SECTION 2. LAW AND DISCUSSION

Section 83(a) provides that if, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of (1) the fair market value of such 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 such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over (2) the amount (if any) paid for such property, is included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not

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tion related to a purpose of the transfer, and the possibility of forfeiture is substantial if such condition is not satisfied.

Section 1.83–3(d) provides that, for § 83 purposes, the rights of a person in property are transferable if such person can transfer any interest in the property to any person other than the transferor of the property, but only if the rights in such property of such transferee are not subject to a substantial risk of forfeiture.

Proposed § 1.83–3(l) provides that, subject to such additional conditions, rules, and procedures that the Commissioner may prescribe in regulations, revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin, a partnership and all of its partners may elect a safe harbor under which the fair market value of a partnership interest that is transferred in connection with the performance of services is treated as being equal to the liquidation value of that interest for transfers on or after the date final regulations are published in the Federal Register if the following conditions are satisfied: (1) the partnership must prepare a document, executed by a partner who has responsibility for federal income tax reporting by the partnership, stating that the partnership is electing, on behalf of the partnership and each of its partners, to have the safe harbor apply irrevocably as of the stated effective date with respect to all partnership interests transferred in connection with the performance of services while the safe harbor election remains in effect and attach the document to the tax return for the partnership for the taxable year that includes the effective date of the election; (2) except as provided below, the partnership agreement must contain provisions that are legally binding on all of the partners stating that (a) the partnership is authorized and directed to elect the safe harbor, and (b) the partnership and each of its partners (including any person to whom a partnership interest is transferred in connection with the performance of services) agrees to comply with all requirements of the safe harbor with respect to all partnership interests transferred in connection with the performance of services while the election remains effective; and (3) if the partnership agreement does not contain the provisions described in clause (2) of this sentence, or the provisions are not legally binding on all of the partners of

subject to a substantial risk of forfeiture, whichever is applicable.

Section 1.83–3(e) provides that, for purposes of § 83 and the regulations thereunder, the term property includes real and personal property other than either money or an unfunded and unsecured promise to pay money or property in the future. For these purposes, under proposed § 1.83–3(e) property includes a partnership interest. Generally, a mere right to allocations or distributions described in § 707(a)(2)(A) is not a partnership interest. Proposed § 1.83–3(e) also provides that, in the case of a transfer of a partnership interest in connection with the performance of services, the Commissioner may prescribe generally applicable administrative rules to address the application of § 83 to the transfer.

Section 83(b) provides that a service provider may elect to include in his or her gross income, for the taxable year in which substantially nonvested property is transferred, the excess of (1) the fair market value of the property at the time of the transfer (determined without regard to any restriction other than a restriction which by its terms will never lapse), over (2) the amount (if any) paid for the property. If such an election is made, § 83(a) does not apply with respect to the transfer of the property upon vesting and, if the property is subsequently forfeited, no deduction is allowed to the service provider in respect of the forfeiture.

Section 1.83–2(b) provides that an election under § 83(b) must be filed not later than 30 days after the date the property was transferred and may be filed prior to the date of the transfer. Section 1.83–2(c) provides that the election is made by filing one copy of a written statement with the Internal Revenue Service Center with which the service provider files his or her return. In addition, one copy of such statement must be submitted with the service provider’s income tax return for the taxable year in which the property was transferred.

Section 1.83–1(a) provides that, unless an election under § 83(b) is made, the transferor is regarded as the owner of substantially nonvested property transferred in connection with the performance of services until such property becomes substantially vested, and any income from such property received by the service provider (or beneficiary thereof), or the

right to the use of such property by the service provider, constitutes additional compensation and is included in the gross income of the service provider for the taxable year in which the income is received or the use is made available. Under this rule, a partnership must treat as unissued any substantially nonvested partnership interest transferred in connection with the performance of services for which an election under § 83(b) has not been made. If the service provider who holds such an interest receives distributions from the partnership with respect to that interest while the interest is substantially nonvested, the distributions are treated as compensation in the capacity in which the service provider performed the services. For example, if a service provider that is not a pre-existing partner holds a substantially nonvested partnership interest that the service provider received in connection with the performance of services and the service provider did not make an election under § 83(b) with respect to that interest, then any distributions made to the service provider on account of such interest are treated as additional compensation and not partnership distributions. If, instead, the service provider who receives a substantially nonvested partnership interest in connection with the performance of services makes a valid election under § 83(b), then the service provider is treated as the owner of the property. See Rev. Rul. 83–22, 1983–1 C.B. 17. The service provider is treated as a partner with respect to such an interest, and the partnership must allocate partnership items to the service provider as if the partnership interest were substantially vested.

Section 1.83–3(b) provides that property is substantially nonvested for § 83 purposes when it is subject to a substantial risk of forfeiture and is nontransferable. Property is substantially vested for § 83 purposes when it is either transferable or not subject to a substantial risk of forfeiture.

