Two questions about ESPP compensation reporting
Whit
shares
of A at 85% of the lesser of FMV on the grant date and FMV on the
exercise
date. An offering period begins on 4/1/2007 (the grant date), at
which time
the FMV of A is $100. On 10/31/07, TP purchases 10 shares under A's
ESPP.
FMV on 10/31/07 is $90. TPs option price is $76.50, being the lesser
of 85%
of $100 and 85% of $90. Assume A's plan qualifies under section 423,
and
TP's sales are all qualifying sales.
1) TP sells all 10 shares in 2010 for $120/share, what compensation
should
be reported?
2) Suppose A spins off B in 2009. What compensation should be
reported
in 2010 when A shares are sold? If the spunoff shares are sold in
2011,
what compensation should be reported then?
(more details below)
Here's my thought process; sorry to be so wordy:
QUESTION ONE:
In 2010, TP sells all 10 shares for $120/share. Per section 423(c),
the
compensation element (per share) of TP's sale is the lesser of:
(1) the excess of the fair market value of the share at the time of
such
disposition over the amount paid for the share under the option, or
(2) the excess of the fair market value of the share at the time
the
option was granted over the option price.
FMV at disposition = $120/share.
FMV on grant date = $100/share.
Amount paid for the share = $76.50
Option price = ???
I've found an example in the IRS regs, and a description at
fairmark.com,
both of which indicate that the meaning of "option price" in (2) is
"the
option price determined as of the grant date".
Section 423(c) explains that throughout that subsection, if the option
price
isn't determinable on the grant date (as is the case here), you
should
compute it as though the option were exercised on the grant date.
Assuming
that this meaning of "option price" is correct, the "option price" in
(2) would
be computed as though the option were exercised on the grant date, so
it
would be 85% of the grant date FMV, or $85. That makes the
compensation
computation:
the lesser of
(1) $120 - $76.50 = $43.50 or
(2) $100 - $85 = $15
So TP would report $15/share (so $150 total) as compensation, and add
it to
his $76.50 basis. His basis would then be $91.50/share, and he would
report
$28.50/share as capital gain ($120 - $91.50).
If one believes that "option price" in (2) means the "price paid under
the
option", then (2) would be $100 - $76.50 = $23.50. I don't believe
this is
the correct meaning, but it's easy to see why such an obvious reading
of the
text would be convincing. One reason for the uncertainty about the
meaning
is that, before 2008, Pub 525 paraphrased the two choices in 423(c)
this
way:
o The amount, if any, by which the price paid under the option was
exceeded by the fair market value of the share at the time the option
was
granted, or
o The amount, if any, by which the price paid under the option was
exceeded by the fair market value of the share at the time of the
disposition or death.
In other words, the older versions of Pub 525 interpreted "option
price" in
(2) as meaning "the price paid under the option". Current versions of
Pub
525 don't paraphrase the code at all, they quote it verbatim without
any
clarification. However, the Regs seem to give an unambiguous example
-
here's the relevant sentence (**'s are mine, of course):
-----------------------------------
Compensation in the amount of $5 is includible in P's gross income for
the
year 2013, the year of the disposition of the share. This is
determined in
the following manner: The excess of the fair market value of the stock
at
the time of the disposition ($150) over the price paid for the share
($95)
is $55; and the excess of the fair market value of the stock at the
time the
option was granted ($100) over **the option price, computed as if the
option
had been exercised at such time** ($95), is $5.
-----------------------------------
As it turns out, in their example, the "price paid for the share"
turns out
to be the same number as "the option price, computed as if the option
had
been exercised at such time", because the price was lower on the grant
date
than the exercise date. But the **text** is clear as to how the
number is
to be computed.
My question is whether the tax preparer community generally
understands
"option price" in (2) to mean "the option price, computed as if the
option
had been exercised on the grant date", or "the price paid under the
option".
I'm not sure which is more authoritative, an Example from the regs
with no
explanatory text, or an old version of Pub 525.
QUESTION TWO
(I am assuming here that "option price" in (2) means as of the grant
date.)
Assume the same facts as above, except that in 2009 A spins off
subsidiary
B, distributing one share of B for each share of A to the holders of
A
shares (to keep the math simple). Just after the spinoff, the FMV of
a
share of A is $88 and B is $22. That is, the value of the old shares
of A
has been divided so that 80% is in the A shares and 20% is in the
newly
distributed B shares. TP adjusts his $76.50 basis in the 10 shares of
A
down to $61.20 (80%), and the B shares have a basis of $15.30. As
before,
in 2010 TP sells all 10 shares of A for $120/share. In 2011, he sells
all
10 shares of B for $30/share.
