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Recent letter ruling illustrates employee stock purchase plan complexities.

In Letter Ruling 9626003, the IRS discusses a Sec. 423 stock purchase plan that allows employees to purchase the employers stock through payroll deductions. Under a stock purchase plan, a specified amount is deducted from an employees paycheck and contributed to the plan during an offering period. At the end of the offering period, employee contributions plus interest are used to buy the employers common stock, often at a discount from its fair market value (FMV). Because a portion of the employee contributions plus interest usually will be left over after shares are purchased, the excess is paid to the employee in cash. Likewise, if an employee terminates employment before the end of an offering period, the amounts in the plan are returned.

The Service determined the interest accrued on plan contributions is a payment of interest within the ordinary course of the employers trade or business, regardless of whether it is actually paid to the employee during the year. The IRS reasoned that, based on Regs. Sec. 1.6041-1(c), which provides that income is fixed when it is to be paid in amounts definitely predetermined, interest payments become fixed the moment they accrue because no substantial restriction exists on an employee's right to receive them. Thus, the Service concluded that the interest on the payroll contributions must be reported on Form 1099-INT on a calendar-year basis if the amount accrued totals more than $600 per year.

Sec. 423 plans have other peculiarities regarding FICA/FUTA and Federal income tax withholding (FITW). For example, the IRS's current thinking is that FICA/FUTA withholding (but not FITW) is required on exercise of the option on the difference between the shares, FMV at the time of exercise of the option over the option's exercise price (including any "discount" element); see Letter Ruling 9243026. FITW would be required only if a disqualifying disposition takes place, including with respect to any "discount" element. However, no further FICA/FUTA withholding would be required on a disqualifying disposition. A disqualifying disposition would occur if the share was disposed of within two years from the date the option is granted or within one year after the date the share is transferred to the employee. For dispositions that occur after the above holding periods expire, any "discount" element would be ordinary income, but would not constitute wages for FICA/FUTA or FITW.
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Author:Bosco, Philip R.
Publication:The Tax Adviser
Article Type:Brief Article
Date:Nov 1, 1996
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