Section 1.83–3(c) provides that, for § 83 purposes, whether a risk of forfeiture is substantial or not depends upon the facts and circumstances. A substantial risk of forfeiture exists where rights in property that are transferred are conditioned, directly or indirectly, upon the future performance (or refraining from performance) of substantial services by any person, or the occurrence of a condi

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made with respect to a substantially nonvested interest, allocations of partnership items while the interest is substantially nonvested cannot have economic effect.

Proposed § 1.704–1(b)(4)(xii)( b ) provides that allocations of partnership items to a holder of a substantially nonvested interest for which a § 83(b) election has been made will be deemed to be in accordance with the partners’ interests in the partnership if the partnership agreement requires that: (1) in the event that the interest for which the § 83(b) election is made is later forfeited, the partnership shall make forfeiture allocations in the year of the forfeiture; and (2) all material allocations and capital account adjustments under the partnership agreement not pertaining to substantially nonvested partnership interests for which a § 83(b) election has been made are recognized under § 704(b). Proposed § 1.704–1(b)(4)(xii)( e ) provides that proposed § 1.704–1(b)(4)(xii)( b ) does not apply to allocations of partnership items made with respect to a substantially nonvested interest for which the holder has made a § 83(b) election if, at the time of the § 83(b) election, there is a plan that the interest will be forfeited. In determining whether there is a plan that the interest will be forfeited, the Commissioner will consider all of the facts and circumstances (including the tax status of the holder of the forfeitable compensatory partnership interest).

Proposed § 1.704–1(b)(4)(xii)( c ) defines forfeiture allocations as allocations to the service provider (consisting of a pro rata portion of each item) of gross income and gain or gross deduction and loss (to the extent such items are available) for the taxable year of the forfeiture in a positive or negative amount equal to (1) the excess (not less than zero) of (a) the amount of the distributions (including deemed distributions under § 752(b) and the adjusted tax basis of any property so distributed) to the partner with respect to the forfeited partnership interest (to the extent such distributions are not taxable under § 731), over (b) the amounts paid for the interest and the adjusted tax basis of property contributed by the partner (including deemed contributions under § 752(a)) to the partnership with respect to the forfeited partnership interest, minus (2) the cumulative net income (or loss) allocated to the partner with respect to the forfeited partnership

the partnership, then each partner in a partnership that transfers a partnership interest in connection with the performance of services must execute a document containing provisions that are legally binding on that partner stating that (a) the partnership is authorized and directed to elect the safe harbor, and (b) the partner agrees to comply with all requirements of the safe harbor with respect to all partnership interests transferred in connection with the performance of services while the election remains effective. The specified effective date of the safe harbor election may not be prior to the date that the safe harbor election is executed. Proposed § 1.83–3(l) provides that the partnership must retain such records as may be necessary to indicate that an effective election has been made and remains in effect, including a copy of the partnership’s election statement under this paragraph (l), and, if applicable, the original of each document submitted to the partnership by a partner under this paragraph (l). If the partnership is unable to produce a record of a particular document, the election will be treated as not made, generally resulting in termination of the election. The safe harbor election also may be terminated by the partnership preparing a document, executed by a partner who has responsibility for federal income tax reporting by the partnership, which states that the partnership, on behalf of the partnership and each of its partners, is revoking the safe harbor election on the stated effective date, and attaching the document to the tax return for the partnership for the taxable year that includes the effective date of the revocation.

Section 83(h) provides that, in the case of a transfer of property in connection with the performance of services or a cancellation of a restriction described in § 83(d), there is allowed as a deduction under § 162, to the person for whom the services were performed (the service recipient), an amount equal to the amount included under § 83(a), (b), or (d)(2) in the gross income of the service provider. The deduction is allowed for the taxable year of the service recipient in which or with which ends the taxable year in which such amount is included in the gross income of the service provider. Under § 1.83–6(a)(3), if property is substantially vested upon the transfer, the deduction is

allowed to the service recipient in accordance with its method of accounting (in conformity with §§ 446 and 461).

Section 1.83–6(c) provides that if, under § 83(h) and § 1.83–6(a), a deduction, an increase in basis, or a reduction of gross income was allowable (disregarding the reasonableness of the amount of compensation) in respect of a transfer of property and such property is subsequently forfeited, the amount of such deduction, increase in basis, or reduction of gross income shall be includible in the gross income of the person to whom it was allowable for the taxable year of the forfeiture. The basis of such property in the hands of the person to whom it is forfeited shall include any such amount includible in the gross income of such person, as well as any amount such person pays upon forfeiture.

Section 704(b) requires that a partner’s distributive share of income, gain, loss, deduction, or credit (or item thereof) be determined in accordance with the partner’s interest in the partnership, determined by taking into account all facts and circumstances, if (1) the partnership agreement does not provide otherwise as to the partner’s distributive share, or (2) the allocation to a partner under the agreement does not have substantial economic effect.

