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Strategies & Market Trends : Income Taxes and Record Keeping ( tax ) -- Ignore unavailable to you. Want to Upgrade?

To: William Sheppard who wrote (2310)	10/1/1999 6:50:00 AM
From: Kaye Thomas	Respond to of 5810

Why can't I get any easy questions? First, ESPP stock is subject to rules similar to (but not identical to) the rules for ISO stock, such that you report ordinary income if you dispose of the stock before it matures. (Actually, if you bought the stock at a discount you report ordinary income even if you dispose of it after it matures, but usually the amount of income (as opposed to capital gain) in that situation is smaller.) For immature stock, the amount of ordinary income is the bargain element on the purchase, and for mature stock the amount of ordinary income is the bargain element determined as of the first day of the option period. For example, if the stock was at $100 at the start of the 6-month period, the bargain element determined on that date is $15. If the stock goes up to $120 during that period, you'll pay $85 to buy a share of $120 stock for an actual bargain element of $35. That means you report $35 of ordinary income on an early disposition, but only $15 of ordinary income if you hold until the stock matures. The stock matures on the later of the date that is 2 years after grant of the option or 1 year after exercise of the option. . . . Wait a minute - what option? The tax law is written on the basis that an ESPP issues options, but as you know, that isn't exactly what happens. You elect to participate and they hold your money for six months, and at the end of that time they use it to buy stock at a discount. (An ESPP doesn't have to work this way, but that's essentially the way most of them are structured.) So the law is a little vague as to when the stock matures in this situation. The rulings I have seen from the IRS (which are "private" rulings, meaning you can obtain copies but you can't rely on them) say that for this purpose they consider that an option was granted at the beginning of the six-month period and exercised at the end of the six-month period. That means you stock matures on the second anniversary of the start of the six-month period (or, if you prefer, 18 months after the end of that period). I note, however, that a message from someone here (not sure it was this thread) quoted language supposedly put out by Intel on their ESPP saying you have to hold the stock 2 years before it's mature. Possibly they were being cautious because of the ambiguity about how to apply the rules here, or possibly they were being a little sloppy. Anyway, whatever the time period, there are some things you can do and other things you can't do if you want to avoid a disqualifying disposition. In the view of the IRS, you can't short the stock. According to a ruling some years ago, that's a disqualifying disposition. (The ruling is from some years ago and applied directly to qualified options, but generally the same rules apply to ESPPs.) On the other hand, the IRS has ruled that buying a put is not a disqualifying disposition. That rule predates the constructive sale rules, though. Under the constructive sale rules, you may be considered to have sold your stock if you buy a put that's in the money. It appears to me that the IRS will not say you have a disqualifying disposition if you buy a put that's at the money, or out of the money. Finally, using the stock as collateral for a loan is not a disqualifying disposition, although surrendering the stock on a foreclosure obviously would be. I'm trying to get a book out on this subject (Compensation in Stock and Options) so I welcome questions in this area. Kaye Thomas, author Fairmark Press Tax Guide for Investors fairmark.com