to a recipient in

connection with the performance of services, and the property is

substantially non-vested, the recipient may elect under section

83(b) to include in gross income, as compensation for services,

the excess (if any) of—

The fair market value of the property (ignoring any “lapse

restriction”) at the time of transfer, over,

The amount (if any) paid for such property

Section 83(b) Election [continued]

32

• The fact that the property’s fair market value does not exceed the

amount paid for it, so there is no “bargain element” and no

amount to include in gross income if the recipient makes the

section 83(b) election, does not prevent the recipient from making

the election

• After a timely and valid section 83(b) election is made, the tax

rules of section 83 generally no longer apply to the property (e.g.,

future dividends on the stock are taxed as dividend income not

compensation), even if it remains substantially non-vested

• Exception for cancellation of a “non-lapse” restriction

Section 83(b) Election – Example

33

With a timely 83(b) Election: • Company A is a privately held corporation and no stock in Company A is traded on an established securities

market.

• On April 1, 2012, in connection with the performance of services, Company A transfers to E, its employee, 25,000

shares of substantially non-vested stock in Company A. In exchange for the stock, E pays Company A $25,000,

representing the fair market value of the shares at the time of the transfer.

• The restricted stock agreement provides that if E ceases to provide services to Company A as an employee prior

to April 1, 2014, Company A will repurchase the stock from E for the lesser of the then current fair market value

or the original purchase price of $25,000. E’s ownership of the 25,000 shares of stock will not be treated as

substantially vested until April 1, 2014 and will only be treated as substantially vested if E continues to provide

services to Company A as an employee until April 1, 2014.

• On April 1, 2012, E makes a valid election under § 83(b) with respect to the 25,000 shares of Company A stock.

Because the excess of the fair market value of the property ($25,000) over the amount E paid for the property

($25,000) is $0, E includes $0 in gross income for 2012 as a result of the stock transfer and related § 83(b)

election. The 25,000 shares of stock become substantially vested on April 1, 2014 when the fair market value of

the shares is $40,000.

• No compensation is includible in E’s gross income when the shares become substantially vested on April 1,

2014.

• In 2015, E sells the stock for $60,000. As a result of the sale, E realizes $35,000 ($60,000 sale price - $25,000

basis) of gain, which is a capital gain.

Section 83(b) Election – Example [continued]

34

Absent an 83(b) Election:

• The facts are the same as in the prior example above, except that E does not make an

election under § 83(b).

• Under § 83(a), E includes $0 in gross income in 2012 as a result of the transfer of stock from

Company A because the stock is not substantially vested.

• When the shares become substantially vested on April 1, 2014, E includes $15,000 ($40,000

fair market value less $25,000 purchase price) of compensation in gross income. E’s basis in

the stock as of April 1, 2014 is $40,000 ($25,000 paid for the stock and $15,000 included in

income under § 83(a)).

• When the stock is sold in 2015 for $60,000, E realizes $20,000 ($60,000 sale price minus

$40,000 basis) of gain, which is a capital gain.

Section 83(b) Election – Example [continued]

35

Comparison

No Section 83(b)

Election

Section 83(b)

Election

Ordinary Income $15,000 $0

Capital Gain $20,000 $35,000

Total $35,000 $35,000

Example based on Revenue Ruling 2012-29

Section 83(b) Election - Requirements

36

• Election must set forth the following information: (1) The name, address and taxpayer identification number of the taxpayer;

(2) A description of each property with respect to which the election is being

made;

(3) The date or dates on which the property is transferred and the taxable year

for which the election was made;

(4) The nature of the restriction or restrictions to which the property is subject;

(5) The fair market value at the time of transfer (determined without regard to

any lapse restriction) of each property with respect to which the election is

being made;

(6) The amount (if any) paid for such property; and

(7) A statement to the effect that copies have been furnished to the IRS and

service recipient.

Section 83(b) Election – Requirements

[continued]

37

• Election must be filed with IRS not later than 30 days after the

date of transfer

However, if the 30th day following the date of transfer falls on a Saturday,

Sunday or legal holiday, the election will be considered timely filed if

postmarked by the next business day

• Copies must be provided to the service recipient (e.g., the

employer/company) and included with the recipient’s income tax

return for the tax year in which transfer occurs

Section 83(b) Election – Requirements

[continued]

38

Generally mail to IRS office where federal income taxes are

filed

See IRS website for addresses at

http://www.irs.gov/uac/Where-To-File-Addresses-for-Tax-

Professionals

Practice Pointer: Use certified mail, return-receipt requested

so you have proof of timely filing

Section 83(b) Election – Model Election

39

• Revenue Procedure 2012-29—Model Election and Guidance

Contains sample language that may be used (but is not required to be used)

for making an election under § 83(b) of the Internal Revenue Code

Includes several examples of the income tax consequences of making an

83(b) election

Revocation of an 83(b) Election

40

• Generally not permitted except with the consent of the IRS and

where there has been a mistake of fact—must be requested

within 60 days of knowledge of mistake. Reg. §1.83-2(f)

