Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company1 A plan for compensating a broad group of employees with options to buy stock of the employer company at a specified price –generally not used for executive compensation –limited to $25,000 / year –forbidden to more than 5% owners What is it?

Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company2 1.Employer willing to compensate employees with shares of company stock 2.Employer wishes to reward executive performance with equity based compensation When is it Indicated?

Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company3 1.provides incentive 2.easy form of savings 3.little to no out-of-pocket cost to company 4.tax deferred to employee Advantages

Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company4 Coverage: Plan must cover all employees, but may exclude those –with < 2 yrs. Service –with customary service < 20 hrs. / week or not more than 5 months in any calendar year –who are highly compensated ESPP Requirements Under Code Section 423

Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company5 Benefits: –same rights and benefits to all covered employees, but amount of stock can be % of compensation –cannot purchase > $25,000 of stock under ESPP in any one calendar year –stock price must not be less than LESSER 85% of fair market value at time option granted 85% of fair market value at time stock purchased –options generally must be exercised within 5 yrs. ESPP Requirements Under Code Section 423

Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company6 1.If employee meets certain criteria, no taxable income to employee when ESPP option is –granted –exercised 2.if holding period met when employee sells stock, taxable income consists of –ordinary compensation income –capital gain Tax Implications

Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company7 3.if employee meets holding period requirements, employer receives NO tax deduction if employee DOES NOT meet holding period requirements, amount included in employee compensation income is amount employer CAN deduct Tax Implications

Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company8 ESPP is not a pension or welfare benefit under ERISA No reporting requirement Other ERISA provisions also not applicable ERISA and Other Requirements

Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company9 Plan must be approved by stockholders of granting corporation within 12 months before or after the date the employer adopts the plan A written plan and notification of employees are wise, but not mandated by law How is the plan set up?

Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company10 1.ESPP benefits are forbidden to more than 5% owners. 2.ESPPs are used by closely-held corporations. 3.ESPPs have little to no out-of-pocket costs. 4.The employer bears the market risk of an ESPP. 5.ESPP options must be exercised within 10 years. True or False?

Chapter 37 Employee Benefit & Retirement Planning Employee Stock Purchase Plan (Section 423 Plan) Copyright 2011, The National Underwriter Company11 Zeta Corp. granted Norman an option under its employee stock purchase plan to buy 100 shares of Zeta for $20 per share when the stock was valued at $22 / share. A year and a half later, when the stock was $23 / share, Norman exercised his option; 14 months later he sold his stock for $30 / share a.What must Norman report as wages? b.What must Norman report as capital gains? Discussion Question