The Dangers of ESPP's $25,000 Limit in a Volatile Mark
Employee Stock Purchase Plans (ESPPs) can serve many purposes. One of the most common objectives of ESPPs is to encourage employee ownership in the company. This can be especially important if the company does not offer broad-based grants of options or RSUs. Building ownership supports employee alignment. Employee alignment helps inspire people to pay attention when the company communicates about growth and success.
The majority of U.S. based ESPPs are tax qualified under IRC Section 423. The rule was created to provide an equity, broad-based plan structure that allows beneficial tax treatment. U.S. based employees have the opportunity to receive tax benefits if they hold their shares for 2 years from their grant date (the beginning of the Offering Period) and 1 year from their date of purchase.
The IRS implemented a $25,000 limit on shares purchased as a method of treating all employees equally and preventing highly compensated employees from purchasing most of the available shares.
The $25,000 rule limits the purchase of stock to no more than $25,000 of stock each calendar year based on the FMV on their grant date. Table 1 provides an example of how the limit is calculated. The company runs the risk of disqualifying the entire plan if an employee is allowed to purchase more than $25,000 in a calendar year. However, when the Offering straddles more than one year any unused portion from the first year can be added to the $25,000 in the following year. See Table 2 for an example. When an offering covers more than one year each purchase will be deducted from the earliest $25,000 limit. The limits are applied in order until the full amount allowed is used or a new offering period begins.
Some stock administration platforms will track the limit and prevent employees from purchasing more than allowed. You may also be able to run reports after each purchase to verify the information and notify employees that is close to the limit.
In a market where stock prices are dropping the $25,000 can be dangerous for companies without a strong set of additional share purchase limitations. In the examples above the stock price heads upward, which means you can accurately the value of the limited shares, and based on contribution percentages the number of people who will possible hit the limit. If the stock price falls, the limited number of shares remains the same, but the cost to purchase that number of shares may be far less than planned.
It is important that as the market recedes your ESPP is fine-tuned to successfully bridge the period until things go back up. Designing the correct individual limits and purchase periods limits requires the expertise to model potential scenarios in a joint effort with Finance, Human Resources, Compensation, and Payroll.
The $25,000 limit is often misunderstood and can be a very useful or frustrating rule. It helps control usage to provide more access to shares for your rank and file staff. In a rising market, it seldom impacts all but the highest earners. In a falling market, care must be taken to properly design your ESPP rules to ensure your shareholder-approved share allocation doesn’t disappear on a single purchase date.
FutureSense has unparalleled equity compensation expertise. Contact us today and learn how we can help.
Some stock administration platforms will track the limit and prevent employees from purchasing more than allowed. You may also be able to run reports after each purchase to verify the information and notify employees that is close to the limit.
In a market where stock prices are dropping the $25,000 can be dangerous for companies without a strong set of additional share purchase limitations. In the examples above the stock price heads upward, which means you can accurately the value of the limited shares, and based on contribution percentages the number of people who will possible hit the limit. If the stock price falls, the limited number of shares remains the same, but the cost to purchase that number of shares may be far less than planned.
It is important that as the market recedes your ESPP is fine-tuned to successfully bridge the period until things go back up. Designing the correct individual limits and purchase periods limits requires the expertise to model potential scenarios in a joint effort with Finance, Human Resources, Compensation, and Payroll.
The $25,000 limit is often misunderstood and can be a very useful or frustrating rule. It helps control usage to provide more access to shares for your rank and file staff. In a rising market, it seldom impacts all but the highest earners. In a falling market, care must be taken to properly design your ESPP rules to ensure your shareholder-approved share allocation doesn’t disappear on a single purchase date.
FutureSense has unparalleled equity compensation expertise. Contact us today and learn how we can help.
About FutureSense
FutureSense is a management consulting firm that provides integrated solutions to build and sustain human capital capacity. The firm can work with you by offering support and guidance to manage your workforce. To learn more about FutureSense, please visit FutureSense.com.