On November 16, 2009, the IRS and the Treasury Department issued final regulations governing employee stock purchase plans (ESPPs) that are subject to Code Section 423, effective January 1, 2010. See T.D. 9471, 74 Fed. Reg. 59074 (Nov. 17, 2009). These final regulations did not make dramatic changes the current regulations or the proposed regulations except in one area regarding determining the grant date for ESPP purposes.
With regard to the “grant date”, the final regulations provide that, in order to have a grant date that is the first day of the offering period, the ESPP plan, or the resolutions authorizing the offering, must contain a limit on the maximum number of shares that can be purchased during the offering period or a formula that will generate the maximum number based on information known on the first day of the offering period. Consequently, a limit that states that no participant can purchase more than 1,000 shares of common stock during an offering period is satisfactory as is a formula that states that no participant can purchase shares with a value equal to more than $25,000 divided the fair market value of the stock of the first day of the offering period. It is not satisfactory to have a plan provision that states that no more than $25,000 of stock can be purchased in a calendar year because a calendar year is not necessarily the same as the offering period (which may be one month, three months or six months instead of one year).
Establishing the grant date as the first day of the offering period is critical to the qualification of all ESPPs that use “look back” pricing, i.e., the purchase price under the ESPP is the lower of 85% of the fair market value of stock on the first day and last day of the offering period. If there is no limit on the shares that can be purchased during the offering period, this pricing does not satisfy the Section 423 requirements and the offering period will not qualify for Section 423 purposes. Consequently, ESPP sponsors with “look back” pricing that do not have per offering period share limits should take immediate corrective action, such as terminating the current offering period, adopting an offering period share limit and starting a new offering period (which may end the same time as the offering that was just terminated.)
For companies that price ESPP purchase based on the fair market value of stock on the last day of the offering period, or as a percentage of that value, this issue is less critical. The two year holding period from the grant date that is one of the requirements for certain ESPP tax benefits will not start on the first day of the offering period but only on the last day of the holding period. Nothing is disqualified, but the holding period for certain tax benefits is extended. It would be useful, but not critical, to correct these arrangements as well.