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Substantial Risk of Forfeiture

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April 22, 2014 | Barbara Baksa

Substantial Risk of Forfeiture

At the same time that the IRS released regulations designed to clarify which restrictions constitute a substantial risk of forfeiture under Section 83 (see my blog entry "IRS Issues Final Regs Under Section 83," March 4), a recent tax court decision casts doubt on the definition in the context of employees that are eligible to retire.


As my readers know, where 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.


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.

On the other hand, there are several aspects to this case that I think make the application of the court's decision to other situations somewhat unclear.  First, and most important, the termination provisions of the award in question were remarkably convoluted. So much so that resignation on the part of the employee would have constituted "cause" under the award agreement. There were not any special provisions relating to retirement; all voluntary terminations by the employee were treated the same under the agreement.  In addition, the employee was subject to an employment agreement and the forfeiture provisions of the award were intended to ensure that the employee fulfilled the terms of this agreement.

Finally, the decision notes that, for a substantial risk of forfeiture to exist, it must be likely that the forfeiture provision would be enforced.  I think that, for retirees, this often isn't the case--the only time a forfeiture provision would be enforced would be in the event of some sort of crime or other egregious behavior. Termination for cause is likely to be met with resistance from the otherwise retirement-eligible employee; many companies feel that, with the exception of circumstances involving clearly egregious acts, it is preferable to simply pay out retirement benefits than to incur the cost of a lawsuit.

Never-the-less, it is worth noting that 26% of respondents to the NASPP's recent quick survey on retirement provisions believe that awards held by retirees are subject to a substantial risk of forfeiture.

- Barbara

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