IRS Issues Final Employee Stock Purchase Plan Regulations

• No disposition of the stock is made within two years from the date of grant of the option or within one year from the date of transfer of the share, and

• At all times during the period beginning on the date of grant and ending on the date three months before the exercise of the option, the individual is an employee of either the corporation granting the option or its related corporations.

• No options are granted to owners of stock possessing 5 percent or more of the total combined voting power or value of all classes of stock of the employer corporation or its related corporations,
• The option price may not be less than the lesser of an amount equal to 85 percent of the fair market value of the stock at the time of grant or at the time of exercise,
• An option cannot be exercised after the expiration of 5 years or 27 months from the date of grant, depending on how the option price is determined, and
• An option cannot be transferable other than by will or laws of descent and distribution and can be exercisable only by the participant during the participant's lifetime.

Multiple Offerings. More than one offering may be made under a plan, and the offerings may be consecutive or overlapping. Although offerings must satisfy the ESPP requirements, offerings are not required to have identical terms.

Employees Covered by ESPP. Like the proposed regulations, the final regulations provide that options must be granted to all employees of any corporation whose employees are granted options by reason of their employment by that corporation. The tax-favored status of options granted under an ESPP will not be jeopardized if the plan excludes:

• Employees employed less than two years,
• Employees who customarily work less than 20 hours per week or less than five months in a calendar year,
• Highly compensated employees who have compensation above a certain level or who are section 16 officers under the Securities Exchange Act of 1934, and
• Employees or citizens of a foreign country (without regard to whether they are also US citizens or green card holders), if the grant of options to such individuals is prohibited by the laws of the foreign country or compliance with the laws of the foreign country would cause the plan to violate the requirements of section 423.

Whether the terms of a plan and offering satisfy this rule is determined on an offering-by-offering basis. As a result, the terms of the offering may provide for different exclusions of employees, but these exclusions must be applied in an identical manner to all employees of every corporation who are granted options under that particular offering.

In addition, the preamble to the final regulations provides that the IRS and Treasury are aware of the complexities associated with participation by nonresident aliens in ESPPs and by employees under a specified age (such as age 18). The Treasury and the IRS have reiterated that they are constrained by statutory authority from creating additional exclusions for those categories of employees.

Rights and Privileges -- The terms of the ESPP must provide that the employees who are granted options have the same rights and privileges. The proposed regulations provide an exception to this rule, if, in order to comply with the laws of a foreign country, options granted to citizens or residents of a foreign country (without regard to whether they are also US citizens or green card holders) are less favorable than the terms of options granted under the same plan or offering to employees who are U.S. residents. This exception will not be satisfied if foreign citizens or residents are provided more favorable options. The final regulations also include this rule.

The offering-by-offering concept in the final regulations also applies to determining whether the equal rights and privileges requirements have been satisfied.

Maximum Number of Shares that May be Purchased -- For purposes of an ESPP, the date of grant is significant in order to determine whether the holding period to obtain tax favored treatment under section 421 has been satisfied, and to determine the fair market value for purposes of calculating the $25,000 limitation. The final regulations provide rules for determining the date of grant based on whether the terms of the plan or offering designate the maximum number of shares that may be purchased by each employee during the offering or apply a formula on the first day of the offering to determine the maximum number of shares that may be purchased by each employee. In response to comments, the final regulations reflect a change from the proposed regulations, and do not require that there be a specified number of shares to satisfy this requirement or to establish the first day of the offering period as the date of grant for an option.

Annual $25,000 Limit -- The terms of an ESPP must provide that no employee may be permitted to accrue the right to purchase stock under all ESPPs sponsored by the employer corporation and its related corporations at a rate that exceeds $25,000 in the fair market value of the stock (determined on the date of grant). In a change from the proposed regulations, the final regulations do not impose this limit only in the year the options are first exercisable, but instead provide that the ESPP limit increases by $25,000 for each calendar year during which the option is outstanding.

If the option gives the holder the right to purchase stock in excess of the $25,000 limit, then no portion of the option will be treated as granted under an ESPP, and the option will not be eligible for tax favorable treatment. This limit applies only to options granted under an ESPP and does not limit the amount of stock an employee may purchase under an ISO plan.

Shareholder Approval -- An ESPP must be approved by shareholders of the granting corporation within 12 months before or after the date the plan is adopted. Generally, a plan is not required to be re-approved by the shareholders unless there is a change in the shares that are subject to options granted under the plan, or there is a change in the granting corporation. Such changes are considered the adoption of a new plan. The final regulations adopt the proposed changes to the section 422 regulations, such that only the shareholders of the specific corporation adopting the plan are required to approve the plan.

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, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955.

Copyright 2009, 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.