• Neither a mistake as to the value (or decline in the value) of the

property for which the election was made nor the failure of

anyone to perform an act that was contemplated at the time of

transfer of the property constitutes a mistake of fact for this

purpose

• See Rev. Proc. 2006-31 for guidance with respect to revoking a

section 83(b) election

Cancellation of a Nonlapse Restriction

41

• Tax recognition may be required in the event of a cancellation of a

“nonlapse restriction.” Reg. § 1.83-2(a)

• A “nonlapse restriction” is a permanent limitation on the

transferability of property which: (1) will require the recipient to

sell, or offer to sell, the property at a price determined under a

formula, and (2) will continue to apply to and be enforced against

the recipient. Reg. § 1.83-3(h)

• A “lapse restriction” means a restriction other than a nonlapse

restriction, and includes (but is not limited to) a restriction that

carries a substantial risk of forfeiture. Reg. § 1.83-3(i)


[continued]

42

• Example of a nonlapse restriction --

A limitation subjecting the property to a permanent right of first refusal

in a particular person at a price determined under a formula

• An obligation to resell or to offer to sell property transferred in

connection with the performance of services to a specific person

or persons at its fair market value at the time of such sale is not a

nonlapse restriction


[continued]

43

Taxable Income Realized

• If a “nonlapse restriction” on the property is cancelled, the

recipient must realize taxable income, as compensation, unless

the recipient establishes that:

(1) the cancellation was not compensatory under all facts and

circumstances, and

(2) the person who would otherwise be allowed a deduction

will treat the cancellation as not compensatory


[continued]

44

Amount of Taxable Income

• If taxable income must be recognized, the amount of the taxable income

will equal the excess of:

(a) the fair market value of such property (computed without regard to

the “nonlapse restriction”) at the time of cancellation, over

(b) the sum of

(i) the fair market value of the property (computed by taking the

“nonlapse restriction” into account) immediately before the

cancellation, and

(ii) the amount, if any, paid for the cancellation

• Reg. § 1.83-5(b)(1)

Stock Options – Generally

45

• Grant of Options

Statutory (i.e., incentive) stock options and employee stock purchase plans

are not subject to section 83 – Code §83(e)

The grant of a nonstatutory option to purchase property does not constitute a

transfer of that property. Reg. §1.83-3(a)(2)

However, the option itself may be subject to section 83 if it has a “readily

ascertainable fair market value” at the time of grant. Reg. §1.83-7(a)

Stock Options – Generally [continued]

46

• Readily Ascertainable Defined

Options have a value at the time they are granted, but that value is ordinarily

not readily ascertainable unless the option is actively traded on an

established market

If an option is actively traded on an established market, the fair market value

of such option is readily ascertainable for purposes of this section by applying

the rules of valuation set forth in § 20.2031-2

Established markets – for example, the Chicago Board of Options Exchange

or the American Stock Exchange

In such a case, option is taxed as property under section 83

http://www.law.cornell.edu/cfr/text/26/20.2031-2



Stock Options – Generally [continued]

47

• Readily Ascertainable Defined (continued)

If an option is not actively traded on an established market, it does not have a readily

ascertainable fair market value unless the recipient can show that all of the following

conditions exist:

The option is transferable by the recipient;

The option is exercisable immediately in full by the recipient;

The option or the property subject to the option is not subject to any restriction or

condition (other than a lien or other condition to secure the payment of the purchase

price) which has a significant effect upon the fair market value of the option; and

The fair market value of the “option privilege” (the right to benefit from an increase in the

value of the underlying property while holding the option) is readily ascertainable in

accordance with Reg. § 1.83-7(b)(3) (requiring that the fair market value must be

measurable with reasonable accuracy)

Stock Options - Taxation

48

• Taxation Generally - Treas. Reg. 1.83-7(a)

If a recipient is granted a nonstatutory option for the performance of services,

the recipient realizes compensation:

(1) at the time of grant, in the amount of option’s fair market value at that

time less any amount paid for it, if the option has a “readily ascertainable

fair market value” at time of grant, or

(2) if the option does not have a “readily ascertainable fair market value” at

the time of grant, at the time the option is exercised or otherwise disposed

of, in the amount equal to the fair market value of the property received on

the exercise or disposition date less the exercise price.

