IRS Revenue Ruling 90-29 holds that a corporation recognizes no gain or loss when it transfers its own stock to an employee as compensation for services. Section 1032 shields the transfer regardless of the corporation’s basis in the shares, and the corporation’s only tax consequence is the compensation deduction allowed 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 originally acquired or issued it.
The IRS concluded that a transfer of stock for services qualifies as a disposition of stock in exchange for property under Section 1032. The corporation recognizes neither gain nor loss, whatever its basis. At the same time, the corporation remains entitled to a compensation deduction under Section 83(h) when the employee eventually includes the value of the stock in income. Those two provisions together describe the complete corporate tax picture for equity compensation.
How Section 1032 Covers the Transfer
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 written with capital-raising in mind, but Revenue Ruling 90-29 extended the same logic to compensatory transfers by treating the employee’s services as the “other property” received.
The interpretation matters most for previously repurchased shares. If a company bought back stock at $20 per share and later transfers those shares to an employee when they are worth $50, there is no $30 gain to the corporation on the transfer. The Treasury Regulations confirm this 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 does not change the result. Whether the corporation issues new shares, uses treasury stock, or sources the stock in some other way, Section 1032 applies the same way. The stock’s acquisition history is irrelevant to the corporation’s tax position on the transfer.
The Section 83(h) Deduction
Section 1032 eliminates gain or loss, but it does not eliminate the corporation’s ability to claim a compensation 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 deduction is claimed in the taxable year that includes or ends with the employee’s year of income recognition.
For restricted stock subject to vesting, the deduction is typically deferred. An employee who receives stock with a four-year vesting schedule does not recognize income until the restrictions lapse, and the corporation’s deduction follows the same timeline. The deduction 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 accordingly.
The Reporting Condition
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 on Form 1099 for independent contractors. A missed or incorrect information return can cost the deduction entirely, a problem companies sometimes discover only on audit.
The Section 162(m) Cap for Public Companies
Public companies face a separate constraint. Section 162(m) limits 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, they remain a covered employee permanently. Section 83(h) deductions count toward the cap, so for senior executives at public companies the limit can wipe out much of the corporate benefit that Revenue Ruling 90-29 otherwise preserves.
Timing Follows the Employee
Revenue Ruling 90-29 is about the corporation, but the employee’s tax treatment drives when and how much the corporation can deduct. Under Section 83(a), an employee who receives stock for services recognizes ordinary income when the stock becomes substantially vested, meaning when it is either freely transferable or no longer subject to a substantial risk of forfeiture.3Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services
The income amount equals the fair market value of the stock at vesting, minus whatever the employee paid for it. That becomes the employee’s basis, and the holding period for capital gains starts on the vesting date. The corporation’s deduction mirrors that income amount and lands in the matching tax year.
The Section 83(b) Election
An employee can elect under Section 83(b) to 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 The election must be filed with the IRS no later than 30 days after the transfer and cannot be revoked without IRS consent. For the corporation, an 83(b) election accelerates the Section 83(h) deduction into the year of transfer. The deduction amount equals whatever the employee includes at that time, which is typically smaller than the vesting-date amount would be if the stock appreciates. Earlier deduction, usually smaller deduction.
If the stock is later forfeited after an 83(b) election, the statute is blunt: no deduction is allowed for the forfeiture, and the employee cannot recover the income tax already paid on the election amount.
Revenue Ruling 2003-98 and Related Shares
Revenue Ruling 2003-98 extended the same principle 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. The IRS held that Section 1032 still applies, with no gain or loss recognized by the corporation regardless of how it obtained the shares. The Treasury Regulations reinforced the point with 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 The mechanism through which a corporation sources or delivers its stock to employees does not change the Section 1032 result.
Incentive Stock Options
Revenue Ruling 90-29 reaches all compensatory stock transfers, including those resulting from the exercise of a stock option. For incentive stock options, the corporation recognizes no gain or loss on the stock transfer under Section 1032 in the same way as any other compensatory transfer. The deduction side differs. The corporation generally cannot claim a Section 83(h) deduction for an ISO unless the employee makes a disqualifying disposition by selling the stock before meeting the required holding periods, which converts the transaction into one that generates ordinary income for the employee and a corresponding deduction for the company.