Proposed § 1.704–1(b)(2)(iv)( b )( 1 ) provides that a partner’s capital account includes the amount contributed by that partner to the partnership, and, in the case of a compensatory partnership interest that is transferred on or after the date final regulations are published in the Federal Register, the amount included on or after that date as the partner’s compensation income under § 83(a), (b), or (d)(2). For these purposes, a compensatory partnership interest is an interest in the transferring partnership that is transferred in connection with the performance of services for that partnership (either before or after the formation of the partnership), including an interest that is transferred on the exercise of a compensatory partnership option. A compensatory partnership option is an option to acquire an interest in the issuing partnership that is granted in connection with the performance of services for that partnership (either before or after the formation of the partnership). See proposed § 1.721–1(b)(4).

Proposed § 1.704–1(b)(4)(xii)( a ) provides that if a § 83(b) election has been

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tion 3.02(2) of this revenue procedure, a Safe Harbor Partnership Interest is any interest in a partnership that is transferred to a service provider by such partnership in connection with services provided to the partnership (either before or after the formation of the partnership), provided that the interest is not (a) related to a substantially certain and predictable stream of income from partnership assets, such as income from high-quality debt securities or a high-quality net lease, (b) transferred in anticipation of a subsequent disposition, or (c) an interest in a publicly traded partnership within the meaning of § 7704(b). Unless it is established by clear and convincing evidence that the partnership interest was not transferred in anticipation of a subsequent disposition, a partnership interest is presumed to be transferred in anticipation of a subsequent disposition for purposes of the preceding clause (b) if the partnership interest is sold or disposed of within two years of the date of receipt of the partnership interest (other than a sale or disposition by reason of death or disability of the service provider) or is the subject, at any time within two years of the date of receipt, of a right to buy or sell regardless of when the right is exercisable (other than a right to buy or sell arising by reason of the death or disability of the service provider). For the purposes of this revenue procedure, “disability” means a condition which causes a service provider to be unable to engage in any substantial gainful activity by reason of a medically determinable physical or mental impairment expected to result in death or to last for a continuous period of not less than 12 months.

(2) An interest in a partnership is not a Safe Harbor Partnership Interest unless at the date of transfer the requirements of section 3.03 of this revenue procedure are satisfied and a Safe Harbor Election has not terminated pursuant to section 3.04 of this revenue procedure. For the first taxable year that a partnership is subject to a Safe Harbor Election, a partnership interest may be a Safe Harbor Partnership Interest if a Safe Harbor Election is attached to the partnership tax return for the taxable year including the date of transfer, provided that the other requirements of section 3.03 of this revenue procedure are satisfied on or before the date of such transfer.

.03 Required Conditions for Safe Har- bor Election . In order to effect and main

interest. Proposed § 1.704–1(b)(4)(xii)( d ) provides that for purposes of proposed § 1.704–1(b)(4)(xii)( c ), items of income and gain are reflected as positive amounts, and items of deduction and loss are reflected as negative amounts.

Section 721(a) provides that no gain or loss is recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.

Proposed § 1.721–1(b)(1) provides that § 721 generally does not apply to the transfer of a partnership interest in connection with the performance of services. Such a transfer constitutes a transfer of property to which § 83 and the regulations thereunder apply. However, under proposed § 1.721–1(b)(2), except as provided in § 83(h) or § 1.83–6(c), no gain or loss is recognized by a partnership upon: (i) the transfer or substantial vesting of a compensatory partnership interest, or (ii) the forfeiture of a compensatory partnership interest.

Proposed § 1.761–1(b) provides that if a partnership interest is transferred in connection with the performance of services, and that partnership interest is substantially nonvested (within the meaning of § 1.83–3(b)), then the holder of the partnership interest is not treated as a partner solely by reason of holding the interest, unless the holder makes an election with respect to the interest under § 83(b).

Rev. Proc. 93–27, 1993–2 C.B. 343, provides generally that if a person receives a profits interest for the provision of services to or for the benefit of a partnership in a partner capacity or in anticipation of becoming a partner, the Service will not treat the receipt of such an interest as a taxable event for the partner or the partnership. The revenue procedure does not apply if (1) the profits interest relates to a substantially certain and predictable stream of income from partnership assets, such as income from high-quality debt securities or a high-quality net lease; (2) within two years of receipt, the partner disposes of the profits interest; or (3) the profits interest is a limited partnership interest in a “publicly traded partnership” within the meaning of § 7704(b).

Rev. Proc. 2001–43, 2001–2 C.B. 191, clarifies Rev. Proc. 93–27 and provides that, for purposes of Rev. Proc. 93–27, if a partnership grants a substan

tially nonvested profits interest in the partnership to a service provider, the service provider will be treated as receiving the interest on the date of its grant, provided that: (1) the partnership and the service provider treat the service provider as the owner of the partnership interest from the date of its grant and the service provider takes into account the distributive share of partnership income, gain, loss, deduction and credit associated with that interest in computing the service provider’s income tax liability for the entire period during which the service provider has the interest; (2) upon the grant of the interest or at the time that the interest becomes substantially vested, neither the partnership nor any of the partners deducts any amount (as wages, compensation, or otherwise) for the fair market value of the interest; and (3) all other conditions of Rev. Proc. 93–27 are satisfied.