Vested Restricted Stock Undervalued at Issuance

[Guest Buzzman]

Privately held corporation issues stock to employees upon board approval. Stock is fully vested at time of issuance and corporation treats issuance as payment of compensation to employee in an amount equal to "50% of book value", which amount is included on employee's W-2 for year of issuance. Stock issued to employee is subject to a stock purchase agreement that prohibits transfer and requires employee to sell, and corporation to purchase, the stock at "book value" upon employee's termination of employment. "Book value" is determined each year by the corporation's accountants.

Assume that the stock issuance is a "transfer of property" for purposes of Section 83. In the event it turns out that "50% of book value" is less than current fair market value for the stock at the time of issuance, is this strictly an issue under section 83 that is not subject to 409A (see Reg. 1.409A-1(b)(6)) or do we have a potential 409A deferral of compensation issue because of the undervaluation of compensation and right to payment potentially in a later tax year?

It seems to me this is a section 83 issue and to the extent "50% of book value" is less than current FMV, then the employee has not included sufficient income under section 83(a). I suppose the "payment" of the stock to the employee could also be excluded from 409A under the short term deferral rules, so long as it is paid within the applicable 2 1/2 month period following approval by the board.

Any thoughts would be appreciated.

[jpod]

I think you've got it all covered. Unless the transfer of property was itself the payment of deferred compensation in violation of 409A I see no 409A issue here, certainly none attributable to the feared undervaluation. Employee may owe back taxes for the year of the transfer if his 1040 is pulled within the limitations period, but that's a separate matter.

[Chaz]

I agree. The employer also may be subject to penalties for under withholding.