ESPP discount w/o fixed option price

Hi, I found a few threads in the archives about dealing with discounted option prices for ESPP stock that is sold, but none really touched on the following point.

From Pub 525 (2007, p. 12, under Option granted at a discount):

"...you must include in your income as compensation, the lesser of:

  • The amount, if any, by which the price paid under the option was exceeded by the fair market value of the share at the time the option was granted, or
  • The amount, if any, by which the price paid under the option was exceeded by the fair market value of the share at the time of the disposition or death.

For this purpose, if the option price was not fixed or determinable at the time the option was granted, the option price is figured as if the option had been exercised at the time it was granted."

In my case, the options were granted every six months with the option price being 85% of the lesser of a) the fair market value of the stock on the offering date (i.e., the beginning of the six month period) or b) the fair market value on the exercise date. Therefore the option price was not fixed or determinable at the time the option was granted, even though the formula allowed the price to be determined on the exercise date.

Accordingly, I interpret this section of Pub. 525 to mean that when I sell my ESPP shares (after meeting the holding period), I should include as ordinary income the lesser of: a) fair market value on the offering date - discounted price on the offering date, or b) sale price - discounted price on the offering date.

In each case, it doesn't necessarily matter what the actual price I paid for the stock was because the amount subtracted is the discounted price on the offering date, given that the option price throughout the six-month period was not determinable on the grant date.

Does this interpretation seem correct, or at least valid? I look forward to your responses.

Thanks, Pedro

Reply to
Pedro
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If you hold the shares for more than the two year statutory period from date of grant AND more than one year from the date of purchase, ordinary gain from a disposition (sale, gift, death) will be the LESSER of 15% of FMV at date of grant or the actual gain on the date of disposition. Any additional gain is long-term capital. If sold at a loss, there is no ordinary income... just a long term capital loss.

If you fail the above test and have a disqualifying disposition, ordinary income is equal to the excess of FMV over the purchase price on the date of purchase. Ordinary income is then added to the purchase price to derive the adjusted cost basis for computing the capital gain or loss.

Reply to
Alan

Let's assume from here on out that the holding period has been met and that there is no disqualifying disposition.

I generally agree with what you've written but my original question still stands. In either case (FMV on grant date OR sale price) the difference is relative to the discounted price on the offering date, not to the actual price paid, right? I believe this is correct because "the option price was not fixed or determinable at the time the option was granted", therefore "the option price is figured as if the option had been exercised at the time it was granted."

Thanks again, Pedro

Reply to
Pedro

Your option price was fixed OR determinable. It was 15% off the date of grant price or it could be determined by the actual market price on the date of purchase if that was lower.

Reply to
Alan

The formula was fixed but the option price was neither fixed nor determinable on the grant date because I could not have accurately predicted the option price on the exercise date. However your original instructions on how to deal with the sale do appear to be correct, and a number of others agree with you.

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Perhaps more importantly, I found the appropriate section of IRS code, section 423(c) which also agrees with your assessment. Oddly enough, this section of the tax code is considerably more clear on this subject than Publication 525, which was supposedly written to make things simpler for me.

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Thanks again for your help, Pedro

Reply to
Pedro

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