Under IRS Revenue Ruling 90-29, a corporation recognizes no taxable gain or loss when it transfers its own stock to an employee as compensation for services. The ruling applies Section 1032 of the Internal Revenue Code — which shields corporations from gain or loss when they exchange their stock for property — to compensatory transfers by treating the employee’s services as the property received. The corporation’s only tax consequence is the compensation deduction it claims under Section 83(h) when the employee recognizes income.
What the Ruling Decided
The ruling addressed a straightforward fact pattern. A corporation transferred shares of its own stock to an employee in exchange for services, and those shares were subject to a substantial risk of forfeiture under Section 83. The question was whether the corporation had to recognize gain or loss on that transfer, particularly if the stock had appreciated or depreciated since the corporation acquired or issued it.
The IRS concluded that the transfer qualifies as a disposition of stock in exchange for property under Section 1032, so the corporation recognizes neither gain nor loss regardless of its basis in the shares. The corporation remains entitled to a compensation deduction under Section 83(h) when the employee eventually recognizes income. Those two provisions together define the complete corporate tax picture for equity compensation.
Why Section 1032 Applies to Services
Section 1032 provides that no gain or loss is recognized when a corporation receives money or other property in exchange for its own stock, including treasury stock.1Office of the Law Revision Counsel. 26 USC 1032 – Exchange of Stock for Property The statute was originally aimed at capital-raising transactions in which a company sells shares for cash. Revenue Ruling 90-29 extended the logic to compensatory transfers by characterizing the employee’s services as “other property” received in exchange for stock.
That interpretation matters most when the corporation uses previously repurchased shares. Suppose a company bought back stock at $20 per share and later transfers those shares to an employee when they are worth $50. Without Section 1032, the corporation would arguably realize a $30-per-share gain on the transfer. The ruling eliminates that concern. The Treasury Regulations confirm the result, stating that a corporation’s transfer of its own stock as compensation is treated as a disposition of stock for purposes of Section 1032 and does not give rise to taxable gain or deductible loss regardless of the circumstances involved.2eCFR. 26 CFR 1.1032-1 – Disposition by a Corporation of Its Own Capital Stock
The source of the shares is irrelevant. Whether the corporation issues new shares, draws from treasury stock, or delivers shares acquired through some other mechanism, Section 1032 applies the same way. The stock’s acquisition history does not create unexpected tax consequences for the corporation.
The Corporate Deduction Under Section 83(h)
Eliminating gain or loss does not eliminate the deduction. Section 83(h) allows the corporation to deduct an amount equal to whatever the employee includes in gross income.3Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services The corporation claims the deduction in the taxable year that includes or ends with the year the employee reports the income.
For restricted stock subject to vesting, the deduction is typically deferred. An employee who receives stock with a four-year vesting schedule doesn’t recognize income until the restrictions lapse, and the corporation’s deduction follows the same timeline. The deduction amount equals the fair market value of the stock at the time the employee recognizes income, minus any amount the employee paid for the shares. If the stock appreciates between grant and vesting, the corporation’s deduction grows correspondingly.
Reporting Is a Condition of the Deduction
The deduction is not automatic. Under Treasury Regulation 1.83-6, the employee is deemed to have included the compensation in gross income only if the employer satisfies its reporting obligations under Sections 6041 or 6041A in a timely manner.4eCFR. 26 CFR 1.83-6 – Deduction by Employer In practice, that means accurately reporting the compensation on Form W-2 for employees or Form 1099 for independent contractors. Failing to file the correct information return on time can cause the IRS to disallow the deduction entirely, an expensive mistake that companies sometimes discover only on audit.
The Section 162(m) Cap for Public Companies
Public companies face an added constraint. Section 162(m) limits the deductible compensation for each “covered employee” to $1 million per year. Covered employees include the CEO, CFO, and the next three highest-paid officers, and once someone qualifies as a covered employee, they remain one permanently. Stock compensation deductions under Section 83(h) count toward this cap. For senior executives at public companies receiving large equity grants, Section 162(m) can eliminate a significant portion of the corporate tax benefit that Revenue Ruling 90-29 otherwise preserves.
The Employee’s Side Drives the Timing
Revenue Ruling 90-29 addresses the corporate side, but the employee’s tax treatment controls when and how much the corporation deducts. Under Section 83(a), an employee who receives stock in connection with services recognizes ordinary income when the stock becomes substantially vested, meaning it is either freely transferable or no longer subject to a substantial risk of forfeiture, whichever comes first.3Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services
The income equals the fair market value of the stock at vesting minus whatever the employee paid for it, taxed at ordinary income rates. The employee’s basis then equals that fair market value, and the capital gains holding period begins on the vesting date.
What Happens If the Employee Elects Under Section 83(b)
Section 83(b) lets the employee recognize income at the time of transfer rather than at vesting.3Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services For the corporation, an 83(b) election accelerates the deduction. The company claims it in the year of transfer rather than at vesting, and the deduction amount equals whatever the employee includes in income at the time of the election, typically a smaller number than the vesting-date figure if the stock appreciates. Earlier deduction, potentially smaller deduction.
If the stock is later forfeited, the statute is blunt: no deduction is allowed for the forfeiture.3Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services The corporation does not get a matching reversal of the deduction it previously claimed.
Revenue Ruling 2003-98 Extended the Principle
Revenue Ruling 2003-98 confirmed and extended Revenue Ruling 90-29’s holding to a more complex fact pattern: a corporation using stock it acquired upon the exercise of a stock option or warrant to satisfy a compensation obligation to an employee.5Internal Revenue Service. Revenue Ruling 2003-98 The IRS held that Section 1032 still applies regardless of how the corporation obtained the shares.
The Treasury Regulations reinforced the approach by providing special rules for situations where a corporation transfers its stock to compensate someone for services performed for a related corporation or partnership.5Internal Revenue Service. Revenue Ruling 2003-98 Together, these authorities establish a unified principle: the mechanism through which a corporation sources or delivers its stock to employees does not change the Section 1032 result. What matters is that the corporation is disposing of its own stock, and the rest follows.
Incentive Stock Options Are a Partial Exception
Revenue Ruling 90-29 applies to all compensatory stock transfers, including those resulting from the exercise of stock options. For incentive stock options, the corporation still recognizes no gain or loss under Section 1032 on the delivery of shares at exercise. The 83(h) deduction, however, generally does not follow. The corporation cannot claim a Section 83(h) deduction for an ISO unless the employee makes a disqualifying disposition, meaning a sale before the required holding periods are met, which converts the transaction into one that generates ordinary income for the employee and a corresponding deduction for the company. Rev. Rul. 90-29 preserves the corporation from gain on the transfer; it does not create a deduction that Section 83(h) otherwise withholds.