Revisit ESPP basis calc given ESPP basis is dependent on the amount reported as income
Closed this issue · 14 comments
Given there's no sale, it's not clear how the ESPP basis should be calculated as it's not yet settled to a value for disqualified lots.
The simplest answer is to wait until 2024-03-01 for the final ESPP lot to qualify, but it'd be good to know and capture this answer.
Read through References:
- https://www.irs.gov/publications/p525#en_US_2023_publink1000229221
- https://workplaceservices.fidelity.com/bin-public/070_NB_SPS_Pages/documents/dcl/shared/StockPlanServices/ESPP%20Qualifying%20and%20Disqualifying%20Dispositions.pdf
- #23
- #86
- add the "lesser of" part into the imputed income calc in the Future section based on eventual sale price. See comment
- #101
Reading through IRS ESPP guidence:
Your basis is equal to the option price at the time you exercised your option
So, what's the option price?
granted you an option ... for $20 ... when the stock had a value of $22
... the stock was $23 a share, you exercised the option...
... you must report as wages the difference between the option price ($20) ...
So the option price on exercise is the Purchase Price. This is what's being used, so no change needed.
Ordinary income for disqualified shares should be added to cost basis
- this needs a change to
ESPP!Zto adjust the new cost basis going forwards. We shouldn't be adjusting the pre-merger basis as that income isn't yet reported.
Body of the IRS section for easy reference
Employee stock purchase plan. If you sold stock acquired by exercising an option granted under an employee stock purchase plan, you need to determine if you satisfied the holding period requirement.
Holding period requirement satisfied. If you sold stock acquired by exercising an option granted under an employee stock purchase plan, and you satisfy the holding period requirement, determine your ordinary income as follows.
Your basis is equal to the option price at the time you exercised your option and acquired the stock. The timing and amount of pay period deductions don't affect your basis.
Example 9. Pine Company has an employee stock purchase plan. The option price is the lower of the stock price at the time the option is granted or at the time the option is exercised. The value of the stock when the option was granted was $25. Pine Company deducts $5 from Adrian's pay every week for 48 weeks (total = $240 ($5 × 48)). The value of the stock when the option is exercised is $20. Adrian receives 12 shares of Pine Company’s stock ($240 ÷ $20). Adrian's holding period for all 12 shares begins the day after the option is exercised, even though the money used to purchase the shares was deducted from Adrian's pay on 48 separate days. Adrian's basis in each share is $20.
Option granted at a discount. If, at the time the option was granted, the option price per share was less than 100% (but not less than 85%) of the FMV of the share, and you dispose of the share after meeting the holding period requirement, or you die while owning the share, you must include in your income as compensation the lesser of:
- The excess of the FMV of the share at the time the option was granted over the option price, or
- The excess of the FMV of the share at the time of the disposition or death over the amount paid for the share under the option.
For this purpose, if the option price wasn't 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.
Any excess gain is capital gain. If you have a loss from the sale, it's a capital loss, and you don't have any ordinary income.
Example 10. Your employer, Willow Corporation, granted you an option under its employee stock purchase plan to buy 100 shares of stock of Willow Corporation for $20 a share at a time when the stock had a value of $22 a share. Eighteen months later, when the value of the stock was $23 a share, you exercised the option, and 14 months after that you sold your stock for $30 a share. In the year of sale, you must report as wages the difference between the option price ($20) and the value at the time the option was granted ($22). The rest of your gain ($8 per share) is capital gain, figured as follows.
Selling price ($30 × 100 shares) $ 3,000
Purchase price (option price)
($20 × 100 shares) − 2,000
Gain $ 1,000
Amount reported as wages
[($22 × 100 shares) − $2,000] − 200Amount reported as capital gain $ 800
Holding period requirement not satisfied. If you don't satisfy the holding period requirement, your ordinary income is the amount by which the stock's FMV when you exercised the option exceeded the option price. This ordinary income isn't limited to your gain from the sale of the stock. Increase your basis in the stock by the amount of this ordinary income. The difference between your increased basis and the selling price of the stock is a capital gain or loss.
Example 11. The facts are the same as in Example 10, except that you sold the stock only 6 months after you exercised the option. You didn't satisfy the holding period requirement, so you must report $300 as wages and $700 as capital gain, figured as follows.
Selling price ($30 × 100 shares) $3,000
Purchase price (option price)
($20 × 100 shares) − 2,000
Gain $1,000
Amount reported as wages
[($23 × 100 shares) − $2,000] − 300Amount reported as capital gain
[$3,000 – ($2,000 + $300)]
Thanks Muhammad Akbar!
Muhammad contends that there should be a symmetric basis adjustment for the ordinary income recognized on qualified shares as well as disqualified. This seems reasonable but isn't explicitly noted in the IRS doc.
I'll look for further guidance.
The ESPP ordinary income calc needs revision. Now I've become more familiar with the terminology:
The excess of the FMV of the share at the time the option was granted over the option price, or
This is explicitly referencing the grant price at the beginning of the period. I'd previously interpreted this that we were granted the option at time of purchase with appropriate discount, but it seems that's the exercise date.
The excess of the FMV of the share at the time of the disposition or death over the amount paid for the share under the option.
It's still not known whether the merger counts as a disposition of the VMW shares.
