Extended risk of forfeiture delays recognition of income with respect to restricted property.

Letter Ruling 9431021 recently addressed an issue that has long been a source of speculation for executive compensation tax specialists. The ruling involved a company that transferred restricted shares of common stock to an employee. The stock was to vest in increments of one-third on the fifth, sixth and seventh years after grant, as long as the employee was still providing services for the employer. In addition, the stock was not transferable until vested. The company proposed to lengthen the period for which the employee would have to remain employed before the shares would vest and commensurably defer the lapsing of the restrictions on transferability. The ruling held that this modification would not cause the employee to be to include the value of the shares in gross income.

Sec. 83 provides that the recipient of restricted property will be taxed on its value when such property is no longer subject to a substantial risk of forfeiture or the property becomes transferable, whichever occurs first. The IRS reasoned that the postponement of the shares' vesting dates did not cause them to become transferable, nor did it free the employee from the obligation to provide future services. This would be true for "[a]s long as the future services required of the Employee were and continue to be substantial." It is not clear from the ruling where the threshold rests with respect to making such a change in the vesting schedule. For example, would a lengthening of the vesting schedule be given effect for tax purposes if it occurs in the same tax year as the original vesting date? Although some questions remain, the ruling does provide a precedent in this area.

Whether the Service will continue to follow this position is also unclear. Subsequent to the issuance of the ruling, at least one IRS official has suggested that the Service may reconsider its position.