[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.83-5]

[Page 338-340]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.83-5  Restrictions that will never lapse.

    (a) Valuation. For purposes of section 83 and the regulations 
thereunder, in the case of property subject to a nonlapse restriction 
(as defined in Sec. 1.83-3(h)), the price determined under the formula 
price will be considered to be the fair market value of the property 
unless established to the contrary by the Commissioner, and the burden 
of proof shall be on the commissioner with respect to such value. If 
stock in a corporation is subject to a nonlapse restriction which 
requires the transferee to sell such stock only at a formula price based 
on book value, a reasonable multiple of earnings or a reasonable 
combination thereof, the price so determined will ordinarily be regarded 
as determinative of the fair market value of such property for purposes 
of section 83. However, in certain circumstances the formula price will 
not be considered to be the fair market value of property subject to 
such a formula price restriction, even though the formula price 
restriction is a substantial factor in determining such value. For 
example, where the formula price is the current book value of stock, the 
book value of the stock at some time in the future may be a more 
accurate measure of the value of the stock than the current book value 
of the stock for purposes of determining the fair market value of the 
stock at the time the stock becomes substantially vested.
    (b) Cancellation--(1) In general. Under section 83(d)(2), if a 
nonlapse restriction imposed on property that is subject to section 83 
is cancelled, then, unless the taxpayer establishes--
    (i) That such cancellation was not compensatory, and
    (ii) That the person who would be allowed a deduction, if any, if 
the cancellation were treated as compensatory, will treat the 
transaction as not compensatory, as provided in paragraph (c)(2) of this 
section, the excess of the fair market value of such property (computed 
without regard to such restriction) at the time of cancellation, over 
the sum of--
    (iii) The fair market value of such property (computed by taking the 
restriction into account) immediately before the cancellation, and
    (iv) The amount, if any, paid for the cancellation, shall be treated 
as compensation for the taxable year in which such cancellation occurs. 
Whether there has been a noncompensatory cancellation of a nonlapse 
restriction under section 83(d)(2) depends upon the

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particular facts and circumstances. Ordinarily the fact that the 
employee or independent contractor is required to perform additional 
services or that the salary or payment of such a person is adjusted to 
take the cancellation into account indicates that such cancellation has 
a compensatory purpose. On the other hand, the fact that the original 
purpose of a restriction no longer exists may indicate that the purpose 
of such cancellation is noncompensatory. Thus, for example, if a so-
called ``buy-sell'' restriction was imposed on a corporation's stock to 
limit ownership of such stock and is being cancelled in connection with 
a public offering of the stock, such cancellation will generally be 
regarded as noncompensatory. However, the mere fact that the employer is 
willing to forego a deduction under section 83(h) is insufficient 
evidence to establish a noncompensatory cancellation of a nonlapse 
restriction. The refusal by a corporation or shareholder to repurchase 
stock of the corporation which is subject to a permanent right of first 
refusal will generally be treated as a cancellation of a nonlapse 
restriction. The preceding sentence shall not apply where there is no 
nonlapse restriction, for example, where the price to be paid for the 
stock subject to the right of first refusal is the fair market value of 
the stock. Section 83(d)(2) and this (1) do not apply where immediately 
after the cancellation of a nonlapse restriction the property is still 
substantially nonvested and no section 83(b) election has been made with 
respect to such property. In such a case the rules of section 83(a) and 
Sec. 1.83-1 shall apply to such property.
    (2) Evidence of noncompensatory cancellation. In addition to the 
information necessary to establish the factors described in paragraph 
(b)(1) of this section, the taxpayer shall request the employer to 
furnish the taxpayer with a written statement indicating that the 
employer will not treat the cancellation of the nonlapse restriction as 
a compensatory event, and that no deduction will be taken with respect 
to such cancellation. The taxpayer shall file such written statement 
with his income tax return for the taxable year in which or with which 
such cancellation occurs.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example (1). On November 1, 1971, X corporation whose shares are 
closely held and not regularly traded, transfers to E, an employee, 100 
shares of X corporation stock subject to the condition that, if he 
desires to dispose of such stock during the period of his employment, he 
must resell the stock to his employer at its then existing book value. 
In addition, E or E's estate is obligated to offer to sell the stock at 
his retirement or death to his employer at its then existing book value. 
Under these facts and circumstances, the restriction to which the shares 
of X corporation stock are subject is a nonlapse restriction. 
Consequently, the fair market value of the X stock is includible in E's 
gross income as compensation for taxable year 1971. However, in 
determining the fair market value of the X stock, the book value formula 
price will ordinarily be regarded as being determinative of such value.
    Example (2). Assume the facts are the same as in example (1), except 
that the X stock is subject to the condition that if E desires to 
dispose of the stock during the period of his employment he must resell 
the stock to his employer at a multiple of earnings per share that is in 
this case a reasonable approximation of value at the time of transfer to 
E. In addition, E or E's estate is obligated to offer to sell the stock 
at his retirement or death to his employer at the same multiple of 
earnings. Under these facts and circumstances, the restriction to which 
the X corporation stock is subject is a nonlapse restriction. 
Consequently, the fair market value of the X stock is includible in E's 
gross income for taxable year 1971. However, in determining the fair 
market value of the X stock, the multiple-of-earnings formula price will 
ordinarily be regarded as determinative of such value.
    Example (3). On January 4, 1971, X corporation transfers to E, an 
employee, 100 shares of stock in X corporation. Each such share of stock 
is subject to an agreement between X and E whereby E agrees that such 
shares are to be held solely for investment purposes and not for resale 
(a so-called investment letter restriction). E's rights in such stock 
are substantially vested upon transfer, causing the fair market value of 
each share of X corporation stock to be includible in E's gross income 
as compensation for taxable year 1971. Since such an investment letter 
restriction does not constitute a nonlapse restriction, in determining 
the fair market value of each share, the investment letter restriction 
is disregarded.
    Example (4). On September 1, 1971, X corporation transfers to B, an 
independent contractor, 500 shares of common stock in X corporation in 
exchange for B's agreement to

[[Page 340]]

provide services in the construction of an office building on property 
owned by X corporation. X corporation has 100 shares of preferred stock 
outstanding and an additional 500 shares of common stock outstanding. 
The preferred stock has a liquidation value of $1,000x, which is equal 
to the value of all assets owned by X. Therefore, the book value of the 
common stock in X corporation is $0. Under the terms of the transfer, if 
B wishes to dispose of the stock, B must offer to sell the stock to X 
for 150 percent of the then existing book value of B's common stock. The 
stock is also subject to a substantial risk of forfeiture until B 
performs the agreed-upon services. B makes a timely election under 
section 83(b) to include the value of the stock in gross income in 1971. 
Under these facts and circumstances, the restriction to which the shares 
of X corporation common stock are subject is a nonlapse restriction. In 
determining the fair market value of the X common stock at the time of 
transfer, the book value formula price would ordinarily be regarded as 
determinative of such value. However, the fair market value of X common 
stock at the time of transfer, subject to the book value restriction, is 
greater than $0 since B was willing to agree to provide valuable 
personal services in exchange for the stock. In determining the fair 
market value of the stock, the expected book value after construction of 
the office building would be given great weight. The likelihood of 
completion of construction would be a factor in determining the expected 
book value after completion of construction.

[T.D. 7554, 43 FR 31918, July 24, 1978]