Full Text Citation: LTR 9810005; Doc 98-8395 (7 pages)”
From: Michael DeHoff
Subject: Pension & Benefits Update — Vol. 9, No. 7
Pension & Benefits Update
Vol. 9, No. 7 — March 30, 1998
A Service of Tax Analysts
Tax Information Worldwide
“Plan Trust Formation Won’t Create Income for Participants”
The Service has ruled that an exempt organization’s adoption of a supplemental retirement plan will not cause any amount to be included in the gross income of the participants and beneficiaries.
A taxable corporation Y provides services to a charitable organization X. Y operates a nonqualified supplemental retirement benefit plan. X and Y propose that X will provide funds to a trust from which Y can satisfy claims under the supplemental plan.
The Service also ruled that X will be the owner of trust assets for which there is a substantial risk of forfeiture under section 83. Y will be taxed on assets at the time those assets are not subject to a substantial risk of forfeiture. Similarly, at that time, Y will be treated as the owner of the assets and the income earned.
Absolute Must Reading to Understand More Completely What All of this
JOURNAL OF DEFERRED COMPENSATION
VOLUME 7, NUMBER 2
Nonqualified Plans and Executive Compensation
Although the Code defines “substantial risk of forfeiture” as transfers
conditioned on the performance of services, the regulations add that
[See also, PLR 9810005 (requirement that participant remain alive until specified age not a substantial risk of forfeiture under § 83; ruling approved three-party deferred compensation arrangement for plan maintained by taxable employer providing services to a tax-exempt entity, where the taxexempt entity funds a trust that is beyond the reach of creditors).
There are a number of other instructive rulings regarding substantial risk of forfeiture in the 457(f) context. See, e.g., PLR 9822030 (amounts credits to a 457(f) account are includible in income when the substantial risk of forfeiture lapses).
42. Treas Reg § 1.83-3(c)(2).
43. Treas Reg § 1.83-3(c)(2). See, e.g., PLR 9615023 (Dec 28, 1995) (stock plan was amended to provide that vesting, exercise and settlement of stock options, SARs and restricted stock will be suspended if grantee has engaged in detrimental activity or accepted employment with another employer; held that bad boy clause will not be a substantial risk of forfeiture because of above regulation).
44. Code § 83(c)(2); Treas Reg § 1.83-3(d).
45. See, however, MacNaughton v United States, 888 F2d
418 (6th Cir1989),
that even in absence of a restrictive legend, stock can be restricted.]
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transfers conditioned on refraining from performance of substantial services are also considered substantial risks of forfeiture.46 Therefore, noncompete clauses that require forfeiture only if the employee accepts a job with a competing firm may, in certain circumstances, be a substantial risk of forfeiture. The regulations state, however, that there is a rebuttable
presumption against classifying noncompete clauses as substantial risks
of forfeiture. They will ordinarily not be considered substantial risks of
forfeiture unless the facts and circumstances indicate to the contrary,
taking into account such factors as: the age of the employee, the availability
of alternative employment, the likelihood of obtaining such
employment, the degree of the employee’s skill, the employee’s health,
and the practice of the employer in enforcing such covenants.47
The regulations give an example of a 45 year old computer salesman
who is granted employer stock in connection with his termination of
employment. Retention of the stock is conditioned on his noncompetition
with the employer for a five-year period in the three-state area where he
had previously sold the employer’s products. Such a restriction is considered substantial.48 If the employee was 65 years old, the result would
very likely be different.
The presumption against a noncompete clause as a substantial risk
of forfeiture is based on the fact that such conditions are wholly within
the employee’s control and may often be merely a camouflage to delay
income.49 Since the determination of whether a noncompete clause is a
[46. Treas Reg § 1.83-3(c)(1).
47. Treas Reg § 1.83-3(c)(2).
48. Treas Reg § 1.83-3(c)(4), Ex (5). See, e.g., PLR 9615023 (Dec 28, 1995)
(stock plan was amended to provide that vesting, exercise and settlement of stock options, SARs, and restricted stock will be suspended if grantee has accepted employment with another employer; held that will not be considered a substantial risk of forfeiture because there is no pattern of enforcement or other indications as to the likelihood of the forfeiture occurring).