Stock Options – Taxation [continued]

49

• Sale of the Property Acquired Upon Exercise Of The Option

If the property acquired upon exercise of an option is sold, then the recipient

recognizes capital gain, equal to the excess of the amount of cash or other

property received due to the sale, less the basis in the property

Basis generally is the exercise price paid, plus any compensation realized

under (1) or (2) above

Stock Options – Taxation [continued]

50

• Substantial Risk of Forfeiture

The above assumes that the property received upon exercise of the option

was not subject to a substantial risk of forfeiture

If the property underlying the option is subject to a substantial risk of forfeiture,

tax treatment depends upon whether there is a readily ascertainable fair

market value:

If not, then tax is not recognized on the property until the time of exercise

of the option.

If yes, then section 83 would apply to the option itself (but not the

underlying property) – absent an 83(b) election as to the unvested option,

taxation occurs when the restrictions lapse – no compensation income

upon exercise

Stock Options – Sale of the Option

51

• If the option did not have a readily ascertainable value at grant,

and then is sold in an arm’s length transaction before exercise,

the recipient realizes compensation equal to the amount received

for the option, less any basis.

Section 83 would cease to apply with respect to the property.

If the sale is not at arm’s length (e.g., a sale to a related party such as a

spouse), presumably, section 83 continues to apply to the underlying property.

• If the option did have a readily ascertainable value at grant, and

then is sold before exercise, the recipient realizes capital gain or

loss equal to the difference between the amount received for the

option and any basis. Reg. § 1.83-7(a)

Partnership Interests Generally

52

Partnership interests generally constitute property

Capital interests

give the holder a right to participate in liquidation of the partnership

from and after the date of issuance – immediate entitlement to

liquidation proceeds

If unrestricted and compensatory, income on date of transfer – rules of

partnership income apply to future allocations and distributions after

the compensation element is closed

Profits interests -give the holder a right to share in distributions/gains

above the liquidation value of the partnership on the date of issuance

Profits Interest Units

53

IRS gives safe harbor for unvested profits interest units whereby if properly

structured:

Value of profits interests at issuance is $0 for tax purposes

Neither issuance nor later vesting will be taxable if grantee is treated as owner from

date of issuance and partnership does not claim deduction

Safe harbor not available if disposed of within two years of receipt, if associated with

interest in publicly traded partnership or if relate to a substantially certain and predictable

stream of income

Risk that carried interest legislation could change characterization of profits interests

Query: What if fail to meet safe harbor requirements? Units taxable at later vesting?

Profits Interest Units [continued]

54

• “Protective” 83(b) elections—

Under Reg. 1.83-2(a), the fact that the property’s fair market value does not

exceed the amount paid for it, so there is no amount to include in gross

income if the recipient makes the section 83(b) election, does not prevent the

recipient from making the election

No requirement to make a section 83(b) election, but 83(b) election on

restricted profits interests is available at the “liquidation value” of $0 on the

date of grant

Service Recipient Tax Deduction

55

• Entitlement To A Deduction

If property is transferred as compensation for service, or a nonlapse restriction

on such property is cancelled while the property is substantially non-vested,

the person for whom the service was performed is entitled to a tax deduction,

under section 162 or 212 of the Code, in an amount equal to the

compensation realized by the recipient of the property, but only to the extent

the amount meets the “ordinary and necessary” and “reasonableness”

requirements of section 162 or 212

The deduction arises at the same time that the recipient realizes the

compensation

To be entitled to the deduction, the recipient’s compensation must be reported

on Form W-2 or Form 1099, as applicable

Reg. § 1.83-6(a)

Service Recipient Tax Deduction [continued]

56

• Gain or Loss - Reg. § 1.83-6(b)

In general, at the time of a transfer of property (other than employer stock) in

connection with the performance of services, the employer recognizes gain to

the extent that the employer receives an amount for the property that exceeds

the employer’s basis in the property.

In addition, at the time a deduction is allowed as above, gain or loss is

recognized by the employer to the extent of the difference between:

(1) the sum of the amount paid to the employer plus the amount allowed

as a deduction as above, and

(2) the sum of the employer's basis in the property plus any gain

recognized on the initial transfer

• Code § 1032(a) – However, no gain or loss recognized to a corporation on the receipt of

money or other property in exchange for stock (including treasury stock) of such corporation.

No gain or loss shall be recognized by a corporation with respect to any lapse or acquisition of

an option, or with respect to a securities futures contract, to buy or sell its stock (including

treasury stock).

