Video included! How does an ESPP work if it is not a tax-qualified plan? For example, can there be a share match?
As explained in another FAQ, "qualified" (or "tax-qualified") means the company set up the plan to meet the requirements in Section 423 of the Internal Revenue Code. If a nonqualified plan is structured like a qualified Section 423 plan (except for whatever feature disqualifies it), it will work in the same way but without the favorable tax treatment for participants.
An ESPP that is not tax-qualified can offer your company more flexibility in plan terms, eligibility, and design. The reasons for not meeting the requirements of 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 executives. For example, Jack-in-the-Box Inc. (see page 10 of its 2006 proxy statement) does not allow ESPP participation for "all employees who are designated as restaurant hourly team members or team leaders, or who are officers subject to Section 16 of the Securities Exchange Act of 1934."
Instead of a discounted purchase price, a small number of companies that have nonqualified ESPPs provide a company match in shares or cash for the payroll contributions allocated to the plan for stock purchases. These types of matches are not allowed for qualified plans because employees need to pay for the value of all shares received, discounted from the price at grant or purchase.
An example of a nonqualified plan with a match occurs at business-software company SAP. In its nonqualified ESPP, called Own SAP, the company matches up to 40% of each employee's contribution. Employees below the executive level also receive a €20 subsidy (about $22.50).
Another example of a nonqualified ESPP with a match is at retailer American Eagle Outfitters. The company's associates are matched 15% on the first $100 per pay period.
An example of a nonqualified ESPP that has both a purchase discount and a match is the "Action 2021" ESPP at Sanofi. Its global employee share ownership plan is open to 92,000 employees in 73 countries. In the 2020 plan, more than 33,000 Sanofi employees chose to invest in the company. The features of the 2021 plan include:
- Shares offered at a subscription price of €69.38, which is equal to a 20% discount off the average of the 20 opening prices of Sanofi shares from May 6 to June 2, 2021.
- For every five shares subscribed, employees receive one free share (up to a maximum of four free shares per employee).
- Each employee will be able to purchase up to 1,500 Sanofi shares within the legal limit of a maximum payment amount that does not exceed 25% of their 2021 gross annual salary, minus any voluntary deductions already made under employee savings schemes.
- The shares must be held five years.
In Don't Discount A Match: Thoughts On Matching Share ESPPs, Deloitte contends that this type of ESPP is getting "new looks" and "growing interest." The reasons include companies' ability to impose conditions on matched shares, such as continued employment or a holding period, giving the plan employee-retention features that make it similar in some ways to the vesting period of restricted stock/RSUs. The firm's survey data indicates that the most common ratio is one matching share for every two or three shares purchased by the employee.
A commentary at the NASPP's blog explains how a nonqualified ESPPs can offer additional assistance or incentives for lower-paid employees with a greater discount, contribution match, or contribution subsidy (see Four Ideas to Make Your ESPP More Equitable).
Direct Purchase Plans
An open-market or direct purchase plan, on the other hand, will likely be more straightforward. These plans have payroll deductions, but purchases are typically made more often, e.g. weekly, monthly, or at the end of every pay period. There is not usually a discount on the price. Shares are held in an account for each participant at the transfer agent or the brokerage firm that is administering the plan. When the shares remain in this account, any dividends may be automatically reinvested into new company shares, depending on your plan. The main benefit to the participant is that the shares are purchased on a hassle-free regular basis and usually without a brokerage commission (charged to the employee).
See the related FAQ on the tax treatment of nonqualified ESPPs.
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