IRS Proposes Updated Regulations for Stock Purchase Plans under Code § 423

• General Requirements. The terms of the plan must be in written or electronic form, and must meet a list of specified requirements. If the terms of an option are inconsistent with the plan, it will not be treated as granted under the plan. If the employee is entitled to an option under the plan but is not granted one, the plan will fail to satisfy the requirement that options be granted to all employees of any corporation whose employees are granted options under the plan -- and the failure will cause all of the options to be ineligible for the special tax treatment of IRC § 421.
• Stockholder Approval. The requirements for stockholder approval are clarified and a more comprehensive list of situations that require new stockholder approval is provided. For example, new stockholder approval is required if there is a change in the shares with respect to which options are issued, or a change in the granting corporation. Guidance is provided regarding stockholder approval where a stock purchase plan is assumed in a corporate transaction.
• Maximum Aggregate Number of Shares. The plan may provide that the maximum aggregate number of shares available for grant may increase annually by a specified percentage of the authorized, issued, or outstanding shares at the date of adoption of the plan. The number may also change based on any other specific circumstance, but only if the stockholders approve an immediately determinable maximum number of shares that may be issued under the plan in any event.
• Employees Covered. Highly compensated employees within the meaning of IRC § 414(q) ("HCEs") -- versus the previously used "officers, persons whose principal duties consist of supervising the work of other employees, or highly compensated employees" -- may be excluded from participation. The plan may also exclude only HCEs with compensation above a certain level, or who are officers subject to the disclosure requirements of section 16(a) of the Securities Exchange Act of 1934. Generally, the plan may not flatly exclude non-resident aliens who receive no U.S. source income, although it may exclude citizens or residents of another jurisdiction if an option grant is prohibited under the laws of that jurisdiction or if compliance with those laws would cause the plan to violate IRC § 423. The plan may not exclude collectively-bargained employees.
• Equal Rights. In limited circumstances, the plan may provide less favorable terms with respect to foreign employees in order to comply with the laws of a foreign jurisdiction. The terms cannot be more favorable than those with respect to U.S. employees. Since carryover of amounts withheld but not applied toward the purchase of stock under an earlier plan may not be applied toward the purchase of stock under a subsequent plan, the regulations clarify that the carryover will not violate the equal rights requirement if the other employees in the current plan are permitted to purchase shares under a subsequent plan equal to the greatest amount any employee is permitted to carry forward from an earlier plan (less the amount, if any, the employee will carry forward from an earlier plan). The mere carryover of amounts representing a fractional share that were withheld but not applied will not violate the equal rights requirement.
• Option Price. Option price may be determined in any reasonable manner, including the valuation methods permitted under § 20.2031-1 (Estate Tax Regulations), so long as the price satisfies the minimum pricing requirements of IRC § 423(b)(6).
• Date of Grant. The date of grant of an option under a plan is the date when the granting corporation completes the corporate action constituting the offer of stock for sale under the option and the maximum number of shares that can be purchased is determinable (without regard to whether the minimum option price is determinable). As a result, the first day of an offering could be the date of grant for an option, even though the minimum option price is not fixed or determinable on that day. However, if the maximum number of shares that can be purchased under an option is not fixed or determinable until the date the option is exercised, then the date of exercise is the date of grant.
• Annual $25,000 Limitation. The limit is calculated in a manner consistent with the $100,000 limit for incentive stock options (i.e., based on when the option first becomes exercisable, and on the fair market value of the stock on the date of grant). The proposed regulations emphasize that an employee may purchase up to $25,000 of stock (based on the fair market value of the stock on the date of grant) in each calendar year in which an option granted to the employee under an employee stock purchase plan is not only outstanding but also exercisable.
• Special Rule Where Option Price Is Between 85 Percent and 100 Percent of the Value of the Stock. The proposed regulations illustrate the tax consequences under a plan that uses a lookback feature to determine the exercise price of the option.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2008, Deloitte.

BenefitsLink is an independent national employee benefits information provider, not formally affiliated with the firms and companies who kindly provide much of the content and advertisements published on this Web site, including the article shown above.