Employee Stock Purchase Plans: myStockOptions.com Newsletter No. 54 (Sept. 2013)
|IN THIS ISSUE|
The basics of qualified and nonqualified ESPPs
What makes a Section 423 ESPP a good deal?
Articles on employee stock purchase plans
Survey shows the appeal of ESPPs
Cost-basis reporting for stock comp and ESPPs to change (again)
Visit us at the NASPP conference in Washington, DC
Continuing education course on ESPPs for CEP and CFP credit
SPONSORS OF THIS ISSUE
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NASPP Annual Conference: The 2013 installment of this premier event for stock plan professionals features four days of critical and timely sessions, September 23–27 in Washington, DC (see the ad below)
myNQDC.com: Developed for both participants and professionals, a complete online resource about nonqualified deferred compensation plans (see the ad below)
This issue of our quarterly newsletter showcases some of our award-winning content on employee stock purchase plans (ESPPs). While stock options have been partly eclipsed by restricted stock and RSUs over the past decade, ESPPs continue their strong presence and popularity at many companies. In fact, as we note in a newsletter article below, companies are enhancing their plans with enticing purchase discounts and lookbacks—a welcome shift after a cooling of interest in these features when ESPP expensing became mandatory several years ago.
Below you will find FAQs, articles, and news items that give a taste of our expertise on this and every other topic in stock compensation. For much more, just click through to our main content section on ESPPs and the related parts of the Tax Center. Thanks for reading!
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|What are the different types of employee stock purchase plans? What are their features?|
All ESPPs involve a post-tax deduction from your paycheck to buy company stock on set dates. In general, any ESPP fits into one of three categories.
Tax-Qualified Section 423 ESPP
The most popular type of employee stock purchase plan is known as a Section 423 ESPP, after the part of the Internal Revenue Code that sets its requirements. An ESPP that qualifies under Section 423 lets you purchase shares at a discount from fair market value without owing any taxes on the discount at the time of purchase. You also never owe Social Security and Medicare taxes, even at sale. If certain holding periods for the purchased stock are met, you receive favorable long-term capital gains tax treatment on most of the gain when you sell the shares. Details about taxes appear in other FAQs on this website. The requirements for Section 423 ESPPs under the US tax code involve employee eligibility, shareholder approval, purchase price, purchase limits, and other matters.
Some plans may not, either by design or operation, qualify under Section 423. A nonqualified ESPP can, however, be structured like a Section 423 plan, but without the preferred tax treatment for participants.
The reasons for not meeting Section 423 vary: the discount may be greater than 15%, the company may match participant contributions, and/or the plan may be available only to a limited group of employees.
Direct Purchase Plan
Another type of nonqualified ESPP is known as an open-market (or direct) purchase plan. The structure of these plans is not controlled by the tax code, they generally do not offer a discount on the stock price at purchase, and you have shorter purchase periods (e.g. every payroll period or every month). This type of plan offers an easy way to buy company stock without brokers' fees.
Surveys show that a majority of ESPPs in the US are Section 423 plans. In its 2011 Domestic Stock Plan Administration Survey, the National Association of Stock Plan Professionals reported that among the 52% of the surveyed companies with ESPPs, 82% have tax-qualified ESPPs, an increase of five percentage points over the figure in 2007. The NASPP found that only 24% have nonqualified plans, though this figure has risen from only 9% in 2004.
For more details, including additional survey data on ESPPs, see the full FAQ on myStockOptions.com.
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What makes this employee benefit attractive is that you can purchase company stock at a discount (up to 15%, depending on your company's ESPP structure) with special tax treatment when you hold the shares long enough. It's an even better deal when your ESPP has a lookback provision. This bases the purchase price discount on the lower price at the start of the offering after the stock price has substantially jumped by the purchase date. You profit even if the stock price has fallen by the purchase date, as an ESPP cannot go underwater.
Example: Your company uses a 15% discount with a six-month lookback, the offering date price is $10, and the stock market price on the purchase date is $20. Your purchase price is thus $8.50. If instead the stock price had fallen to $8 on the purchase date, your purchase price would be $6.80. In the price-gain situation your increase is 135% ($11.50 spread at purchase divided by $8.50 purchase price). Even in the price-drop example you gain by 17.64% ($1.20 spread at purchase divided by $6.80 purchase price).
Example with 10% discount: Your company uses a 10% discount with a six-month lookback, the offering date price is $10, and the stock market price on the purchase date is $12. Your purchase price is thus $9. If instead the stock price had fallen to $8 on the purchase date, your purchase price would be $7.20. In the price-gain situation your increase is 33% ($3 spread at purchase divided by $9 purchase price). Even in the price-drop example you gain by 11% (80 cents spread at purchase divided by $7.20 purchase price). Plus, this is the appreciation on your money for just six months!
Example without lookback: Your company still uses a 10% discount and a six-month offering period. When the stock market price on the purchase date is $12, your purchase price is thus $10.80. If instead the stock price had fallen to $8 on the purchase date, your purchase price would be $7.20. In the price-gain situation your increase is almost 11% ($1.20 spread at purchase divided by $10.80 purchase price). In the price-drop example you gain by 11% for six months (80 cents spread at purchase divided by $7.20 purchase price). In the down market, the pre-tax gain is identical to an ESPP with a lookback.
