Foregoing Restricted Stock

[kgr12]

Is there any reason an individual holding restricted stock (before the restriction lapses) couldn't rework the restricted stock agreement to either (1) extend the restriction (i.e. keep it nontaxable); or (2) trade it for some other form of benefit (nontaxable, taxable, or otherwise)?

[Guest Scott Diamond]

In the current envrionment, executives can choose a variety of methods to defer taxation of restricted stock. You were right on target with your thoughts. The taxation can be deferred utilizing a deferred compensation plan and subsequently allowing either diversification or maintaining the investment in company stock. One other option in certain circumstances would be to utilize that stock to fund a estate benefit using pre-tax dollars. The second option is much trickier and would be dependant on the makeup of the restricted stock plan as well as new split dollar regulations.

[Kirk Maldonado]

Representatives of the IRS continually mention in public that they don't like continuing to defer amounts via "rolling elections," but I don't think that they are on firm ground. Also, given their defeat in Martin v. Commissioner, I doubt that they'd be eager to litigate this issue.

[Guest Harry O]

Actually, the IRS might just get emboldened in this area. A lot of the Enron/WorldCom legislation has some little nuggets tucked away that attack deferred compensation. The Thomas Ways and Means bill (I believe) repeals the 1978 Congressional restriction on the IRS's issuance of new deferred comp regulations and also prohibits deferrals to certain rabbi trusts. The point is that Congress may turn the IRS loose in this area and we would see guidance that is much more anti-deferral.

[mbozek]

I may be wrong, but my recollection is that the 1978 legislation pertained to the issuance of regulations restricting the ability of employees to make elective deferrals to a nonqualified plan. The IRS can issue regs on whether there is constructive receipt of income under any provision of the IRC as was recently done in the proposed regs under IRC 457 for public and NP non qualified deferred comp. plans. As Kirk noted the IRS has been badly battered in constructive receipt litigation because their position has no basis under the tax law going back to the first Veit case in 1944. Rabbi trust deferrals are supposed to be subject to the claims of the employers creditors, so in an Enron type situation the creditors could claim the assets. I would be interested in knowing what types of rabbi trust deferrals would be taxed.

Finally an individual who elects to contine restrictions on stock to prevent taxation may wind up seeing the value of the stock decline in the future. It may be better to include the stock as income in order to get a higher price. An indiviual can use hedges to protect the stock price but hedges are expensive.

[Guest Harry O]

That is what the IRS tried to do in 1978 - overturn the doctrine of constructive receipt by saying that any election to defer compensation would be disregarded and would be taxable at the time the compensation would have otherwise been received. The 1978 Act prohibited the IRS from changing the constructive receipt rules in effect as of 1978. This prohibition only applied with respect to taxable entities. That is why the section 457 regs are permissible.

Congress is apparently interested in offshore rabbi trusts and other rabbi trusts that appear unfunded and subject to claims of the employer's creditors but really aren't. We have all seen pitches for these types of trusts.

Finally, I know I am in a minority, but I never believed that the cases cited by taxpayers in the constructive receipt area are necessarily so pro-taxpayer. This is especially true in the case of second elections where executives want a naked right to further defer. But the IRS picked a lousy case to litigate (Martin) and has been spooked ever since.