What is the compensation income to be reported for each sale? It
seems that
the spinoff should have no impact on the total compensation that TP
is
ultimately required to report... it should still be $150 total. One
approach that works is to apply the 80% adjustment to all the
relevant
values in the compensation computation. In other words:
For first sale, of 10 A shares
FMV at disposition = $120
FMV on option grant date = 80% * $100 = $80
Price paid for the (new) A shares = 80% * $76.50 = $61.20
"Option price" = 80% * $85 = $68
Compensation is lesser of
(1) $120 - $61.20 = $58.80, or
(2) $80 - $68 = $12
So, report $12/share (or $120 total) compensation for the A shares
For the sale of B shares
FMV at disposition = $30
FMV on option grant date = 20% * $100 = $20
Price paid the B shares = 20% * 76.50 = $15.30
"Option price" = 20% * $85 = $17
Compensation is lesser of
(1) $30 - $15.30 = $14.70
(2) $20 - $17 = $3
So, report $3/share (or $30 total) compensation for the B shares
That "works" - the reported compensation for the two sales combined
adds up
to $150, which seems correct. However, I find no support (other than
"common sense") for the idea that, for purposes of computing the
compensation element for a sale of ESPP shares after a spinoff, the
FMV and
option price should be adjusted in the same was as the basis, or any
mention
of the messy side-effect of doing that, namely, that part of the
compensation element is carried into the shares of the spun-off
company,
creating a record keeping nightmare. If HP spins off Agilent which
spins
off Verigy, etc...
Since (1) is intended to compute your "profit" on the sale, it would
seem
that the numbers must be adjusted to match what it is you're actually
selling, namely post-spinoff shares of A. Also, since one of the
numbers
(FMV at disposition) is a post-spinoff value, it seems that the other
number
(price paid for a share under the option) must also be adjust so that
it is
a post-spinoff value. If those two numbers are post-spinoff, then it
seems
the numbers in (2) should also be.
So - am I correct that the price paid under the option, and the FMV
and
option price on the grant date, should all be adjusted by 80% for the
spinoff?
Whit Matteson
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Mark Bole
[...]
> So - am I correct that the price paid under the option, and the FMV
> and
> option price on the grant date, should all be adjusted by 80% for the
> spinoff?
>
> Whit Matteson
I glanced at your post but found it difficult to read due to hard line
breaks and overall length, so I didn't.
-Mark Bole
Whit Matteson
Whit Matteson
"Mark Bole" <ma...@pacbell.net> wrote in message
news:i9hnme$3ej$1...@news.eternal-september.org...
> On 2010/10/17 14:57, Whit wrote:
> [...]
>> So - am I correct that the price paid under the option, and the FMV
>> and
>> option price on the grant date, should all be adjusted by 80% for the
>> spinoff?
>>
>> Whit Matteson
>
> I glanced at your post but found it difficult to read due to hard line
> breaks and overall length, so I didn't.
>
> -Mark Bole
Mark -
Thanks for at least glancing! I can blame the line breaks on a series of
problems with Outlook Express vs. Google, and trying to find a new news
server that allows posting, after my ISP stopped supporting it. I've
reposted it, hopefully without as many breaks. We'll see.
The length is my fault; it's two questions in one post, and I probably
included more detail than I needed to. I'll look again to see if I can be
more concise, but so often, the posts omit information that's necessary to
give a good answer, or omit the part the poster has already figured out, and
lots of subsequent posts are wasted getting to the crux of the matter.
Whit
Chip Wood
> "Mark Bole"<ma...@pacbell.net> wrote in message
> news:i9hnme$3ej$1...@news.eternal-september.org...
>> On 2010/10/17 14:57, Whit wrote:
>> [...]
>>> So - am I correct that the price paid under the option, and the FMV
>>> and
>>> option price on the grant date, should all be adjusted by 80% for the
>>> spinoff?
>>>
>>> Whit Matteson
>>
>> I glanced at your post but found it difficult to read due to hard line
>> breaks and overall length, so I didn't.
>>
>> -Mark Bole
>
> Mark -
>
> Thanks for at least glancing! I can blame the line breaks on a series of
> problems with Outlook Express vs. Google, and trying to find a new news
> server that allows posting, after my ISP stopped supporting it. I've
> reposted it, hopefully without as many breaks. We'll see.
