[Federal Register Volume 59, Number 232 (Monday, December 5, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-29701]


[[Page Unknown]]

[Federal Register: December 5, 1994]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[EE-81-88]
RIN 1545-AN55

 

Deductions for Transfers of Property

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of hearing.

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SUMMARY: This document contains proposed amendments to the regulations 
to eliminate the special rule that requires an employer to deduct and 
withhold income tax as a prerequisite for claiming a deduction for 
property transferred to an employee in connection with the performance 
of services. Under the existing regulation, employers have been denied 
a deduction for failure to withhold even where the employee has 
reported the income and paid the tax. The proposed amendments will 
provide guidance on substantiating deductions for property transferred 
in connection with the performance of services. The proposed amendments 
will affect employers and other service recipients who transfer 
property for services.

DATES: Written comments and requests for a public hearing must be 
received by February 3, 1995.

ADDRESSES: Send comments and requests for a public hearing to: Internal 
Revenue Service, POB 7604, Ben Franklin Station, Attn: CC:DOM:CORP:T:R 
(EE-81-88), room 5228, Washington, DC 20044. In the alternative, 
submissions may be hand delivered between the hours of 8 a.m. and 5 
p.m. to: CC:DOM:CORP:T:R (EE-81-88), Courier's Desk, Internal Revenue 
Service, 1111 Constitution Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Charles T. Deliee, telephone 202-622-
6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act (44 U.S.C. 
3504(h)). Comments on the collection of information should be sent to 
the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, PC:FP, Washington, DC 
20224.
    The collection of information is in Secs. 1.6041-1 and 1.6041-2 of 
the Regulations. This information is required by the IRS to ensure the 
proper matching of income recognized by service providers with 
deductions claimed by service recipients. The likely respondents are 
individuals, farms, business or other for-profit institutions, 
nonprofit institutions, and small businesses or organizations.
    The burden for the reporting requirement contained in Secs. 1.6041-
1 and 1.6041-2 is reflected in the burden for Forms W-2 and 1099.

