Substantial Risk of Forfeiture

Publisher: NASPP

At the same time that the IRS released regulations designed to clarify which restrictions constitute a substantial risk of forfeiture under Section 83, a recent tax court decision casts doubt on the definition in the context of employees that are eligible to retire.

Background

When an employee is eligible to retire and holds restricted stock that provides for accelerated or continued vesting upon retirement, the awards are considered to no longer be subject to a substantial risk of forfeiture, and, consequently, are subject to tax under Section 83. This also applies to RSUs, because for FICA purposes, RSUs are subject to tax when no longer subject to a substantial risk of forfeiture and the regs in this area look to Section 83 to determine what constitutes a substantial risk of forfeiture.

Although there’s usually some limited risk of forfeiture in the event that the retirement-eligible employee is terminated for cause, that risk isn’t considered to be substantial. As a practical matter, at many companies just about any termination after achieving retirement age is treated as a retirement.

Austin v. Commissioner

In Austin v. Commissioner however, the court held that an employee’s awards were still subject to a substantial risk of forfeiture even though the only circumstance in which the awards could be forfeited was termination due to cause. In this case, in addition to the typical definition of commission of a crime, “cause” included failure on the part of the employee to perform his job or to comply with company policies, standards, etc.

Implications

Up until now, most practitioners have assumed that providing for forfeiture solely in the event of termination due to cause is not sufficient to establish a substantial risk of forfeiture, regardless of how broad the definition of “cause” is. Austin seems to suggest, however, that, in some circumstances, defining “cause” more broadly (e.g., as more than just the commission of a crime) could implicate a substantial risk of forfeiture, thereby delaying taxation (for both income and FICA purposes in the case of restricted stock, for FICA purposes in the case of RSUs) until the award vests.

For full access to the rest of the implications of Austin v. Commissioner, please click here.