>
> The length is my fault; it's two questions in one post, and I probably
> included more detail than I needed to. I'll look again to see if I can be
> more concise, but so often, the posts omit information that's necessary to
> give a good answer, or omit the part the poster has already figured out, and
> lots of subsequent posts are wasted getting to the crux of the matter.
>
> Whit
>
pre-spin-off, then some ESPP in the spin-off in $ not %, then more
post-spin-off, then the spin-off went private. I just took a common
sense approach (I know, I know, the tax code is NOT common sense) and
they haven't arrested me yet. All those numbers, percentage, and
particulars just made my head ache. I figure if they ever come after me
on it, I will plead stupid and unable to follow their own jumbled,
contradictory, and confusing instructions.
Chip
Chip Wood
>
> Thanks for at least glancing! I can blame the line breaks on a series of
> problems with Outlook Express vs. Google, and trying to find a new news
> server that allows posting, after my ISP stopped supporting it.
Sorry, forgot this piece of advice. I used nntp.aioe.org as an
absolutely, no hidden agenda, free news server for the past 6 years.
Very dependable and has 1000's of groups. Allows you to post and only
balks at cross-posting which I hate anyway. I use Thunderbird as a news
reader and it works a treat. Much better than Outlook Express.
Chip.
Alan
your profit or the discount offered to you on the date of grant. In your
case, the profit is $43.50 per share and the discount on 4/1/07 was $15.
Therefore you report on a per share basis: $15 of ordinary income; add
the $15 to your purchase price of $76.50 to arrive at your adjusted
basis of $91.50 and a LTCG of $28.50. If you add $28.50 to $15.00 you
get $43.50 (your total profit).
Q2: There are series of revenue rulings on this issue that I don't have
on hand. However, I believe that no adjustment is made to the grant date
data. Given your assumption that the FMV just before the spinoff was
$110 and the drop in FMV is directly related to the spinoff:
You allocate 80% of your cost basis of $76.50 to A and 20% to B. That
puts A at $61.20 and B at $15.30 per share. Your profit on the A sale
is $58.80. $15 is compensation (same as Q1) and $43.80 is LTCG. Your
profit on the B sale is $30 - $15.30 = $14.70. All of it is LTCG.
--
Alan
http://taxtopics.net
Whit Matteson
"Chip Wood" <chip....@gmail.com> wrote in message
news:i9i7ue$81h$1...@speranza.aioe.org...
> On 10/18/2010 9:23 AM, Whit Matteson wrote:
>
>>
>> Thanks for at least glancing! I can blame the line breaks on a series of
>> problems with Outlook Express vs. Google, and trying to find a new news
>> server that allows posting, after my ISP stopped supporting it.
>
> Sorry, forgot this piece of advice. I used nntp.aioe.org as an
> absolutely, no hidden agenda, free news server for the past 6 years. Very
> dependable and has 1000's of groups. Allows you to post and only balks at
> cross-posting which I hate anyway. I use Thunderbird as a news reader and
> it works a treat. Much better than Outlook Express.
>
> Chip.
Chip -
Thanks, I'll check it out!
Whit
Whit Matteson
"Alan" <sfcn...@yahoo.com> wrote in message
news:i9igao$9qj$1...@news.eternal-september.org...
> On 10/18/10 10:23 AM, Whit Matteson wrote:
>> TP participates in company A's ESPP. Under A's plan, TP may purchase
>> shares
>> of A at 85% of the lesser of FMV on the grant date and FMV on the
>> exercise
>> date. An offering period begins on 4/1/2007 (the grant date), at which
>> time
>> the FMV of A is $100. On 10/31/07, TP purchases 10 shares under A's
>> ESPP.
>> FMV on 10/31/07 is $90. TPs option price is $76.50, being the lesser of
>> 85%
>> of $100 and 85% of $90. Assume A's plan qualifies under section 423, and
>> TP's sales are all qualifying sales.
>>
>> 1) TP sells all 10 shares in 2010 for $120/share, what compensation
>> should
>> be reported?
>>
>> 2) Suppose A spins off B in 2009. What compensation should be reported
>> in
>> 2010 when A shares are sold? If the spunoff shares are sold in 2011,
>> what
>> compensation should be reported then?
>>
>> subsidiary
>> B, distributing one share of B for each share of A to the holders of A
>> shares (to keep the math simple). Just after the spinoff, the FMV of a
>> share of A is $88 and B is $22. That is, the value of the old shares of
>> A
>> has been divided so that 80% is in the A shares and 20% is in the newly
>> distributed B shares. TP adjusts his $76.50 basis in the 10 shares of A
>> down to $61.20 (80%), and the B shares have a basis of $15.30. As
>> before,
>> in 2010 TP sells all 10 shares of A for $120/share. In 2011, he sells
>> all
>> 10 shares of B for $30/share.
