Tax planning and compliance for investors
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Generally, stock is vested when you have a right to keep it — even if you can't sell it right away.
If you acquire stock from your employer, the tax consequences depend on whether the stock is vested. In the language of the IRS, the question is whether you have a substantial risk of forfeiture. These words have a special meaning. In general you have a substantial risk of forfeiture — and your stock isn't vested — if termination of your employment would cause you to lose some or all of the value of your stock.
Part VII of Consider Your Options deals with vesting.
Stock you receive as compensation is vested if either of the following are true:
The simplest example of a risk of forfeiture is where you receive stock from your employer but have to give it up if your employment terminates within a specified period of time. Stock received under these conditions isn't vested. Your stock becomes vested when your employment continues long enough so you don't have to give the stock back upon termination.
Your employer may insist that you sell your stock back to the company if your employment terminates within a specified period. This requirement may or may not create a substantial risk of forfeiture.
You may have agreed that you forfeit the stock if you're terminated for cause. The tax regulations say this is not a substantial risk of forfeiture, apparently because this is a relatively rare and unexpected event.
The risk that your stock will decline in value is not a substantial risk of forfeiture. This may be a genuine risk of loss, but it's not the kind of risk that's covered by this rule.
The Securities laws require certain executives of public corporations to disgorge (give up) any profits they have on sales of stock that occur under certain conditions. (These rules generally apply only to board members and certain top executives, so if you haven't heard about them they probably don't apply to you.) For tax purposes your stock is considered restricted (not vested) until such time as you can sell it at a profit without being subject to a suit under section 16b of the Securities Exchange Act of 1934. The interaction between the tax rules and section 16b is complicated, and the IRS hasn't explained how these rules work in connection with the current version of the section 16b regulations. If you're subject to section 16, you should strongly consider making the Section 83b Election when you acquire stock — even in an "exempt" transaction. The reason: the sale of this stock isn't necessarily an exempt transaction even if the acquisition was.
What if you have a restriction that never terminates? In the terminology of the tax law, this is a non-lapse restriction. Regardless of what you call it, you don't have a risk of forfeiture when this type of condition exists. The vesting rules deal only with restrictions that will lapse (or terminate) after some period of time, or if a particular event occurs.
Normally a risk of forfeiture is connected with continuing employment. But it can also be attached to an agreement not to compete or similar obligation. If you receive stock under an agreement that says you'll forfeit it if you compete with the company that granted the stock, you may have a substantial risk of forfeiture.
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