How is income determined when selling ESPP shares?
July 10, 2002
Date: Wed, 19 Jun 2002
Hello Mr. Gray!
In the March 2, 2002 issue of the ESOAA Option Alert, you state “Some (ESPP) plans set an option price at the lesser of 85% of the fair market value on the grant date or the exercise date. When the option price is not fixed or determinable at the time the option is granted, then in determining the ordinary income to be reported, the option price is determined as if the option was exercised when granted.”
Am I to understand that if the stock is worth $10 as of the grant date and it is worth $5 on the exercise date, then the option price to determine the ordinary income to be reported when the shares are sold would be $8.50 ($10 X 85%)?
Date: 26 Jun 2002
First, remember this rule applies when the holding period requirements have been met. (The stock has been held more than two years after the grant date (sometimes called the subscription date) and more than one year after the exercise or purchase date.)
Yes, the deemed purchase price to compute the ordinary income to be reported would be $8.50. The ordinary income to be reported in the year of sale would be the lesser of (a) $10.00 (FMV on grant date) – $8.50 (option price on grant date) = $1.50 or (b) the excess of the fair market value at the date of disposition (usually the sale price) over the amount paid for the share ($4.25 = 85% X $5.00 in your example). (Internal Revenue Code Section 423(c))
The tax basis of the shares to report on Schedule D would be increased by the amount of ordinary income reported. Assuming the sale price exceeded $5.75, the tax basis in your example would be $4.25 (option price) + $1.50 (ordinary income reported) = $5.75.