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Banking & Finance Law Report

Final IRS Regulations Issued on Restricted Stock Grants

Posted in Employment and Compensation Law, Tax Law

Restricted stock grants have been a popular executive compensation component for over a decade now. With a restricted stock grant, the employer gives shares of stock to the employee, but subject to two main conditions. One condition is a vesting condition, which generally requires the employee to remain continuously employed with the employer for a period of years, satisfy performance targets, or both. If the employee fails to satisfy the vesting requirements, the employee forfeits the stock. The other condition is that during the vesting period, the employee is prohibited from selling or otherwise transferring the stock.

Restricted stock is popular because it provides a link between the performance of the company and the compensation of the employee. At the same time, unless a complete disaster occurs, the employee generally is guaranteed of receiving some payment because the compensation is equal to the value of the stock, rather than only the appreciation in the value of the stock. In a turbulent economy, that protection is valued by employees.

With any executive compensation arrangement, however, it is important to consult the tax rules. Generally, the value of the stock to the employee who receives a restricted stock grant is not taxed until the earlier of when the stock becomes either no longer subject to a substantial risk of forfeiture (i.e., vested), or when the stock becomes transferable. The IRS and Treasury recently issued final regulations that “clarify” the types of conditions that the IRS will respect as imposing a substantial risk of forfeiture. The clarifications stress that vesting conditions will impose a substantial risk of forfeiture only if they require completion of a period of service, or satisfaction of performance goals, and that it is not a certainty that these conditions will be satisfied.

In some ways, the “clarifications” feel more like new rules than clarifications of existing rules. The IRS, however, says that it has always interpreted the applicable regulations this way. Over time, it has seen employers try to use other types of vesting conditions, such as clawback provisions and insider trading policies, when granting these awards. The IRS felt that it was worth publishing that these conditions, by themselves, will not impose a substantial risk of forfeiture. Unless other service or performance-based vesting requirements apply to the awards, the restricted stock would be immediately taxable upon the date of grant.

The good news is that most restricted stock agreements should be written in a manner consistent with the recent clarifications. It may still be worth reviewing any outstanding agreements to make sure they do not contain any unpleasant tax surprises. To learn more about these clarifications, we invite you to read the following blogs that describe these issues in more detail:

“Substantial Risk of Forfeiture” Clarification Impacts Restricted Property (Stock) Grants

Substantial risk of forfeiture guidance clarifies when Section 16 short-swing profit liability can defer taxation of equity compensation awards