Non-423 ESPP Tax Issue

[Guest cole stevenson]

I have been asked to work on an Employee Stock Purchase Plan and have a question about the possible tax issues surrounding the difference between participant purchase price and the fair market value. First, some key plan info:

--The plan is not intended to satisfy IRC sec. 423 although it has many similar provisions as a true 423 plan.

--Employee contributions are deducted on an after-tax basis

--This plan provides a 15% discount via imputed, taxable income at the payroll level. EX: Each payday ptpt has $100 deducted after-tax and employer increases pay by about $15. The $15 is also deducted after-tax and added to ptpt contribution so that a total of $115 worth of stock is actually purchased.

--The plan makes quarterly offerings to it's U.S. employees and sets the purchase price to be the NYSE closing price on the first or last market day of the calendar quarter - *whichever is less*. EX: Price is $50/sh on Apr 1 & $70/sh on Jun 30. Plan purchase price is set at $50/sh.

QUESTION: Is there any immediate taxable event at the time of purchase as a result of the actual market price being $20/sh greater than the plan participant's purchase price?

Cole Stevenson

[Guest EAKarno]

I don't understand the 15% imputed income. This sounds like a gift to the IRS of prepaid tax. The Service would never object to an option with a 15% discounted grant price, so why not just do that and be even more like a 423 plan.

As for the tax consequences of an exercise (purchase), the difference between the price paid and the value of the stock on the day of the transfer is taxable (immediately) as ordinary income subject to state and federal income tax withholding and FICA.

[Guest cole stevenson]

Thanks, EAKarno.

I agree, the 15% imputed income discount thing is a little strange. I have only encountered one other time before. I don't really recall what the case is for doing it this way. Anyone know? Are SEC burdens lighter?

As far as the immediate tax obligation due on the difference between the price paid and the actual value of the stock, I am interested in how this is operational accomplished. Any first-hand experiences shared will be greatly appreciated.

Cole

[pjkoehler]

EAKarno is right. You're stock purchase plan transactions would almost certainly be taxed as under the NQSO rules. Therefore, the company should collect taxes on the gain at the time of purchase (i.e. exercise), entitling the company to a compensation expense tax deduction in the amount of the gain. Code Sec. 83(h). This deduction should be calculated on an option tracking system and communicated to paryoll and tax departments shortly after each purchase period ends. The gain and the taxes withheld are reported on the optionee's W-2 or 1099 in the same manner as cash compensation. Code Sections 83, 1401 and 1402. The employer can treat this income as supplemental wages that qualify for the 28% flat withholding rate if the employer has also withheld from the employee's regular wages. Alternatively, the employer can include the amount of wages atributable to the stock plan purchase as regular wages during the payroll period and withhold using the general withholding rates. Treas. Regs. Sec. 31.3402(g)-1(a)(2). See also Rev. Rul. 67-257. The ordinary income recognized upon purchase is subject to FICA/FUTA taxes in the same manner as if paid in cash. Rev. Rul. 78-185. Many states conform to federal guidelines regarding incidents of taxation, but not all. Each state has its own standard or default rate of withholding, so you'll also want to make sure that payroll is properly withholding for state income tax purposes as well.

PLEASE NOTE: this treatment differs substantially from the tax treatment for ESPPs under Code Sec. 423 and the regs. You might want to revisit the wisdom of not conforming this plan to those requirements.[Edited by PJK on 08-29-2000 at 01:47 PM]

[IRC401]

I don't understand your description of the plan. I'm guessing that the company wants to treat the plan as the sale of stock, not as the grant of options, so that it can get immediate deductions, and the employees can get capital gains treatment when they sell.

[Guest cole stevenson]

Where did I lose you? I think your guess is essentially right - The plan is simply intended to be a convenient way to buy stock with the effect of a discount via the imputed income. However, the twist for this particular plan comes into play where the purchase price is lower at the start of the quarter versus the end and the actual value at purchase is greater than the price paid by the employee. The resultant "gain" is apparently reportable as ordinary income. It doesn't appear that this plan has ever tracked or reported such amounts since the plan's inception back in the mid-1980s.