Another advantage of an ESPP is that you can easily sell the shares for immediate or long-term savings needs; by contrast, company stock in your 401(k) plan can be sold only for other investments in the plan. Of course, your final net gain in these examples depends on the stock price when you sell the shares and on the taxes. The special tax requirements and treatment pertaining to Section 423 ESPP shares are detailed in the FAQs of the section ESPPs: Taxes.
For more on the possible financial gains from ESPPs, see a related article on myStockOptions.com.
Below we list the major articles about ESPPs in the award-winning content of myStockOptions.com. Our extensive section of articles and FAQs on ESPPs is also joined by a podcast, an interactive quiz, a PowerPoint presentation, and a self-study course and exam for CFP and CEP continuing education credits. All of these are available with Premium or Pro Membership or through corporate licensing.
Six ESPP Essentials by Matt Simon
This two-part article series explains important ESPP aspects and concepts in plain English. Part 1 discusses the basics of ESPP participation, such as enrollment rules, plan types, and offering/purchase periods. Part 2 covers holding periods, tax rules, and the impact of various events, both personal (e.g. job loss) and corporate (e.g. M&A).
Fundamentals Of Employee Stock Purchase Plans by Alisa Baker
Your company's employee stock purchase plan (ESPP) may be one of the best employee benefits in your total compensation package. However, to maximize the value of your ESPP, you need to understand how it works. This four-part series covers all aspects of ESPPs, from the basic to the complex. Part 1 is free to all registered users of the site.
Key Dates And Terms You Must Know For Your Company's ESPP by Matt Simon
Your employee stock purchase plan may be one of the best benefits your company offers. However, to maximize its value, you must know its key dates and terms. This article explains the basics you need to know for your ESPP participation.
Are You Taking Full Advantage Of Your Company's Employee Stock Purchase Plan? by Sandra Sussman
Strangely, many employees don't take advantage of their companies' employee stock purchase plans. This article will show you exactly why ESPPs are a good deal.
ESPP Taxation Made Simple by Matt Simon
To achieve the full advantages of enrolling in your company's ESPP, you must understand the tax consequences of participation. This article explains the tax basics.
Employee Stock Purchase Plans & Your Financial Planning by Bruce Brumberg
ESPPs are popular and prevalent at most public companies. However, the structure of these plans is changing. As this two-part article series shows, these modifications may affect your decision to participate in your ESPP and its place in your financial planning.
ESPP Choices: Flip Or Hold? by Timothy Farmer and Gregory Geisler
After you decide to participate in your company's ESPP, you must choose whether to sell the stock soon after purchase or to hold it (and for how long). This two-part article series examines different ways to participate in your ESPP according to relative risk tolerance, timeframe, and needs for money.
IRS Form 3922 For ESPPs: What You Need To Know, And How It Can Help You Understand ESPP Taxation by Bruce Brumberg
Stock purchases made through an ESPP during a calendar year are reported to you and the IRS on Form 3922 early in the following year. This article explains what you need to know about the information on the form, and how the form can help you better understand the complexities of ESPP taxation.
We have always been a big fan of employee stock purchase plans and have an extensive section about ESPPs on myStockOptions.com. A new survey by Fidelity, summarized in a press release, reveals that over half of the surveyed companies (51%) plan to modify their ESPPs in the next few years, and that 31% will make their plans more attractive for participants by, for example, increasing the purchase-price discount or adding a lookback provision.
This is a cheering development after some of the trends the NASPP observed in its 2011 stock plan survey. The results showed that, among the surveyed ESPP companies, the percentage with a 15% discount on the purchase price fell from 87% in 2004 to 71% in 2011, while the percentage with lookbacks dropped from 82% in 2004 to 62% in 2011. (For more survey data on recent ESPP trends, see an FAQ on myStockOptions.com.)
A company's ESPP is available to all of its employees, a refreshing contrast with the recent corporate trend of narrowing the population that receives stock options and restricted stock. It is good to see how companies view their ESPPs, as reflected in Fidelity's survey:
- 50% of the surveyed companies consider an ESPP to be part of the company's benefits package, as opposed to a form of compensation.
- 72% consider ESPPs to be as valuable as pensions and dental benefits, and more valuable than company-provided life insurance.
- 28% believe their employees value their ESPP more than other company benefits.
It is also good to see that this survey generated news-media interest in the benefits of ESPPs. See, for example, an article in the San Francisco Chronicle.
|Rules On Cost-Basis Reporting For Stock Comp And ESPPs To Change—Again|
The cost basis is the all-important number you must subtract from your stock-sale proceeds to determine the capital gain or loss that you report on Form 8949 of your federal tax return. At least for covered securities, the IRS Form 1099-B that your broker issues to you for stock sales does include the cost basis. For regular stock that you buy on the open market, the cost basis is the purchase price. With stock compensation and ESPPs, however, figuring out the basis can be tricky, as the compensation element that appears on your W-2 is part of the basis under this formula:
cost to acquire securities +
the compensation recognized by acquiring it
However, this W-2 income may not be included as part of the basis on the Form 1099-B that the IRS receives. The possible need for you to make an adjustment in the gain/loss you report on Form 8949 creates the potential for tax return mistakes and for overpaying taxes, as an incorrectly reported basis would probably be too low. (For more about the W-2 income that is part of your basis, see a related FAQ on myStockOptions.com.)
