On January 1, 2010, when the market value is $12 per share, an employee enrolls in his employer's ESPP, which has an 18-month purchase period. On June 30, 2011, when the market value is $10 per share, his contributions purchase 200 shares under the plan at a price of $8 per share. On July 15, 2013, the employee sells all 200 shares at a price of $15 per share. How much compensation income does he recognize for the sale?
A. $0
B. $720
C. $800
D. $1,600
Answer:A
On January 1, 2010, when the market value is $12 per share, an employee enrolls in his employer's ESPP, which has an 18-month purchase period. On June 30, 2011, when the market value is $10 per share, his contributions purchase 200 shares under the plan at a price of $8 per share. On July 15, 2013, the employee sells all 200 shares at a price of $15 per share. How much compensation income does he recognize for the sale?
A. $0 B. $720 C. $800 D. $1,600
Explanation: Under Section 423, the minimum price cannot be discounted by greater than 15% of the market value on enrollment or purchase. The price in this scenario is discounted 20% off the purchase date market value and an even greater discount off the enrollment date market value. Therefore, the plan is not a Section 423 qualified plan. Because the plan is not qualified, it is taxed upon exercise as if it were an NSO. When he purchased the stock (the "exercise" under the ESPP), the employee recognized compensation income equal to the spread at that time. At the time of sale, he will recognize capital gains but not compensation income. The exercise avoids taxation under Section 409A because the exercise date is set in advance.