Overview

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR Part 1) under section 83(h) of the Internal Revenue 
Code of 1986 (Code). The proposed regulations eliminate the requirement 
to deduct and withhold income tax as a prerequisite for claiming a 
deduction.
    Under section 83(h) of the Code, in the case of a transfer of 
property to which section 83(a) applies, the person for whom services 
were provided may deduct an amount equal to the amount included in the 
service provider's gross income. In light of the difficulty that a 
service recipient may have in demonstrating that an amount has actually 
been included in the service provider's gross income, the general rule 
in existing Sec. 1.83-6(a)(1) permits the deduction for the amount 
``includible'' in the service provider's gross income. Thus, the 
deduction may be allowed to the service recipient even if the service 
provider does not properly report the includible amount. Where the 
service provider is an employee of the service recipient, however, the 
special rule in Sec. 1.83-6(a)(2) provides that a deduction may be 
claimed only if the service recipient (employer) deducts and withholds 
income tax in accordance with section 3402. The special rule was 
designed to ensure that the service recipient's deduction is in fact 
offset by a corresponding inclusion in the service provider's gross 
income. The special rule is limited to employer-employee situations 
because in other situations there is no underlying withholding 
requirement upon which the deduction could be conditioned.
    Taxpayers have expressed concern that it is often difficult to 
satisfy the prerequisite that employers must deduct and withhold income 
tax from payments in kind as a condition for claiming a deduction. The 
proposed amendments to the section 83 regulations would address this 
concern by eliminating this prerequisite, while still ensuring 
consistent treatment between service recipients and service providers 
as required by the statute. In addition, because the deduction no 
longer would be conditioned on withholding, there no longer would be a 
need to have different rules for those who receive services from 
employees and those who receive services from others.
    Under the proposed amendments, the existing general rule and 
special rule would be replaced by a revised general rule that more 
closely follows the statutory language of section 83(h). The service 
recipient would be allowed a deduction for the amount ``included'' in 
the service provider's gross income. For this purpose, the amount 
included means the amount reported on an original or amended return or 
included in gross income as a result of an IRS audit of the service 
provider.
    Because of the potential difficulty of demonstrating actual 
inclusion by the service provider, a special rule would provide that, 
if the service recipient timely complies with applicable Form W-2 or 
1099 reporting requirements under section 6041 (or 6041A), as 
appropriate, with respect to the amount includible in income by the 
service provider, the service provider will be deemed to have included 
the amount in gross income for this purpose. Thus, the proposed 
amendments would allow the deduction without requiring the service 
recipient to demonstrate actual inclusion by the service provider. If a 
transfer met the requirements for exemption from reporting for payments 
aggregating less than $600 in any taxable year, or was eligible for any 
other reporting exemption, no reporting would be required in order for 
the service recipient to rely on the deemed inclusion rule.
    In order to allow service recipients to take advantage of the 
deemed inclusion rule with respect to property transfers to all service 
providers, the proposed amendments would permit service recipients to 
use the special rule also in the case of transfers to corporate service 
providers. To that end, service recipients would be permitted, solely 
for purposes of this rule, to treat the Form 1099 reporting 
requirements as applicable to transfers to corporate service providers 
in the same manner as those requirements would apply to transfers to 
noncorporate service providers. Thus, if a service recipient who 
transferred property to a corporate service provider timely reported 
that income on Form 1099 (to both the service provider and the federal 
government), the service recipient would be entitled to rely on the 
deemed inclusion rule in claiming a deduction for the amount of that 
income. If the transfer met the requirements for exemption from 
reporting for payments aggregating less than $600 in any taxable year, 
or was eligible for any other reporting exemption applicable to a 
service provider that is not a corporation, no reporting would be 
required in order for the service recipient to rely on the deemed 
inclusion rule.
    The deemed inclusion rule could be used only by a service recipient 
whose compliance with applicable Form W-2 or 1099 reporting 
requirements was timely. Thus, for example, under the current reporting 
requirements, if amounts attributable to one or more section 83 
transfers of property are includible in an employee's income in year 1 
(and are not eligible for any reporting exemption), the employer 
generally would be required to furnish the employee a Form W-2 
reflecting that amount by January 31 of year 2 and generally would be 
required to file a copy of the Form W-2 with the federal government by 
the last day of February of year 2. If the employer did report to the 
employee and the government in a timely manner, the employer would be 
able to rely on the deemed inclusion rule to claim a deduction for the 
amount in year 1. If the employee's Form W-2 were not furnished until 
after January 31 of year 2 or the government's copy of Form W-2 were 
not filed until after the last day of February of year 2, the employer 
generally would be required to demonstrate that the employee actually 
included the amount in income in order to support its deduction of such 
amount.
    Under the proposed amendments, a special rule would apply with 
respect to an amount includible in an employee's or former employee's 
income by reason of a disqualifying disposition of stock that had been 
acquired pursuant to a statutory stock option. In the case of such a 
disposition, a Form W-2 or W-2c (as appropriate) would have to be 
furnished to the employee or former employee, and filed with the 
federal government, only by the date on which the employer files its 
tax return (including an amended return) claiming a deduction for that 
amount.
    With respect to disqualifying dispositions, the proposed amendments 
would modify the conditions for an employer's deduction under section 
83(h) in a manner that is not inconsistent with the guidance provided 
by Notice 87-49 (Changes to Incentive Stock Option Requirements by 
Section 321 of the Tax Reform Act of 1986), 1987-2 C.B. 355. The 
proposed amendments are not intended to have any effect on the 
application of Notice 87-49 or the analysis contained therein, and 
therefore should not be viewed as constituting a reconsideration of 
Revenue Ruling 71-52, 1971-1 C.B. 278, within the meaning of Notice 87-
49.
    Although the withholding requirement would be eliminated as a 
prerequisite for claiming a deduction, the proposed amendments would 
not relieve the service recipient from any applicable withholding 
requirements of subtitle C or from the statutorily prescribed penalties 
or additions to tax for noncompliance with those requirements. Thus, 
for example, if an employer transferred to an employee property to 
which section 83 applies and failed to withhold income tax on the 
payment, the employer would be liable for the tax under section 3403. 
However, under section 3402(d), any tax liability assessed against the 
employer would be offset by any tax paid by the employee. In addition, 
nothing in this proposed regulation would relieve the service recipient 
from penalties or additions to tax for noncompliance with the 
requirements of section 6041 or 6041A (relating to information 
reporting) to the extent they otherwise apply.
    The proposed regulation that was published in the Federal Register 
on November 16, 1983 (48 FR 52079), proposing to amend the special rule 
in Sec. 1.83-6(a)(2), is hereby withdrawn.
    These amendments are proposed to be effective for deductions 
allowable for taxable years beginning on or after January 1, 1995. 
However, taxpayers may apply these proposed amendments when claiming a 
deduction for any year not closed by the statute of limitations. For 
example, if substantially vested (within the meaning of Sec. 1.83-3(b)) 
stock was transferred to an employee in 1992 upon the exercise of a 
nonstatutory stock option, and if the calendar year employer furnished 
a Form W-2 to the employee by January 31, 1993, reflecting the income 
generated by such transfer, and filed the appropriate Form W-2 with the 
federal government by February 28, 1993, then the employer could apply 
these proposed amendments to claim a deduction for 1992 for the amount 
of the income, even if the employer failed to withhold in accordance 
with section 3402 and could not demonstrate actual inclusion in income 
by the employee. If that employer did not claim a deduction for the 
amount of the income on its 1992 tax return, it could file an amended 
return for 1992 claiming such a deduction pursuant to the proposed 
amendments, provided that 1992 is still an open year.