Service Recipient Tax Deduction [continued]

57

• Income Paid On Restricted Property Until the transferred property becomes substantially vested, any income (e.g., dividends

or interest) the recipient obtains from the property is deductible by the employer, so long

as the “reasonableness” requirement of section 162 is met

• Property Returned On Forfeiture If a deduction is allowable to the employer under the section 83 rules (disregarding the

reasonableness of the amount of compensation) in respect of a transfer of property, and

the property is subsequently forfeited by the recipient, the amount of such deduction

becomes includible in the employer’s gross income under Reg. § 1.83-6(c)

• Parent Company Stock When a subsidiary transfers the stock of its parent company for services rendered, then

the subsidiary (not the parent) is entitled to the tax deduction

New Final Regulations Under Section 83

58

Generally

• On February 25, 2014, the Treasury Department and IRS issued final

regulations clarifying the forfeiture provisions under Section 83, for

transactions occurring after January 1, 2013

• The regulations are consistent with prior guidance, except that they offer

several clarifications on what constitutes a “substantial risk of forfeiture”

• The final regulations further clarify the impact of insider trading

restrictions under Section 16(b) of the Securities Exchange Act of 1934

and involuntary separations from service on the Section 83 “substantial

risk of forfeiture” analysis

New Final Regulations Under Section 83

[continued]

59

• More specifically, the new provision of the final regulations

clarifies the meaning of a “substantial risk of forfeiture” for

purposes of section 83

• Absent a section 83(b) election, transferred unvested property

becomes taxable to the recipient, under the section 83

regulations, when it becomes transferable by the recipient, or

when it ceases to have a substantial risk of forfeiture

New Reg. § 1.83-3(c)(1):

60

For purposes of section 83 and the these regulations thereunder, whether a risk of forfeiture is substantial

or not depends upon the facts and circumstances. A Except as set forth in paragraphs (j) and (k) of this

section, a substantial risk of forfeiture exists where `only if rights in property that are transferred are

conditioned, directly or indirectly, upon 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, and if the possibility of forfeiture is substantial if such. Property is not transferred subject to a

substantial risk of forfeiture if at the time of transfer the facts and circumstances demonstrate that the

forfeiture condition is not satisfied. Property unlikely to be enforced. Further, property is not transferred

subject to a substantial risk of forfeiture to the extent that the employer is required to pay the fair market

value of a portion of such property to the employee upon the return of such property. The risk that the

value of property will decline during a certain period of time does not constitute a substantial risk of

forfeiture. A nonlapse restriction, standing by itself, will not result in a substantial risk of forfeiture. A

restriction on the transfer of property, whether contractual or by operation of applicable law, will result in a

substantial risk of forfeiture only if and to the extent that the restriction is described in paragraph (j) or (k)

of this section. For this purpose, transfer restrictions that will not result in a substantial risk of forfeiture

include, but are not limited to, restrictions that if violated, whether by transfer or attempted transfer of the

property, would result in the forfeiture of some or all of the property, or liability by the employee for any

damages, penalties, fees, or other amount.

Substantial Risk of Forfeiture under the Final

Regulations

61

Facts and Circumstances Test

The revised provision continues the idea that the existence of a substantial

risk of forfeiture depends on all facts and circumstances

For example, as indicated in the current regulations (Reg. § 1.83-3(c)(2)), in

determining whether a covenant not to complete constitutes a substantial risk

of forfeiture as to an employee, factors to be considered include:

For an employee, the employee’s age;

The availability of alternative employment opportunities;

The likelihood of the employee's obtaining such other employment;

The degree of skill possessed by the employee;

The employee's health; and

The practice (if any) of the employer to enforce such covenants


Regulations [continued]

62

The new provision indicates that a “substantial risk of forfeiture” will not

exist, unless, at a minimum, the recipient’s rights in the transferred

property are either:

(a) conditioned on the future performance, or future refraining from

performance of substantial services, or

(b) subject to a condition related to the purpose of the transfer if

the possibility of not satisfying the condition is substantial



63

Likelihood of Occurrence and Enforcement :

A “substantial risk of forfeiture” will not exist, if at the time of the

property transfer the facts and circumstances demonstrate that the

forfeiture condition is unlikely to occur or be enforced

Implication for non-compete clauses?



64

• Employer Does NOT Pay FMV For Property

The new provision indicates that a “substantial risk of forfeiture” will not exist

to the extent the employer is required to pay the fair market value of a portion

of the transferred property to the employee if he or she returns the property

• No Substantial Risk Of Forfeiture

Each of the following, by itself, will not result in a “substantial risk of forfeiture”

The risk that the value of property will decline during a certain period of

time; or

The existence of a nonlapse restriction on the transferred property



65

• A restriction on the transfer of property, whether contractual or by

operation of applicable law, will result in a “substantial risk of forfeiture”

only if and to the extent that the restriction is described in paragraph (j) or

(k) of Reg. § 1.83-3 Under paragraph (j), if the sale of the property at a profit, within six months after the

transfer of the property to the recipient, could subject the recipient to suit under section

