ESPP case study - how much ordinary income?

There was a qualifying disposition of ESPP early in 2018, so I'm trying to figure how much of the gain, if any, is W-2 income, for planning purposes. (taxpayer is still an employee)

I have checked Pub 525, some CE material, and the fairmark.com web site, and it's still not clear. I think, because there is no look-back (i.e., there is no discount as of the grant date), there will never be ordinary income from a qualifying disposition under this plan, correct?

Facts (box numbers refer to Form 3922).

69.71 FMV grant date Box 3 (beginning of year)

64.20 FMV exercise date Box 4 (end of year)

54.57 Exercise price Box 5 = 85% of Box 4

69.71 Exercise price determined as if exercised on grant date Box 8

72.29 Sale price

For qualifying ESPP if you sell at profit then have to report compensation income that is the Lesser of: 1) the amount of the profit or 2) the difference between the Grant FMV and the option price as determined on the Grant date.
So in your case the FMV at grant and the option price at grant are the same $69.71 so no W-2 income.
See "Consider your Options" Kaye Thomas Fairmark

Look at IRC 423(c).

I don't understand the reference to beginning and end of year. 2017? Relevance? Box 3 should be FMV on grant date.

Exercised on 12/31?

Look at IRC 423(c).

I don't understand the reference to beginning and end of year. 2017? Relevance? Box 3 should be FMV on grant date.

I should have included these items: Box 1 (grant date): 1/1/20172016. Box 2 (exercise date): 12/31/20172016. Those were the source of my references to "beginning/end of year".

As mentioned, I did do some research prior to posting, including the IRC and this example from a Rev Rule:

https://www.federalregister.gov/d/E9-27452/p-177

My problem is, none of the examples matches my scenario. From four years of empirical data, I can see that this ESPP can be summarized as follows:

The exercise price is the lesser of the FMV at grant date, or 85% of the FMV at exercise date. (Box 3 always equals Box 8).

Under this rule, I would like to confirm that there will never be ordinary compensation income from a qualifying disposition. Correct?

Was the grant date really 1/1/2017?

Qualified is meeting 2 rules. 2 year past grant date, one year past exercise date. This form 3922 does not indicate it to be qualified for CG treatment.

makbo, Are you sure that Box 3 and Box 8 have the same number in it? That seems to be an error. I have glanced at a dozen Forms 3922 that I have scanned in for my clients. All but one of them have Box 8 @ 85% of Box 3. That one oddball, has Box 8 @ 95% of Box 3, but Box 5 is also @ 95% of Box 4.

But as Doug points out, it does not sound like we have a Qualifying Disposition here.

makbo, Are you sure that Box 3 and Box 8 have the same number in it?

Yes, absolutely, for four years in a row. In fact, I have the plan document, and here is what it states:

"The price at which each share covered by a Purchase Right may be purchased will be the lower of:
• 100% of the Fair Market Value of a share of XYZ Common Stock on the first day of the applicable Purchase Right Period; or
• 85% of the Fair Market Value of a share of XYZ Common Stock on the last day of that Purchase Right Period."

So am I correct? There will never be compensation income from a qualifying disposition under this plan?

But as Doug points out, it does not sound like we have a Qualifying Disposition here.

Correction: it was 2016, not 2017. With four years of 3922 statements for the same taxpayer floating around on my desktop (not common), I was looking at the wrong one. For my purposes, the year wasn't important, as I already stated it was a qualifying disposition. Doug M wanted to know the dates, the only reason why I posted them, sorry for the error.

Under this rule, I would like to confirm that there will never be ordinary compensation income from a qualifying disposition. Correct?

No.

The amount of ordinary income to include can be found in 423(c). You need the grant date and grant price to determine the ordinary income

https://www.law.cornell.edu/uscode/text/26/423

The lesser of:

(1) the excess of the fair market value of the share at the time of such disposition or death over the amount paid for the share under the option, or
(2) the excess of the fair market value of the share at the time the option was granted over the option price.

(1) is 15% or $9.63

(2) Need to know FMV on grant date and the option price on grant date to answer this.

Most ESPP programs run on a 6 month cycle. It appears this is annual. So, you have the 4 annual forms in front of you. Four different purchase dates. It would seem that the shares exercised in 12/2016 and 12/2017 are non-qualified. The 100% gain on those shares are ordinary. The 15% gain will be on the W-2. The 2014 and 2015 purchases are subject to CG treatment and maybe an ordinary income component as described above.

You need the grant date and grant price to determine the ordinary income

1/1/2016 grant date (Box 1)
69.71 FMV as of grant date (Box 3)

This info was previous posted.

(2) the excess of the fair market value of the share at the time the option was granted over the option price.

Is zero. FMV is equal to option price at grant date (Box 8). This info was previously posted.

It would seem that the shares exercised in 12/2016 [...] are non-qualified.

Disposed early 2018. This information was previously posted. Held more than two years after grant date (1/1/2016) and more than one year after transfer (exercise date 12/31/2016). It really doesn't matter anyway, as my question as stated was to assume it was a qualifying disposition.

Hopefully someone else will respond.

Is zero. FMV is equal to option price at grant date (Box 8). This info was previously posted.

If you would have only read the instructions for box 8, we would have been done 4 posts ago...........

If the exercise price per share was not fixed or determinable on the date of grant entered in box 1, enter the exercise price per share determined as if the option was exercised on the date of grant entered in box 1. If the exercise price per share is fixed or determinable on the date of grant entered in box 1, then leave box 8 blank.

The specific instructions state that don't put anything in box 8 if it is the same as box 1..................hence my questions about FMV and grant price.

If you would have only read the instructions for box 8, we would have been done 4 posts ago...........

If the exercise price per share was not fixed or determinable on the date of grant entered in box 1, enter the exercise price per share determined as if the option was exercised on the date of grant entered in box 1. If the exercise price per share is fixed or determinable on the date of grant entered in box 1, then leave box 8 blank.

I did read that a long time ago, as well as the code section you have cited several times. The price per share was "not fixed or determinable on the date of grant" because 85% of the FMV on exercise date might be a lesser number, and of course that number is unknown at grant date.

"The specific instructions state that don't put anything in box 8 if it is the same as box 1"

I think you meant Box 3 instead of Box 1. Even with that correction, I don't believe that is at all what the instructions state. They don't say anything about whether the two numbers are the same, the condition is whether the final exercise price is "fixed or determined" as of grant date.

Let's just assume that the employer is correctly filling out the Form 3922. The Form merely paraphrases Sec. 423(c), which says, "If the option price is not fixed or determinable at the time the option is granted, then for purposes of this subsection, the option price shall be determined as if the option were exercised at [grant date]". But that price is 100% of the grant date FMV per the employer plan document, therefore no discount.

"hence my questions about FMV and grant price." -- which was provided in the initial post.

I agree, makbo. Due to the '100% of grant value' in the plan document, there would be no ordinary income. They should write them all this way.

I have glanced at a dozen Forms 3922 that I have scanned in for my clients. All but one of them have Box 8 @ 85% of Box 3. That one oddball, has Box 8 @ 95% of Box 3, but Box 5 is also @ 95% of Box 4.

According to the Kaye Thomas (Fairmark) book I have, this is referred to as "lookback pricing", and "is less common than it once was due to a change in accounting rules".