49. Treas Dept News Release, dated October 1, 1970, quoted in GCM 38739
(June 1, 1981) provides: “Ordinarily a covenant not to compete or an agreement to provide consulting services will not constitute a substantial risk of forfeiture in view of the fact that these conditions are wholly within the employee’s control. However, in special cases, a covenant not to compete could constitute such a risk as when it constitutes a major constraint on the employee’s normal working activities and sources of income under circumstances where he could otherwise be expected to compete.” The Treas Notice of Prop Rulemaking, December 14, 1970,
TD 7544, discusses substantial risk of forfeiture and provides that a covenant not to compete ordinarily does not constitute a substantial risk of forfeiture, and it goes on to state that: “It is hoped that these rules will emphasize that a restriction in order to be considered a substantial risk of forfeiture under § 83(a) must be related to the performance or refraining from performance of services, and in addition, must impose a meaningful economic restraint on the ultimate receipt of the property.”]
COMPENSATORY TRANSFERS OF RESTRICTED STOCK / Page 37
substantial risk of forfeiture is a factual determination, the IRS will not
rule on it.50
Possibility of Forfeiture Must be Substantial
Even though a condition may appear to be a substantial risk of forfeiture,
it may not be considered so if it is unlikely that the condition will
be enforced. The regulations provide that a substantial risk of forfeiture
exists only when the possibility of forfeiture is substantial should the
condition not be satisfied.51 This requirement is particularly relevant in
the employee/shareholder situation where it is very possible that even if
the condition is not satisfied the property will not actually be forfeited.52
In determining whether a possibility of forfeiture is substantial when the
property is transferred to an employee who owns a significant amount of
the voting power or value of stock of the employer, the regulations list
the following factors that must be taken into account: (1) the employee’s
relationship to other stockholders; (2) the position of the employee in the
corporation; (3) the employee’s relationship to the officers and directors;
(4) the persons who must approve the employee’s discharge; and (5) past
actions of the employer in enforcing the restrictions.53 The IRS will not
rule on whether a restriction is a substantial risk of forfeiture where the
employee is a controlling shareholder.54
Transfers that are conditioned on the occurrence of a “condition
related to a purpose of the transfer,” rather than on the performance of
services, will also be considered to result in a substantial risk of forfeiture. 55 The regulations cite as an example a transfer of property subject to the requirement that it be returned if the total earnings of the employer do not increase.56 This relates to the purpose of the transfer, because the
property is presumably being transferred to provide an incentive to
[50. PLR 8049091, citing Rev Proc 80-22 § 4.02, 1980-1 CB 654 (superseded by Rev Proc 2001-3 § 4.02(1), 2001-1 CB 111), that the IRS will not issue rulings in areas where the determination requested is primarily of fact.
51. Treas Reg § 1.83-3(c)(1).
52. See Treas Reg § 1.83-3(c)(3).
53. Treas Reg § 1.83-3(c)(3). The prolongation by the employer and employee of the period during which stock is nonvested does not cause any adverse tax consequences. See PLR 9431021(where the vesting of restricted stock, which was to vest after the fifth, sixth, and seventh year of employment, was postponed the employee was not subject to taxation presuming future services required were and continue to be substantial). Other IRS officials have criticized this ruling and are of the opinion that rolling vesting to avoid taxation will not be effective. See, e.g. 79 BNA Daily Tax Rep G-5 (Apr 25, 95) and 22 BNA PenRptr 1319 (June 5, 1995) (comments from Brisendine).
54. Rev Proc 2000-3 § 3.01(3), 2001-1 CB 111.
55. Treas Reg § 1.83-3(c)(1).
56. Treas Reg § 1.83-3(c)(2).]
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employees to increase earnings.57 Such transfers of restricted stock conditioned on the attainment of specific performance goals will become
more prevalent than the typical earn-out type of restrictions due to the
enactment by the Omnibus Budget Reconciliation Act of 1993 (OBRA)
of Code Section 162(m), which provides that the deduction limit on
employee remuneration in excess of $1 million will not apply to performance-based compensation.58