16(b) of the Securities Exchange Act of 1934, the recipient’s rights in the property are

treated as subject to a substantial risk of forfeiture and as not transferable until the earlier

of

(i) the expiration of such six-month period, or

(ii) the first day on which the sale of such property at a profit will not subject the

person to such suit

Under paragraph (k), the property is subject to substantial risk of forfeiture and is not

transferable so long as the property is subject to a restriction on transfer to comply with

the “Pooling-of-Interests Accounting” rules set forth in Accounting Series Release

Numbered 130



66

• For these purposes, transfer restrictions that will not result in a

substantial risk of forfeiture include restrictions that if violated,

whether by transfer or attempted transfer of the property, would

result in the forfeiture of some or all of the property, or liability by

the recipient for any damages, penalties, fees, or other amount

Such restrictions include insider-trading restrictions, Rule 10b-5 policies, lock-

up arrangements and blackout periods



67

• Note that the rules under paragraph (j) will not be applicable if the

recipient has made a section 83(b) election

• Also, as the new examples in the Final Regulations make clear,

the six month period in paragraph (j) cannot be extended, at least

for tax purposes, by making new purchases that may extend the

period for security law purposes


Regulations - Examples

68

§ 1.83-3(c)(4)

Example 6. On April 3, 2013, Y corporation grants to Q, an officer of Y, a nonstatutory option to

purchase Y common stock. Although the option is immediately exercisable, it has no readily

ascertainable fair market value when it is granted. Under the option, Q has the right to purchase

100 shares of Y common stock for $10 per share, which is the fair market value of a Y share on

the date of grant of the option. On August 1, 2013, Y sells its common stock in an initial public

offering. Pursuant to an underwriting agreement entered into in connection with the initial public

offering, Q agrees not to sell, otherwise dispose of, or hedge any Y common stock from August 1

through February 1 of 2014 (“the lock-up period”). Q exercises the option and Y shares are

transferred to Q on November 15, 2013, during the lock-up period. The underwriting agreement

does not impose a substantial risk of forfeiture on the Y shares acquired by Q because the

provisions of the agreement do not condition Q’s rights in the shares upon anyone’s future

performance (or refraining from performance) of substantial services or on the occurrence

of a condition related to the purpose of the transfer of shares to Q. Accordingly, neither

section 83(c)(3) nor the imposition of the lock-up period by the underwriting agreement precludes

taxation under section 83 when the shares resulting from exercise of the option are transferred to

Q.


Regulations – Examples [continued]

69

§ 1.83-3(c)(4)

Example 7. Assume the same facts as in Example 6, except that on August 1, 2013, Y also adopts an insider

trading compliance program, under which, as applied to 2013, insiders (such as Q) may trade Y shares only

during a limited number of days following each quarterly earnings release (“a trading window”). Under the

program, if Q trades Y shares outside a trading window without Y’s permission, Y has the right to terminate Q’s

employment. However, the exercise of the nonstatutory options outside a trading window for Y shares is not

prohibited under the insider trading compliance program. Q fully exercises the option, and Y shares are

transferred to Q, on November 15, 2013. The exercise of the option occurs outside a trading window, and, on the

date of exercise, Q is in possession of material nonpublic information concerning Y that would subject him to

liability under Rule 10b–5 under the Securities Exchange Act of 1934 if Q sold the Y shares while in possession of

such information. Neither the insider trading compliance program nor the potential liability under Rule

10b–5 impose a substantial risk of forfeiture on the Y shares acquired by Q because the provisions of the

program and Rule 10b–5 do not condition Q’s rights in the shares upon anyone’s future performance (or

refraining from performance) of substantial services or on the occurrence of a condition related to the

purpose of the transfer of shares to Q. Accordingly, none of section 83(c)(3), the imposition of the trading

windows by the insider trading compliance program, and the potential liability under Rule 10b–5 preclude taxation

under section 83 when the shares resulting from exercise of the option are transferred to Q.



70

§ 1.83-3(j)(2)

Example 4. (i) On June 3, 2013, Y corporation grants to Q, an officer of Y, a nonstatutory option to purchase Y

common stock. Y stock is traded on an established securities market. Although the option is immediately

exercisable, it has no readily ascertainable fair market value when it is granted. Under the option, Q has the right

to purchase 100 shares of Y common stock for $10 per share, which is the fair market value of a Y share on the

date of grant of the option. The grant of the option is not one that satisfies the requirements for a transaction that

is exempt from section 16(b) of the Securities Exchange Act of 1934. On December 15, 2013, Y stock is trading

at more than $10 per share. On that date, Q fully exercises the option, paying the exercise price in cash, and

receives 100 Y shares. Q’s rights in the shares received as a result of the exercise are not conditioned upon the

future performance of substantial services. Because no exemption from section 16(b) was available for the June

3, 2013 grant of the option, the section 16(b) liability period expires on December 1, 2013. Accordingly, the

section 16(b) liability period expires before the date that Q exercises the option and the Y common stock

is transferred to Q. Thus, the shares acquired by Q pursuant to the exercise of the option are not subject

to a substantial risk of forfeiture under section 83(c)(3) as a result of section 16(b). As a result, section

83(c)(3) does not preclude taxation under section 83 when the shares acquired pursuant to the December 15,

2013 exercise of the option are transferred to Q.