According to merger documents, VMW shares were surrendered in lieu of cash+AVGO stock consideration, so yes, the merger counts as a disposition of VMW shares. However, only the income received is taxable so the gain is limited to lesser of cash received or the basis step up. Given that AVGO shares where close to $900 at the time of the merger, the basis step up is greater than cash received. You can add cash received divided by number of shares to ESPP grant price and use that number as sale price in ESPP disposition calculations. The entire cash consideration is taxable gain. In ESPP case, some of it will be ordinary income and some capital gains since it is qualified disposition (ESPP plan ended 2 years ago and the last purchase was over a year ago).
@alkom do you have a reference for the surrender being a disposition?
I've spoken to a CPA about it and they responded strongly that the surrender for conversion wasn't a disposition.
I'm likely to add a tweak setting that lets users decide whether to treat surrender as full disposition, pro-rata disposition based on lot ratio, or no disposition (assuming the lot isn't pure cash). That way people can take their CPAs interpretation and use it.
If you've got explicit reference citation for it being a disposition that incurs the imputed income, please share it and I can avoid that hassle.
You (and your CPA) are right. Disposition specifically excludes exchanges under section 356 (see section 424(c)(1)(b)). Which means section 423(c) (15% discount reporting) does not apply. It appears it will apply when converted AVGO shares are sold.
These three lines combined:
(1) Option price isn't fixed at grant time as it's the lesser of start/end of the offering period, so this applies:
For this purpose, if the option price wasn't 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.
(2) Basis - impacted by (1) so fixed at grant time. Possible (1) isn't intended to apply to this paragraph, but this is my best understanding as of comment date:
Your basis is equal to the option price at the time you exercised your option and acquired the stock.
(3) Imputed income, clause 1 of 2 - based on option price, which is fixed at grant time, so known:
The excess of the FMV of the share at the time the option was granted over the option price
I'm currently reading this as:
- (1) - option price for the purpose of the calc is set at grant, so (
grant_date_fmv * 0.85) - (1) + (2) - basis is always
grant_date_fmv * 0.85 - (3) - maximum imputed income is
grant_date_fmv * 0.15- it's possible to incur less if the FMV on actual sale has dropped substantially. I'll add a task to add this calc into the Future section for tracking eventual sale.
I'll update ESPP calcs for ordinary income to reflect this.
this fairmark qualifying disposition page clearly states basis is adjusted by imputed income although this throws my recent conclusion into doubt as it actually agrees with my original take that basis is what you paid.
This is the amount you paid for the shares, increased by the amount of compensation income reported
It also aligns better with the bracketed option example that indicates Adrian's basis is based on the actual exercise price and not the grant date price, despite the true option price not being fixed or determinanble:
Adrian's basis in each share is $20.
And this example indicates that your basis is the purchase price without discount... which is at least consistent with the IRS example without discount noted above. Wish there was an IRS example with discount and lookback as that seems the most complex case.
There are actually two questions I'm trying to answer here and separating them may be useful:
- what's the conceptual basis of an ESPP share prior to disposition?
- what's the basis at sale?
Moving forwards with:
- basis is the dollar value actually paid
- basis active for merger calc is the basis adjusted for return of capital, but not imputed income as it's not yet known or reported
- avgo basis for post-merger sale has imputed income added for both disqualified and qualified shares
- qualified shares use the grant date fmv as the fmv from which to calculate imputed income --> grant_date_fmv * 0.15
- disqualified use the actual purchase date fmv --> purchase_date_fmv - actual amount paid
Moving forwards with:
* basis is the dollar value actually paid * basis active for merger calc is the basis adjusted for return of capital, but not imputed income as it's not yet known or reported * avgo basis for post-merger sale has imputed income added for both disqualified and qualified shares * qualified shares use the grant date fmv as the fmv from which to calculate imputed income --> grant_date_fmv * 0.15 * disqualified use the actual purchase date fmv --> purchase_date_fmv - actual amount paid
@hickeng My apologies for re-opening this thread. I'm curious why the qualified shares straightly use (grant_date_fmv * 0.15) to calculate the discount portion, and not the lesser of (grant_date_fmv*0.15) or (sales price - purchase price)?
According to the websites below, "the ordinary income tax on the lesser of the discount offered on the offering date price (which is grant fmv) or the gain between the actual purchase price and the final sales price". If $142.5 was the final sales price, then some ESPPs (e.g. purchase date 2019/8/31) may fall into the (sales price - purchase price) category because the gain was lesser than 15% of grant date fmv.
Perhaps I'm missing something here maybe some rules override the definition?
https://www.kinetixfp.com/post/espp-taxes-explained
https://www.wealthenhancement.com/s/blog/espp-tax-rules-what-you-need-to-know-MC7NEMNJHGRBD3NPLYMZUQQ23MAQ
This is me being lazy in typing that summary because the second clause doesn't apply to anyone at this time.... and avgo would have to drop a LOT for it to do so.
However, for completeness this commit from this morning added the conditional handling.
Shouldn't the second clause (sales price - purchase price) apply based on the VMW sales price $142.5 and VMW ESPP purchase price? I may misunderstand your response, but it sounds to me that the adjustment was reset and it is now based on AVGO price...