>>
>
> hand. However, I believe that no adjustment is made to the grant date
> data. Given your assumption that the FMV just before the spinoff was $110
> and the drop in FMV is directly related to the spinoff:
> You allocate 80% of your cost basis of $76.50 to A and 20% to B. That puts
> A at $61.20 and B at $15.30 per share. Your profit on the A sale is
> $58.80. $15 is compensation (same as Q1) and $43.80 is LTCG. Your profit
> on the B sale is $30 - $15.30 = $14.70. All of it is LTCG.
>
> --
> Alan
> http://taxtopics.net
>
Alan -
Thanks for wading through that, and for the confirmation that I was on track
in the first scenario.
I like the approach you describe for the second situation (leave the grant
date data unadjusted and take all the compensation income with the
disposition of the A shares) because it's simpler and cleaner. Would you
take the same position if the two lots had been created from a stock split
instead of a spinoff? It seems like a very similar situation (similar basis
adjustment, etc.) but if I take the same approach of not adjusting the grant
date data, I think I would have a bunch of A shares with the same basis and
acquisition date, but 10 would carry the compensation income attribute and
the rest wouldn't. That doesn't seem right somehow.
I'll try to track down the revenue rulings; if you come across them, please
point me in the right direction!
Thanks,
Whit
lakshmi
Hi Whit
Wondering if you were able to access the IRS rulings on the topic of ESPP
spin-offs. I am in a similar situation as yours. And the company has
attributed all the compensation to the ESPP stock of A. Not pro-rating the
compensation element is akin to 1) pre-payment of tax if you sell stock A but
not B at the same time 2) A higher proportion of tax get attributed to simple
income as compared to it being capital gains. Should the employee carry the
extra burden of the spin off of the company ?
--
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<< ------------------------------------------------------- >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
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<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< ------------------------------------------------------- >>
Alan
> replying to Whit Matteson, lakshmi wrote:
> Hi Whit
> Wondering if you were able to access the IRS rulings on the topic of ESPP
> spin-offs. I am in a similar situation as yours. And the company has
> attributed all the compensation to the ESPP stock of A. Not pro-rating the
> compensation element is akin to 1) pre-payment of tax if you sell stock
> A but
> not B at the same time 2) A higher proportion of tax get attributed to
> simple
> income as compared to it being capital gains. Should the employee carry the
> extra burden of the spin off of the company ?
>
Companies have a lot of flexibility on how they handle this.
http://www.semlerbrossy.com/wp-content/uploads/HowtodealwithEquity.pdf
omkar nayak
Thanks Alan. My company took the Shareholder approach. So if I relate the
"Stock Options" calculations in your PDF to my ESPP situation, I should be
adjusting the compensation element based on the % FMV of the RemainCo & SpinCo
shares. Did I under your PDF correctly ?
And apologies for the late response. I was expecting a notification from
Beansmart and did not receive it.
--
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using BeanSmart's Web, RSS and Social Media Interface to
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Always include the content to which you are responding, so people don't
have to guess or wade through past posts to understand the context.
Alan
> replying to Alan, omkar nayak wrote:
> Thanks Alan. My company took the Shareholder approach. So if I relate the
> "Stock Options" calculations in your PDF to my ESPP situation, I should be
> adjusting the compensation element based on the % FMV of the RemainCo &
> SpinCo
> shares. Did I under your PDF correctly ?
> And apologies for the late response. I was expecting a notification from
> Beansmart and did not receive it.
>
used and they kept the employee stock purchase element with the original
company then:
The basis in the stock purchased under ESPP is split between the two
companies based on FMV on the closing date. Using the example in the
document you read ($20 FMV was split $15 to original co. and $5 to
spin-off) then 25% of the basis moves to the new company. 75% of the
basis (what you paid) stays with the old co. This basis gets divided by
.85 (I assume the discount was 85%) and multiplied by .15 to arrive at
the bargain element. If the stock had risen after the grant, the bargain
element would represent the 15% discount off the derived option price.
If the stock had fallen in price, the bargain element would represent
the 15% discount off the market price on the date of purchase. Either
way, you would now have the amount needed to determine how much of any
profit on the sale is ordinary income and how much is capital gain when
it is sold. This obviously depends upon whether you have a qualifying or
disqualifying disposition of the ESPP stock. The gain or loss on the
sale of the spin-off company is cut and dry as it is all capital in nature.