Probate & Trust Law Section Conference Manual ... - Minnesota CLE

The Well-Prepared Executive: Personal Wealth Preservation Strategies
applied to the ESPP are after tax funds, not pretax.
2.
Executive’s Income Tax Consequences
a. Grant
The executive recognizes no income tax
when the company grants the option to participate in
the ESPP.
b. Exercise
The executive also recognizes no income
tax when the employee is deemed to have exercised
the option (i.e. when shares are purchased on behalf
of the employee at the end of the purchase period).
3. Sale of Stock Acquired Through ESPP
Assuming the holding period requirements
(described below) are met, the executive recognizes
capital gain when the stock acquired through the
ESPP is sold. Thus, just like with ISOs, (i) the
executive defers any tax until the stock is sold, and
(ii) all of the gain from the time of purchase under
the ESPP is treated as capital gain.
4. Holding Period Requirement and
Disqualified Dispositions
a. To obtain the favorable ESPP tax
consequences, the executive must not dispose of the
stock received through the ESPP before the later of
(i) 2 years from the grant of the purchase right or (ii)
1 year from the date of exercise or purchase. IRC §
423(a)(1). Thus, both holding periods must be
satisfied.
b. Failure to satisfy the holding period
requirement does not disqualify the ESPP but rather
results in a disqualifying disposition. Any gain
recognized by the executive on a disqualifying
disposition will first be treated as ordinary income
to the extent of the difference between the stock’s
fair market value on the date the purchase right was
exercised and the purchase price. Treas. Reg.
1.421-6(d). Any remaining gain will be treated as
long-term capital gain if the executive held the stock
after the exercise of the purchase right for at least
one year or short-term capital gain if the executive
did not hold the stock for a year.
c. In the event of the employee’s death, the
transfer of a purchase right to an estate is not a
disqualifying disposition. Assuming the plan allows
it, an estate may exercise a purchase right held by
the decedent. IRC 421(c)(1)
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5. ESPP Requirements
Just like ISOs, there are several
requirements that an ESPP must meet to qualify for
this favorable tax treatment. IRC 423, 421.
a. Shareholder Approval
The company’s shareholders must approve
the ESPP.
b. All Employees Eligible
Although stock options and restricted stock
awards often are given only to top executives or key
employees, all employees (with few exceptions)
must be eligible to participate in the ESPP. Five
percent owners, however, cannot participate. The
participation rights and options under the ESPP
must be identical for all employees.
c. Non-transferable
The purchase rights are not transferable,
except upon the death of the employee.
d. Offering Period Limit
If the purchase price is a percentage of fair
market value, then the maximum offering period is
five years from the date of grant. If the purchase
price is determined in any other manner, then the
maximum offering period is 27 months from date of
grant of the option.
e. Limit on Grants
An employee cannot accrue a right to
purchase stock at a rate that exceeds $25,000 of fair
market value for each calendar year. Assuming the
ESPP allows for purchase at 85% of fair market
value, this limitation means that an employee cannot
invest more than $21,250 ($25,000 x .85) in the
ESPP each year.
f. Limit on Purchase Price Discount
The purchase price cannot be less than 85%
of the fair market value of the stock on (i) the first
day of the purchase period, or the grant date, and (ii)
the lat day of the purchase period, or exercise date.
VI. EMPLOYER SECURITIES
DISTRIBUTED FROM QUALIFIED PLAN
A. Background
1. An executive often will own company stock
in a qualified plan, such as a 401(k) plan. When the
time comes to take a distribution from the plan or to
consider whether to roll-over the 401(k) into an