IRS Clarifies Rules on Transfers of Substantially Vested Stock

July 6, 2007 (PLANSPONSOR.com) - In its latest revenue ruling the Internal Revenue Service (IRS) clarifies the tax consequences under Section 83 of the Internal Revenue Code when restrictions are imposed on substantially vested stock causing that stock to become substantially nonvested.

Revenue Ruling 2007-49 holds that if the imposition of restrictions on substantially vested stock, which causes such stock to become substantially nonvested, occurs in the absence of an exchange of stock, the substantially nonvested stock is not subject to Section 83. 

Specifically, the IRS addressed a situation in which an employee is issued shares of employer stock that are substantially vested in return for services rendered. When the employer receives funding from an investor in exchange for shares, a restriction is placed on the employee’s stock that makes it substantially unvested.

The IRS explains that since the shares are continuously owned by the employee and included in gross income when received, the employee does not have to include the value of the shares in gross income again when the stock again becomes substantially vested.

However, according to the ruling, if substantially vested stock is exchanged for substantially nonvested stock, the nonvested stock is subject to Section 83. The examples given by the IRS include a situation where the employer is acquired by another company with an exchange of shares for shares, and a situation where the acquisition occurs with an exchange of shares for part cash and part shares.

In these two scenarios, the transfer of stock of the new company indicates a new receipt of shares by the employee, and the value of the shares becomes taxable once the shares become substantially vested and the employee is able to sell them.

IRS Revenue Ruling 2007-49 is here .

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