Rev. Rul. 80-76

ISSUE

What are the federal income tax consequences of a transfer of stock under the circumstances described below?

FACTS

On January 2, 1979, A, an individual who owned a majority of the outstanding shares of P, a domestic corporation, transferred 10 shares of P stock to B. B was a key employee of S, also a domestic corporation and controlled by P within the meaning of section 368(c) of the Internal Revenue Code. The fair market value of the 10 shares on the date of transfer was 75x dollars. B's rights in the P stock were not subject to a substantial risk of forfeiture. The total compensation received by B in 1979, including the fair market value of the P stock, was reasonable compensation for services performed by B for S. Both S and B file federal income tax returns on a calendar year basis.

LAW

The applicable sections of the Code and the Income Tax Regulations are 83(a) and 1.83-1(a)(1), relating to the inclusion in gross income of the fair market value of property transferred in connection with the performance of services; 83(h) and 1.83-6, relating to the allowance of a deduction by the employer; and 3402 and 31.3402(a)-1, relating to the withholding of income tax at source on wages.

Section 83(a) of the Code provides that if, in connection with the performance of services, property is transferred to any person other than the person for whom the services are performed, the excess of (1) the fair market value of the property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of the person having the beneficial interest in the property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over (2) the amount (if any) paid for the property, is includible in the gross income of the person who performed the services in the first taxable year in which the rights of the person having the beneficial interest in the property are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable.

Section 1.83-6(a)(1) of the regulations provides that, in the case of a transfer of property in connection with the performance of services, a deduction is allowable under section 162 or 212 of the Code, to the person for whom the services were performed. The amount of the deduction is equal to the amount includible as compensation in the gross income of the service provider, but only to the extent the amount meets the requirements of section 162 or 212 and the regulations thereunder.

Section 1.83-6(a)(2) of the regulations provides that, if the service provider is an employee of the person for whom services are performed, the deduction is allowed only if the employer deducts and withholds upon the amount in accordance with section 3402 of the Code.

HOLDINGS

(1) No gain or loss is recognized by A as a result of the transfer of the 10 shares of P stock; however, A must allocate A's basis in the transferred stock to A's remaining shares of P stock.

(2) The fair market value of the stock on January 2, 1979, 75x dollars, is includible in B's gross income under section 83(a) of the Code for 1979 and is subject to the withholding of income tax at source on wages.

(3) Pursuant to section 83(h), S is allowed a deduction under section 162 of 75x dollars for 1979.

(4) Because section 83 applies to the transfer of the P stock to B, S does not recognize gain or loss on the transfer of the P stock.

The above principles would also apply had B's rights in the P stock been subject to a substantial risk of forfeiture.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 69-369, 1969-2 C.B. 27, which holds that the fair market value of stock transferred to a corporation by its majority shareholder pursuant to a prearranged plan for distribution by the corporation to certain of its employees is includible in the gross incomes of the employees under section 61 of the Code, but is not deductible by the corporation under section 162, is obsoleted with respect to transfers occurring after June 30, 1969, the effective date of section 83.

Rev. Rul. 69-368, 1969-2 C.B. 27, which holds that the fair market value of stock contributed to a corporation by its majority shareholder, not under a prearranged plan, and subsequently distributed by the corporation to its employees is includible in the gross incomes of the employees under section 61 of the Code and is deductible by the corporation under section 162, is also obsoleted with respect to transfers occurring after June 30, 1969.