71

§ 1.83-3(j)(2)

Example 4. (ii) Assume the same facts as in paragraph (i) of this Example 4 except that Q

exercises the nonstatutory option on October 30, 2013 when Y stock is trading at more than $10

per share. The shares acquired are subject to a substantial risk of forfeiture under section

83(c)(3) as a result of section 16(b) through December 1, 2013.



72

§ 1.83-3(j)(2)

Example 4. (iii) Assume the same facts as in paragraph (i) of this Example 4 except that

on November 5, 2013, Q also purchases 100 shares of Y common stock on the public

market. The purchase of the shares is not a transaction exempt from section 16(b) of the

Securities Exchange Act of 1934. Because no exemption from section 16(b) was available

for the November 5, 2013 purchase of shares, the section 16(b) liability period with

respect to such shares will last for a period of six months after the November 5, 2013

purchase of shares.

Notwithstanding the non-exempt purchase of Y common stock on November 5, 2013, the

shares acquired by Q pursuant to the December 15, 2013 exercise of the option are not

subject to a substantial risk of forfeiture under section 83(c)(3) as a result of section 16(b).

As a result, section 83(c)(3) does not preclude taxation under section 83 when the shares

acquired pursuant to the December 15, 2013 exercise of the option are transferred to Q.

Preamble to New Final Regulations Under

Section 83

73

One comment expressed concern that the new regulations, as proposed, narrow

the circumstances that would establish a substantial risk of forfeiture and requested

clarification regarding whether an involuntary separation from service without cause

could establish a substantial risk of forfeiture

The comment noted that, for purposes of section 409A of the Code, an amount that

is payable only upon a service provider’s involuntary separation from service without

cause is subject to a substantial risk of forfeiture if the possibility of forfeiture is

substantial

IRS argued that these regulations are intended to clarify the definition of a

substantial risk of forfeiture and are consistent with the interpretation that the IRS

historically has applied (Robinson v. Commissioner, 805 F.2d 38 (1st Cir. 1986)), and

therefore from the perspective of Treasury and the IRS they do not constitute a

narrowing of the requirements to establish a substantial risk of forfeiture


Section 83 [continued]

74

• Further, Treasury and the IRS believe that these regulations should not be modified to

state that an involuntary separation from service without cause may qualify as a

substantial risk of forfeiture under section 83

• While a service provider’s right to receive property (or an amount in cash) in the future

upon the service provider’s involuntary separation from service without cause may be

subject to a substantial risk of forfeiture for purposes of section 409A if the possibility of

forfeiture is substantial, a substantial risk of forfeiture under section 83 can exist only

when property is actually transferred in connection with the performance of services

• A right to receive property in the future is generally not property for purposes of section

83 (see § 1.83–3(e))

• Accordingly, an involuntary separation from service without cause cannot qualify as a

substantial risk of forfeiture under section 83 if property is not transferred until after the

separation from service occurs


Section 83 [continued]

75

• When a transfer of property does occur, a substantial risk of forfeiture may be

established through a substantial services condition or a condition related to the

purpose of the transfer if the possibility of forfeiture is substantial

• The acceleration of vesting upon an involuntary separation from service without

cause (or separation from service as a result of death or disability) will not cause a

requirement of substantial services, which otherwise would be treated as a

substantial risk of forfeiture, to fail to qualify as such, provided that facts and

circumstances do not demonstrate that the occurrence of an involuntary

separation from service without cause is likely to occur during the agreed upon

service period

Recent Case Law

76

Tax Court Case [Austin v. Commissioner, 141 T.C. 18 (Dec. 16,

2013)]

• The Employees exchanged property for ostensibly restricted stock of a newly

formed S corporation (“S”)

• The issue arose as to whether the restricted stock was subject to a substantial risk

of forfeiture, so that it was not immediately taxable under section 83

• The governing agreements provided that the Employees, upon termination of

employment, would receive less than the full fair market value of their S shares

only if they were terminated “for cause” during the initial term of the employment

agreement

• Section 7(B) of the employment agreement defined termination “for cause” to

include termination upon “[f]ailure or refusal by Employee * * * to cure by faithfully

and diligently performing the usual and customary duties of his employment”

77

Recent Case Law [continued]


2013)] [continued]

• In analyzing the case, the Tax Court noted Reg. § 1.83-3(c)(2), which provides

that a requirement that stock be forfeited “if the employee is discharged for cause

or for committing a crime will not be considered to result in a substantial risk of

forfeiture”