It's "Comp"-licated: Final Cost-Basis Rules Make Form 1099-B More Confusing When Stock Comp Is Involved
The final cost-basis regulations, which apply to equity awards (including ESPP stock) "granted or acquired" on or after January 1, 2014, present a few important changes relating to equity compensation that differ from the treatment under the proposed regulations:
- The cost basis reported to the IRS on Form 1099-B for NQSO exercises cannot include the compensation element that is part of the basis. It can include only the exercise cost. Similarly, with any type of ESPP only the purchase price can be reported.
- Form 1099-B will not have a box, field, or other item that indicates whether the shares sold were acquired from stock compensation—a feature that would help to warn you that the basis could be too low. Initially, the IRS seemed inclined to add this type of feature to the form, but it dropped the idea in the final regulations.
According to several tax professionals, in the IRS's phrase "granted or acquired" the word "acquired" refers to the acquisition of the underlying shares. Therefore, even though a stock option award may have been granted before 2014, what really matters is the time when the shares are exercised (i.e. acquired). Given that reporting only the exercise price has always been permitted, the expectation is that brokers will conform to the reporting under the final rules by 2014 at the latest.
While brokers have not been required to report the full basis on Form 1099-B after an employee has sold shares from an NQSO exercise, a cashless ISO exercise, or an ESPP purchase, they have voluntarily started to do so. (For restricted stock and RSUs, which are considered noncovered securities, no cost basis is reported on Form 1099-B, but you still need to report the full basis on Form 8949.) However, the final regulations now prohibit brokers from reporting the full basis. According to the final regulations, the IRS found the permissive approach "unworkable." As a result, the reporting on Form 1099-B is limited to the purchase price and will underreport the cost basis. The IRS seems to believe this is a better approach, as its narrative discussion in the final regulations explains:
By prohibiting adjustment by a broker, an employee will know that the basis number reported by the broker only reflects the strike price paid for the stock and that a basis adjustment may be necessary to reflect the full amount paid by the employee.
For the 2013 tax season (i.e. for sales made this year that you will report on your 2013 tax return next year), the 1099-B that the IRS receives may or may not include the full basis. You want to make sure you know whether it does. For stock acquired through equity grants and ESPPs in 2014, it will not include the compensation element. As a courtesy, your broker may include information in a supplemental form that helps you by including the full basis. The Tax Center on myStockOptions.com also has annotated versions of Form 8949 that explain what to do with the 1099-B information and how to properly report stock sales when the basis is too low (i.e. does not include the compensation element).
Nonqualified Deferred Compensation: myNQDC.com, A Complete Online Resource For Participants And Professionals
Tax-rate increases and the new Medicare surtax have boosted the popularity of nonqualified deferred compensation. From the award-winning publishers of myStockOptions.com, myNQDC.com features articles, FAQs, a glossary, podcasts, interactive quizzes, and a calculator, all to help you, your clients, or your executives understand and make the most of nonqualified deferred compensation.
For companies, education and communication are vital for ensuring NQDC plans work properly to motivate and retain vital executives, directors, and key employees. Companies can license our educational content and tools for websites, print materials, newsletters, and presentations.
For more information on myNQDC.com, including its prestigious advisory board, see the About Us section of the website, and please contact us by phone (617-734-1979) or email (firstname.lastname@example.org).
|Visit Us At The NASPP Conference: Exhibit Hall & Conference Session|
We are excited about the NASPP's annual conference, being held this year in Washington, DC (September 23–27). As always, myStockOptions.com will have its cheerful booth in the exhibit hall. If you attend the conference, please stop by for a chat and pick up a myStockOptions.com souvenir!
Conference attendees will also have a chance to hear Editor-in-Chief Bruce Brumberg speak on Tuesday, Sept. 24 (4:15–5:30). He will be a member of the panel in the session entitled A Change Will Do You Good: Getting Employees On Board With Program Changes. During this lively talk, you will learn how to emphasize the benefits of program changes, overcome skepticism, and communicate change in a positive way.
|Continuing Education Course On ESPPs For CEPs And CFPs|
The myStockOptions.com Learning Center has courses of study and exams offering continuing-education credits for Certified Equity Professionals (CEPs) and Certified Financial Planners (CFPs). The course on employee stock purchase plans features articles, FAQs, and a podcast on all aspects of ESPPs. These features are woven into a dynamic, interactive learning tool that teaches the topics in a memorable way. In the exam that follows the course, the answer key also links to relevant content on the site for further reading and learning.
Other courses offered through the Learning Center focus on nonqualified stock options, restricted stock/RSUs/performance shares, SEC law for stock compensation, and financial planning with equity awards. In total, the courses in the Learning Center can provide up to 20 continuing education credits for CEPs and 15 credits for CFPs.
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