Rev. Rul. 68-86

Advice has been requested as to the time income is realized, and as to the amount of income realized, for Federal income tax purposes, by an employee under the circumstances described below.

An agreement between a corporation and an employee provides that the employee is to receive as compensation a base salary plus an annual bonus established by the board of directors of the corporation. The employee has the right to elect, prior to January 1 of each year, to have all or part of any bonus which may be awarded to him for that year paid to him in restricted stock of the corporation. The election for that year can be neither modified nor revoked thereafter.

The certificates of restricted stock paid to the employee pursuant to his election are stamped with a legend stating that the shares represented by such certificates shall not be sold, assigned, transferred, discounted, or pledged as collateral for a loan, without the prior written consent of the salary committee of the board of directors. Those restrictions continue in effect during the member of years after the effective the corporation, and lapse a specific number of years after the effective date of termination of such employment for whatever cause. However, the corporation's salary committee will approve a release from the restrictions in the case of hardship which in the sole judgment of the committee justifies such action.

The foregoing restrictions, as evidenced by the legend stamped on the certificates of stock, have a significant effect on the value of the stock. Thus, under section 1.61-2(d)(5) of the Income Tax Regulations, the time and amount of compensation paid the employee in the form of such stock are determined by application of the rules prescribed by section 1.421-6(d)(2) of the regulations. Under the provisions of that section of the regulations, compensation is realized when the restrictions on the stock lapse, or when the stock is sold or exchanged in an arm's length transaction, whichever occurs earlier. The amount of such compensation is the lesser of (1) the fair market value of the stock (determined without regard to the restrictions) at the time of its acquisition, or (2) either the fair market value of the stock at the time the restrictions lapse, or the consideration received upon the sale or exchange, whichever is applicable.

Accordingly, the election by the employee in the instant case, prior to January 1 of a given year, to have all or part of any bonus awarded him for that year paid to him in stock of his employer corporation that is subject to restrictions which have a significant effect on its value, will result in the realization of compensation by the employee at the time the restrictions on the stock lapse, or the stock is sold in an arm's length transaction, whichever event occurs earlier.