Reliance on These Proposed Regulations

    Taxpayers may rely on these proposed amendments for guidance 
pending their issuance as final regulations. If future amendments are 
more restrictive than these proposed amendments, the future amendments 
will be applied without retroactive effect.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) do not apply to these regulations and, therefore, a 
Regulatory Flexibility Analysis is not required. Pursuant to section 
7805(f) of the Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying. A public 
hearing may be scheduled if requested in writing by a person that 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place for the hearing will be published 
in the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Charles T. 
Deliee, Office of the Associate Chief Counsel (Employee Benefits and 
Exempt Organizations), IRS. However, personnel from other offices of 
the IRS and Treasury Department participated in their development.

List of Subjects in 26 CFR 1.61-1 through 1.281-4

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:
    Paragraph 1. The authority for part 1 continues to read in part as 
follows:

    Authority: 26 U.S.C. 7805* * *

    Par. 2. In Sec. 1.83-6, is amended as follows:
    1. Paragraphs (a)(1) and (2) are revised.
    2. Paragraph (a)(5) is added.
    3. The revisions and addition read as follows:


Sec. 1.83-6  Deduction by employer.

    (a) Allowance of deduction--(1) General Rule. In the case of a 
transfer of property in connection with the performance of services, or 
a compensatory cancellation of a nonlapse restriction described in 
section 83(d) and Sec. 1.83-5, a deduction is allowable under section 
162 or 212 to the person for whom the services were performed. The 
amount of the deduction is equal to the amount included as compensation 
in the gross income of the service provider under section 83(a), (b), 
or (d)(2), but only to the extent the amount meets the requirements of 
section 162 or 212 and the regulations thereunder. The deduction is 
allowed only for the taxable year of that person in which or with which 
ends the taxable year of the service provider in which the amount is 
included as compensation. For purposes of this paragraph, any amount 
excluded from gross income under section 79 or section 101(b) or 
subchapter N is considered to have been included in gross income.
    (2) Special Rule. For purposes of paragraph (a)(1) of this section, 
the service provider is deemed to have included the amount as 
compensation in gross income if the person for whom the services were 
performed satisfies in a timely manner all requirements of section 6041 
or section 6041A, and the regulations thereunder, with respect to that 
amount of compensation. For purposes of the preceding sentence, whether 
a person for whom services were performed satisfies all requirements of 
section 6041 or section 6041A, and the regulations thereunder, is 
determined without regard to Sec. 1.6041-3(c) (exception for payments 
to corporations). In the case of a disqualifying disposition of stock 
described in section 421(b), an employer that otherwise satisfies all 
requirements of section 6041 and the regulations thereunder will be 
considered to have done so timely if Form W-2 or Form W-2c, as 
appropriate, is furnished to the employee or former employee, and is 
filed with the Federal Government, on or before the date on which the 
employer files the tax return claiming the deduction relating to the 
disqualifying disposition.
* * * * *
    (5) Effective Date. Paragraphs (a)(1) and (a)(2) of this section 
apply to deductions for taxable years beginning on or after January 1, 
1995. However, taxpayers may also apply paragraphs (a)(1) and (a)(2) of 
this section when claiming deductions for taxable years beginning 
before that date if the claims are not barred by the statute of 
limitations. Paragraphs (a)(3) and (a)(4) of this section are effective 
as set forth in Sec. 1.83-8(b).
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 94-29701 Filed 12-2-94; 8:45 am]
BILLING CODE 4830-01-P