• However, said the Tax Court, the term “discharged for cause,” as used in § 1.83-

3(c)(2), does not necessarily have the same meaning the parties have given that

term in their private agreements, but refers to termination for serious misconduct

which, like criminal misconduct, is highly unlikely to occur

• Hence, no substantial risk of forfeiture in the regulation


78


2013)] [continued]

• But here, the risk that the Employees would receive less than full fair market value

upon forfeiture of their stock if they failed faithfully and diligently to perform the

usual and customary duties of their employment during the prescribed period—

resulting in the “for cause” termination—constituted an earn-out restriction that

could create a “substantial risk of forfeiture” if there existed a sufficient likelihood

that the restriction would actually be enforced

• That is, there could be a substantial risk of forfeiture under section 83(c)(1) of the

Code, which provides “[t]he rights of a person in property are subject to a

substantial risk of forfeiture if such person’s rights to full enjoyment of such

property are conditioned upon the future performance of substantial services by

any individual”


79


2013)] [continued]

• Result The case proceeds to determine if, based on the facts, there is a substantial risk of forfeiture, for

example, because it is likely that the employer would enforce the “for cause” provision in the

governing agreements

• Takeaways When property is subject to restriction, it may be more likely that the restriction creates a

substantial risk of forfeiture than the regulations indicate on their face

Thus, one may wish to argue that a substantial risk of forfeiture exists, and postpone taxation, or

consider making a section 83(b) election, pay tax up front and convert subsequent appreciation

to capital gain

Also, when drafting an agreement governing the restriction, consider that broad definitions, for

example, broad forfeiture “for cause” provisions, will make forfeiture more likely to occur, thus

bettering the argument that a substantial risk of forfeiture-and postponed tax-exists for the

property in question

Other Tax Code Provisions

80

The definition of “substantial risk of forfeiture” in section 83

applies to the following Code provisions:

- section 430 (disregarding any amount includible in income with respect

to the granting of service recipient stock which is subject to a substantial

risk of forfeiture for at least 5 years after date of grant)

- section 3121(v) (under which deferred pay becomes subject to FICA tax

upon the later of the performance of the services creating entitlement to

the pay or ceasing to be subject to a substantial risk of forfeiture within

the meaning of section 83 - see below)

- section 280G (which defines vesting-and the application of tax on golden

parachute payments- by reference to section 83’s definition of

substantial risk of forfeiture - see below)

Other Tax Code Provisions

81

• Code Section 409A Compensation is subject to a substantial risk of forfeiture for purposes of section 409A if

entitlement to the amount is conditioned on the performance of substantial future services

by any person or the occurrence of a condition related to a purpose of the compensation,

and the possibility of forfeiture is substantial

A condition related to a purpose of the compensation must relate to the service provider's

performance for the service recipient or the service recipient's business activities or

organizational goals (e.g., the attainment of a prescribed level of earnings or equity value

or completion of an initial public offering)

If a service provider's entitlement to the amount is conditioned on the occurrence of the

service provider's involuntary separation from service without cause, the right is subject to

a substantial risk of forfeiture if the possibility of forfeiture is substantial

An amount is not subject to a substantial risk of forfeiture merely because the right

to the amount is conditioned, directly or indirectly, upon the refraining from the

performance of services

Reg. § 1.409A-1(d)

Other Tax Code Provisions [continued]

82

• Code Section 409A [continued]

Non-Competes – may be SROF for section 83, but not 409A

Termination without Cause – Generally not SROF for section 83, but may be

SROF for 409A

Restricted Stock Units (RSUs) and Cash - section 409A does not apply to

restricted stock or to most stock options, but it applies to certain RSUs and

cash awards; by contrast, section 83 applies to restricted stock and certain

stock options but does not apply to RSUs or to cash awards


83

Code Section 457A

“The rights of a person to compensation shall be treated as subject to a

substantial risk of forfeiture only if such person’s rights to such compensation

are conditioned upon the future performance of substantial services by any

individual”

No apparent SROF for either non-compete or performance-based property


84

Sub S Status

• In order for a corporation to obtain, and maintain, Sub S status,

the corporation cannot have more than 100 shareholders, and

cannot have more than one class of stock

• Restricted stock is not taken into account for this purpose until it

vests or until a section 83(b) election is made. Reg. § 1.1361-

1(b)(3)

• Planning Point: Be careful that restricted stock, when it

vests or is subject to a section 83(b) election, does not cause

the company to fail to meet the foregoing requirements for

maintaining Sub S status


85

Tax Withholding Generally

• The tax withholding obligation arises on realized compensation.

