Interpretation of Stock Vesting Rule

January 5, 2014

Compensation in stock and optionsThe Tax Court recently rejected an IRS attempt to treat stock as vested based on a provision in the regulations dealing with termination for cause. The court found that the employment agreement used the word “cause” with a different meaning than in the regulation.

The case deals with one of the core concepts of compensation in stock and options: when will stock be considered substantially vested? You don’t pay tax on stock compensation until it’s vested.

The regulations say stock vesting occurs when the stock becomes transferable, or when it’s no longer subject to a substantial risk of forfeiture. The most common SRF is a requirement to continue working for the company. A risk of forfeiture isn’t considered substantial, though, if it’s based on an improbable event, such as termination for cause or for commission of a crime.

In this case, the taxpayers claimed to have a substantial risk of forfeiture based on a contractual provision dealing with termination for cause. They contended that as defined in the contract, “cause” had a different meaning than in the regulation. The Tax Court agreed, finding that under the peculiar terms of this contract, a voluntary decision by the employee to stop working for the company could be treated as a termination for cause. In short, so avoid a forfeiture, the taxpayers had to continue providing services to the company, so the contract imposed a substantial risk of forfeiture.

Tax Court opinion: Austin v. Commissioner


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