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LTR 9810005 - As it applies to the Permanente Pension Plan

Full Text Citation: LTR 9810005; Doc 98-8395 (7 pages)"
From: Michael DeHoff
Subject: Pension & Benefits Update -- Vol. 9, No. 7

Pension & Benefits Update

Vol. 9, No. 7 -- March 30, 1998
A Service of Tax Analysts
Tax Information Worldwide
Copyright 1998
"Plan Trust Formation Won't Create Income for Participants

The Service has ruled that an exempt organization's adoption of a supplemental 
retirement plan will not cause any amount to be included in the gross income of 
the participants and beneficiaries. 

A taxable corporation Y provides services to a charitable organization X. Y operates 
a nonqualified supplemental retirement benefit plan. X and Y propose that X will 
provide funds to a trust from which Y can satisfy claims under the supplemental plan.
The Service also ruled that X will be the owner of trust assets for which there is a 
substantial risk of forfeiture under section 83. Y will be taxed on assets at the time 
those assets are not subject to a substantial risk of forfeiture. Similarly, at that time, 
Y will be treated as the owner of the assets and the income earned.


Absolute Must Reading to Understand More Completely What All of this Means.
Winter 2002
Nonqualified Plans and Executive Compensation
Page 35

Noncompete Clauses
Although the Code defines “substantial risk of forfeiture” as transfers
conditioned on the performance of services, the regulations add that

[See also, PLR 9810005 (requirement that participant remain alive until specified 
age not a substantial
risk of forfeiture under 83; ruling approved three-party deferred 
compensation arrangement
for plan maintained by taxable employer providing services 
to a tax-exempt entity, where the taxexempt
entity funds a trust that is beyond the reach 
of creditors).

There are a number of other instructive rulings regarding substantial risk of forfeiture
in the
457(f) context. See, e.g., PLR 9822030 (amounts credits to a 457(f) account 
are includible in income
when the substantial risk of forfeiture lapses).

42. Treas Reg 1.83-3(c)(2).

43. Treas Reg 1.83-3(c)(2). See, e.g., PLR 9615023 (Dec 28, 1995) (stock plan was amended to provide that vesting, exercise and settlement of stock options, SARs and restricted stock will be suspended if grantee has engaged in detrimental activity or accepted employment with another employer; held that bad boy clause will not be a substantial risk of forfeiture because of above regulation).

44. Code 83(c)(2); Treas Reg 1.83-3(d).

45. See, however, MacNaughton v United States, 888 F2d 418 (6th Cir1989), 
that even in absence
of a restrictive legend, stock can be restricted.]

transfers conditioned on refraining from performance of substantial services
are also considered substantial risks of forfeiture.46 Therefore, noncompete
clauses that require forfeiture only if the employee accepts a job
with a competing firm may, in certain circumstances, be a substantial risk
of forfeiture. The regulations state, however, that there is a rebuttable
presumption against classifying noncompete clauses as substantial risks
of forfeiture. They will ordinarily not be considered substantial risks of
forfeiture unless the facts and circumstances indicate to the contrary,
taking into account such factors as: the age of the employee, the availability
of alternative employment, the likelihood of obtaining such
employment, the degree of the employee’s skill, the employee’s health,
and the practice of the employer in enforcing such covenants.47
The regulations give an example of a 45 year old computer salesman
who is granted employer stock in connection with his termination of
employment. Retention of the stock is conditioned on his noncompetition
with the employer for a five-year period in the three-state area where he
had previously sold the employer’s products. Such a restriction is considered
substantial.48 If the employee was 65 years old, the result would
very likely be different. 

The presumption against a noncompete clause as a substantial risk
of forfeiture is based on the fact that such conditions are wholly within
the employee’s control and may often be merely a camouflage to delay
income.49 Since the determination of whether a noncompete clause is a
[46. Treas Reg 1.83-3(c)(1).

47. Treas Reg 1.83-3(c)(2).

48. Treas Reg 1.83-3(c)(4), Ex (5). See, e.g., PLR 9615023 (Dec 28, 1995) 
(stock plan was
amended to provide that vesting, exercise and settlement of 
stock options, SARs, and restricted stock
will be suspended if grantee has accepted employment with another employer; held that will not be considered a substantial 
risk of forfeiture because there is no pattern of enforcement or other indications

as to the likelihood of the forfeiture occurring).

