3532 / What are the tax consequences for the employee of a Section 83 funded deferred compensation agreement?

An interest is substantially vested if it is transferable or not subject to a Section 83 substantial risk of forfeiture. Under Section 83, an interest is transferable if it can be transferred free of a substantial risk of forfeiture ( Q 3538).¹ On May 29, 2012, the IRS released proposed regulations clarifying the definition of “substantial risk of forfeiture” under Section 83,² and incorporating its ruling in Revenue Ruling 2005-48 as to Section 83 equity plans (for details on the changes see Q 3538). On February 25, 2014, the IRS issued final regulations that are substantially similar to the proposed regulations. These regulations will apply to all transfers of property on or after January 1, 2013, and the proposed regulations may be relied on as to transfers after May 30, 2012.³

A partner is immediately taxable on the partner’s distributive share of contributions made to a trust in which the partnership has a substantially vested interest even if the partner’s right is not substantially vested.⁴

If an employee’s rights change from substantially nonvested to substantially vested, the value of the employee’s interest in the trust or the value of the annuity contract on the date of change (to the extent such value is attributable to contributions made after August 1, 1969) must be included in the employee’s gross income for the taxable year in which the change occurs. The value on the date of change also probably constitutes “wages” for the purposes of withholding⁵ and for purposes of FICA and FUTA ( Q 3576). The value of an annuity contract is its cash surrender value.⁶