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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.
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Trends, Considerations and New Developments in Employee Stock Purchase Plans Sandra Sussman, Buck ConsultantsMichael Voves, Dorsey & Whitney LLP NASPP Twin Cities, February 7, 2013
Agenda • Overview • Plan Design Alternatives • Trends/Best Practices • New Developments • Questions & Answers
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) ornon-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
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
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 qualifiedSection 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%), then24 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 to12 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
Cost Basis Reporting • ESPP purchases for cash are covered • Brokers have choice to report complete basis or just purchase price
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