The Advisors' Blog

This blog features wisdom from respected compensation consultants and lawyers

June 10, 2024

Non-Competes: Tax Implications of FTC’s Ban

The FTC’s non-compete ban, set to be effective September 4, but the subject of pending litigation, presents a number of complications for employers. This Morgan Lewis blog, the fourth in a series on compensation-related implications of the ban, addresses potential impacts on the timing of taxation under Sections 83, 3121(v), and 457(f) of the Code.

Here’s an excerpt discussing Section 83:

Under Section 83 of the Code, transfers of property in connection with the performance of services, including certain equity awards, are generally included in the gross income of the person performing the services at the then-fair market value of the property in the first taxable year in which the property is not subject to a substantial risk of forfeiture (i.e., when it is substantially vested) or is transferable. A person may make an election to accelerate the taxation to the date of grant, based on the fair market value of the property at grant, if such person makes an “83(b) election” within 30 days of the date of grant.

If no 83(b) election is made, based on a facts and circumstances test set forth in the Treasury regulations promulgated under Section 83, a substantial risk of forfeiture can in some circumstances be supported by an enforceable requirement that the transferred property be returned to the employer in the event that the employee breaches his or her postemployment noncompete covenant (without any continuing employment condition required).

Currently, if an enforceable noncompete covenant is used to support a substantial risk of forfeiture as permitted under the regulations, the result is that taxation of the property subject to Section 83 would be postponed until the noncompete covenant lapses (or until the property becomes transferable, if sooner).

If the Final Rule becomes effective, companies should reevaluate their reliance on noncompete covenants to create a substantial risk of forfeiture for purposes of postponing taxation on Section 83 transfers. To the extent that the Final Rule invalidates a noncompete covenant that was used to support a substantial risk of forfeiture, such property would cease to be subject to a substantial risk of forfeiture and would become immediately taxable under Section 83.

Meredith Ervine