Trends, Considerations and New
Developments in Employee Stock
Purchase Plans
Sandra Sussman, Buck Consultants
Michael Voves, Dorsey & Whitney LLP
NASPP Twin Cities, February 7, 2013
Agenda
• Overview
• Plan Design Alternatives
• Trends/Best Practices
• New Developments
• Questions & Answers
Overview
What is an ESPP?
• ESPPs are broad-based stock purchase plans that
allow employees to purchase company stock
through after-tax payroll deductions
• Often, shares are purchased at a discount
• ESPPs may be tax-qualified (under IRC 423) or
non-qualified
• ESPPs may be “compensatory” (ASC 718 / FAS
123R) or non-compensatory
Why Offer an ESPP?
• Facilitates employee ownership
• Creates corporate identity/ownership culture
• Aligns employees’ interests with shareholders’
• Good bang for the buck
Qualified ESPP (Code Section 423)
• Basic statutory requirements:
–
–
–
–
–
–
Employees only
Exclude 5% owners
Stockholder approval
Equal rights and privileges
$25,000 limit and share limit
Purchase rights non-transferable
Qualified ESPP (Code Section 423)
• Additional requirements allow for design alternatives:
– Eligibility
– Purchase price – no less than 85% of the lesser of
grant date and purchase date fair market values
– Length of offering (3 to 27 months)
– Look-back feature
• Purchase discount, offering length, look-back feature
all affect the ASC 718 compensation expense
Qualified ESPP (Code Section 423)
• Tax Treatment
– No tax at purchase; no FICA or withholding (in the US)
– Tax triggered by sale of shares
– Favorable tax treatment if stock held two years from
offering date and one year from purchase
• Qualifying Disposition (QD): Most of (if any) gain over
purchase price taxed at capital gains rate; always small
amount of ordinary income
• Disqualifying Disposition (DD): Ordinary income on spread at
purchase; company gets tax deduction for same amount
– Ordinary income reported on W-2
– Form 3922 reports prior year’s purchases
Nonqualified ESPP
• No rules or limits
• More flexibility around eligibility/exclusions
• Company match permitted
• Spread on purchase taxed like NQSO
–
–
–
–
Withholding (including FICA) at purchase
W-2 reporting
Company tax deduction
No Section 6039 reporting
ESPP Accounting
• No earnings charge if non-compensatory
– Discount does not exceed 5% of purchase date FMV
– Minimal or no “option-like” features (e.g., look back)
• Subject to ASC Topic 718 if compensatory
• Expense (fair value) comprises 3 components:
– Value of any discount
– Value of call option (if look-back feature)
– Value of put option (if no limit on shares purchased if
price declines)
• Certain features trigger modification accounting
Plan Design
Design Decisions
• Qualified or nonqualified?
• Eligibility
• Offering period/purchase period(s)
• Withdrawals, contribution increases/decreases
• Discount
• Match
• Look back
• Holding requirement
• Refund or rollover residual cash
Design Considerations
• Plan objectives
• Workforce demographics
– Sophistication level and needs
– Pay level (ability to accumulate enough during a purchase period
to purchase a meaningful number of shares)
• The greater the benefit to the employee, the greater the
accounting expense and/or administrative cost
–
–
–
–
Discount
Look-back feature
Length of offering period
Contribution rate changes (increases)
Administrative Considerations
• Shorter offering periods
– Creates ownership faster
– More purchases to administer
• Avoid scheduling purchase dates during blackouts or at quarter
or year end
– Schedule during mid-pay cycle to allow time to reconcile
contribution data
• Limit frequency of contribution-rate changes
• Reporting back to enrollees
– Beyond Section 6039
Trends/Best Practices
ESPP or no ESPP?
The NASPP’s 2011 Domestic Stock Plan Administration
Survey tells us that, among the 583 companies participating in
the survey
•
52% have an ESPP
– 60% in 2007
– 64% in 2004
•
Of those that do not have an ESPP, 71% never did
Qualified or Non-Qualified?
• Qualified Pros
– Opportunity for favorable tax treatment to the
employee at purchase
• Qualified Cons
–
–
–
–
–
Must be non-discriminatory
Complicated tracking and reporting requirements
Complicated accounting
Shareholder approval required
No tax deduction (unless disqualified disposition)
Qualified or Non-Qualified?
• Non-Qualified Pros
– More flexibility in design
– Less complicated reporting and accounting
• Non-Qualified Cons
– No favorable tax treatment at purchase
– Withholding on purchase
– Shareholder approval may still be required under
applicable exchange rules
Qualified or Non-Qualified?
• NASPP survey results:
– 82% of companies with ESPPs have qualified
Section 423 plans
• 77% in 2007
• 84% in 2004
– 24% have nonqualified plans
• 26% in 2007
• 16% in 2004
Key Plan Features
• Six-month offering period is most common (53%)
– Three months is next (19%), then 12 months (11%)
– In 2004, order was six months (29%), 12 months (24%), then
24 months (19%)
– Purchase periods = offering period at 67% of companies
• 15% is most common purchase discount (71%, vs 79% in 2007,
87% in 2004); 5% is next, at 17% of companies
• Look back (lower of beginning/end) still is most common
(62% vs 66% in 2007, 82% in 2004)
• Contribution-rate changes not typical—fewer than 25% in any
scenario
• Automatic resets not typical—85% of companies do not use
Key Plan Features
• Trend has been to eliminate look back and shorten offering
periods, in order to reduce compensation expense
– Assuming 50% volatility, shortening a 15% look back from 24 to
12 months cuts expense by 20%; shortening to three months cuts
expense by 40%
– Lowering discount to 5% from 15% with 24-month look back
reduces the expense by 22%
• Studies have shown that elimination of look-back feature does
not significantly affect participation levels, in contrast to
changes to purchase discount
• Contribution rate increases, automatic resets trigger
modification accounting
Other Features
• 20% of companies mandate holding periods to
prevent same-day sale for quick gain
– Six months most common (38%) followed by 12 (34%)
– May also ease burden of tracking dispositions
• Per person limits (in addition to IRS limits)
– Contribution max
– Share max
• Match if nonqualified plan
New Developments
Cost Basis Reporting
• ESPP purchases for cash are covered
• Brokers have choice to report complete basis or just
purchase price
Questions & Answers
Legal Notice and Treasury Circular 230 Notice
This presentation is intended for general information purposes only
and should not be construed as legal advice or legal opinions on
any specific facts or circumstances. An attorney-client relationship
is not created through this presentation.
To comply with certain Internal Revenue Service (“IRS”) rules,
please note that any U.S. federal tax advice contained in this
presentation, including handouts, is not intended or written to be
used, and cannot be used, for the purpose of avoiding any
penalties that may be imposed by the IRS. We understand that
you do not intend to use or refer to anything contained in this
presentation to promote, market, or recommend any particular
entity, investment plan, or arrangement.