Revenue Ruling 79-305

• The employer may treat the compensation as regular or

supplemental wages

• Since the restricted property is not cash, the parties need to

determine how to ensure that taxes are paid—generally, the

employer can withhold from other cash compensation or the

recipient can give cash or part of the property to the employer


86

FICA/FUTA Employment Taxes

• FICA and FUTA Tax is imposed on any compensation which is

realized by the recipient with respect to restricted property

(generally upon vesting or under an 83(b) election). Revenue

Ruling 79-305

• Under sections 3121(v)(2)(A) and 3306(r)(2)(A) of the Code, any

amount deferred under a plan of nonqualified deferred

compensation is treated as wages, and is subject to FICA and

FUTA taxation, at the later of the time:

(1) the services resulting in the entitlement to the amount deferred are

performed, or

(2) there is no substantial risk of forfeiture of the rights to the amount deferred


87

Treasury

• Regulation § 31.3121(v)(2)-1(e)(3) states that, for purposes of this

section, the determination of whether a substantial risk of forfeiture exists

must be made in accordance with the principles of section 83 and the

regulations thereunder

• Planning Point: If the compensation is realized after the recipient has

reached the applicable wage base for the year ($118,500 for FICA and

$7,000 for FUTA in 2015), then there is no FUTA tax and only 1.45% of

the income is subject to both the employer and employee share of FICA

tax (usual rate is 7.65% for both employer and employee share)

It may pay to have the property “vest” in a year when the recipient has other

compensation, thereby avoiding most FUTA and FICA tax


88

Golden Parachute Rules

• Section 280G of the Code imposes a 20% excise tax on, and

treats as nondeductible, any “excess parachute payments”

• In general, “excess parachute payments” are payments made to a

“disqualified individual” which are contingent upon a change in

control and which exceed 3 times the individual’s average pay for

the prior 5 years


89

Golden Parachute Rules

• A “disqualified individual” is an individual who is:

(1) an employee, independent contractor, or other person specified in IRS

regulations who performs personal services for the company, and

(2) an officer, shareholder, or highly-compensated individual (highest paid 1%

of employees) of the company

• To the extent restricted stock vests upon a change in control, the 280G

value of the acceleration of vesting is considered in determining whether

there are any excess parachute payments, with any such excess

parachute payments subject to an additional 20% excise tax and

rendered nondeductible


90

Golden Parachute Rules [continued]

• Reg. § 1.280G–1, Q/A-22 discusses, for purposes of the Golden Parachute Rules of

section 280G of the Code, when a payment is contingent on a change in ownership or

control, and thus could be treated as a golden parachute payment

• Pursuant to this Q/A, a payment is treated as contingent on a change in ownership or

control, if the payment would not, in fact, have been made had no change in ownership or

control occurred, even if the payment is also conditioned on the occurrence of another

event -- A payment generally is treated as one which would not, in fact, have been made in

the absence of a change in ownership or control unless it is substantially certain, at the

time of the change, that the payment would have been made whether or not the change

occurred.

• A payment that becomes “vested” as a result of a change in ownership or control is not

treated as a payment which was substantially certain to have been made whether or not

the change occurred -- For these purposes, “vested” means the payment is substantially

vested within the meaning of §1.83–3(b) and (j), or the right to the payment is not

otherwise subject to a substantial risk of forfeiture as defined by section 83(c)


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Section 162(m)—$1 Million Tax Deduction

• Section 162(m)(1) of the Code limits a public company’s tax deduction

for compensation paid to a “covered person” to $1,000,000 per year

A “covered employee” is the CEO and three highest paid officers other than

the CEO and CFO

• Restricted stock will be count towards this $1,000,000 threshold unless

structured so as to be “qualified performance-based compensation”

• Restricted stock generally will not be considered to be performance

based unless “the amount of compensation the employee will receive

[under the restricted property] is not based solely on an increase in the

value of the stock after the date of grant or award.” Reg. § 1.162-

27(e)(2)(vi)(A)


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Section 162(m)—$1 Million Tax Deduction [continued]

• To qualify as qualified-performance-based compensation under

section 162(m):

the vesting occurs only upon attaining one or more pre-established, objective

performance goals set forth in writing by the compensation committee by the

time required by the regulations;

the performance goals under which vesting occurs must be established by a

compensation committee comprised solely of two or more outside directors;

the material terms of the performance goals must be disclosed to and

subsequently approved by shareholder vote before vesting can occur; and

the compensation committee must certify in writing that the performance goals

and the material terms thereof have been satisfied before the restricted stock

becomes vested


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Section 162(m)—$1 Million Tax Deduction [continued]

• Planning Point: The vesting of restricted stock generally counts

towards the $1,000,000 deduction limit for public companies

under section 162(m), unless structured as “qualified performance

based” compensation

• See Reg. § 1.162-27(e)

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