49. Treas Dept News Release, dated October 1, 1970, quoted in GCM 38739 
(June 1, 1981) provides:

“Ordinarily a covenant not to compete or an agreement to provide consulting 
services will not
constitute a substantial risk of forfeiture in view of the fact 
that these conditions are wholly within
the employee’s control. However, in 
special cases, a covenant not to compete could constitute such a
risk as when 
it constitutes a major constraint on the employee’s normal working activities and

sources of income under circumstances where he could otherwise be expected
to compete.” The
Treas Notice of Prop Rulemaking, December 14, 1970, 
TD 7544, discusses substantial risk of forfeiture
and provides that a covenant 
not to compete ordinarily does not constitute a substantial risk of
forfeiture, and 
it goes on to state that: “It is hoped that these rules will emphasize that a restriction 
order to be considered a substantial risk of forfeiture under 83(a) must be 
related to the performance
or refraining from performance of services, and in 
addition, must impose a meaningful economic
restraint on the ultimate receipt of the property.”]

substantial risk of forfeiture is a factual determination, the IRS will not
rule on it.50

Possibility of Forfeiture Must be Substantial

Even though a condition may appear to be a substantial risk of forfeiture,
it may not be considered so if it is unlikely that the condition will
be enforced. The regulations provide that a substantial risk of forfeiture
exists only when the possibility of forfeiture is substantial should the
condition not be satisfied.51 This requirement is particularly relevant in
the employee/shareholder situation where it is very possible that even if
the condition is not satisfied the property will not actually be forfeited.52
In determining whether a possibility of forfeiture is substantial when the
property is transferred to an employee who owns a significant amount of
the voting power or value of stock of the employer, the regulations list
the following factors that must be taken into account: (1) the employee’s
relationship to other stockholders; (2) the position of the employee in the
corporation; (3) the employee’s relationship to the officers and directors;
(4) the persons who must approve the employee’s discharge; and (5) past
actions of the employer in enforcing the restrictions.53 The IRS will not
rule on whether a restriction is a substantial risk of forfeiture where the
employee is a controlling shareholder.54

Transfers that are conditioned on the occurrence of a “condition
related to a purpose of the transfer,” rather than on the performance of
services, will also be considered to result in a substantial risk of forfeiture.
55 The regulations cite as an example a transfer of property subject to
the requirement that it be returned if the total earnings of the employer do
not increase.56 This relates to the purpose of the transfer, because the
property is presumably being transferred to provide an incentive to
[50. PLR 8049091, citing Rev Proc 80-22 4.02, 1980-1 CB 654 (superseded by
Rev Proc 2001-3
4.02(1), 2001-1 CB 111), that the IRS will not issue rulings in 
areas where the determination
requested is primarily of fact.

51. Treas Reg 1.83-3(c)(1).

52. See Treas Reg 1.83-3(c)(3).

53. Treas Reg 1.83-3(c)(3). The prolongation by the employer and employee 
of the period during
which stock is nonvested does not cause any adverse tax consequences. See PLR 9431021(where the vesting of restricted stock, which 
was to vest after the fifth, sixth, and seventh year of employment,
was postponed 
the employee was not subject to taxation presuming future services required were 
continue to be substantial). Other IRS officials have criticized this ruling and 
are of the opinion that
rolling vesting to avoid taxation will not be effective. 
See, e.g. 79 BNA Daily Tax Rep G-5 (Apr 25,
95) and 22 BNA PenRptr 1319 
(June 5, 1995) (comments from Brisendine).

54. Rev Proc 2000-3 3.01(3), 2001-1 CB 111.

55. Treas Reg 1.83-3(c)(1). 56. Treas Reg 1.83-3(c)(2).]


employees to increase earnings.57 Such transfers of restricted stock conditioned
on the attainment of specific performance goals will become
more prevalent than the typical earn-out type of restrictions due to the
enactment by the Omnibus Budget Reconciliation Act of 1993 (OBRA)
of Code Section 162(m), which provides that the deduction limit on
employee remuneration in excess of $1 million will not apply to performance-
based compensation.58