Letting employees borrow to buy shares does not disqualify an employee stock purchase plan

Plain-English summary

An employee stock purchase plan (ESPP) that qualifies under section 423 gives employees favorable tax treatment: no income at the time they buy discounted employer stock, with tax deferred until they sell. To qualify, the plan must meet a list of requirements, including that all participating employees have the "same rights and privileges" (section 423(b)(5)) and that the purchase price be at least 85% of the stock's fair market value at grant or exercise (section 423(b)(6)). Here a company's plan let participants pay for their shares through payroll deductions and/or the proceeds of a bona fide loan from the company or an unrelated third party, and it provided that participants who could not get a loan because of the Sarbanes-Oxley Act's ban on company loans to insiders (section 402) would simply be unable to use that financing option. The company asked whether these loan features would disqualify the plan. The IRS ruled they would not: allowing loan-financed purchases does not violate the same-rights-and-privileges rule or the 85%-price rule, and does not prevent the options from being "statutory options" (pledging the purchased stock as security for a loan used to pay the option price does not break the nontransferability requirement). The IRS did not rule on whether the plan as a whole qualifies as an ESPP or on the tax consequences of the loans themselves. This confirms that adding a loan-financing option to an ESPP is compatible with section 423's requirements.

Ruling snapshot

• Question: Will letting participants finance ESPP purchases with a company or third-party loan prevent the plan from meeting the requirements of section 423(b)?
• Outcome: approved (the loan provisions do not violate sections 423(b)(5) or (b)(6) and do not defeat statutory-option treatment)
• Key authorities: IRC §§ 423(a), 423(b)(5), 423(b)(6), 421(a); Treas. Reg. §§ 1.423-2(f), 1.423-2(g), 1.421-1(b)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201911002                                              [Third Party Communication:
Release Date: 3/15/2019                                        Date of Communication: Month DD, YYYY]
Index Number: 423.00-00
                                                               Person To Contact:
-----------------------                                        -----------------------, ID No. -------------------
------------------                                             ---------------------------------------------------
------------------------------------------------------------
---------------                                                Telephone Number:
--------------------------------------------                   ----------------------
                                                               Refer Reply To:
                                                               CC:TEGE:EB:EC
                                                               PLR-119721-18
                                                               Date:
                                                               December 12, 2018

Legend

Taxpayer = ------------------
Plan = --------------------------------------------------------------
Third Party = -------------------------------------

Dear ------------------:

This letter is in response to a letter dated June 19, 2018, submitted by your authorized
representative, requesting a ruling under section 423 of the Internal Revenue Code
(Code). Taxpayer is requesting a ruling that certain Plan provisions will not prevent the
Plan from meeting the requirements of Section 423(b) of the Code.

Taxpayer expects to adopt the Plan, a stock option plan that is intended to meet the
requirements of an employee stock purchase plan under section 423(b) of the Code.
Pursuant to the terms of the Plan, a Plan participant may purchase Taxpayer shares at
the end of the offering period for an amount equal to 85% of the fair market value of the
Taxpayer stock at either the first or last day of the offering period, whichever is less.
The exercise price will be paid through salary reduction amounts and/or the proceeds of
a loan from Taxpayer or a Third Party, unrelated to Taxpayer. Taxpayer intends to
include the following provisions in the Plan and related enrollment documents:

        A Plan participant may obtain a loan (Loan) from Taxpayer or Third Party to
         purchase shares pursuant to the Plan, unless the Loan is prohibited by section
         402 of Pub. L. 107-204 (commonly referred to as the Sarbanes-Oxley Act of
         2002). Taxpayer represents that the Loan is a bona fide loan and that the terms
         of the loan --------------------------------------------------. A Plan participant who obtains
         a Loan --------------------------------------------------------------------------------------------------
         -------------------------------------------.
PLR-119721-18                                           2

      A Plan participant who chooses to obtain a Loan ------------------------------------------
       ------------------------------------------------------------------------------------------------------------
       ------------------------------------------------------------------------------------------------------------
       --------------------------------------------------------------------------------------------. A Plan
       participant may choose to finance the purchase of the shares using either a
       salary reduction election or a Loan, or a combination of both. Prior to the
       beginning of the offering period,-----------------------------------------------------------------
       ------------------------------------------------------------------------------------------------------------
       ------------------------------------------------------------------------------------------------------------
       ------------------------------------------------------------------------------------------------------------
       ------------------------------------------------------------------ purchase the stock, which will
       be deposited in the participant’s brokerage account. The Third Party ----------------
       ------------------------------------------------------------------------------------------------------------
       ------------------------------------------------------------------------------------------------------------
       ----------------------------------------------------------------------------------. If requested by
       the participant-----------------------------------------------------------------------------------------
       ------------------------------------------------------------------------------------------------------------
       ----------------------------------------------- the participant’s brokerage account.

      A Plan participant may withdraw from an offering period at any time, but no later
       than ten days before the last trading day of the offering period. ------------------ will
       terminate upon a participant’s withdrawal from an offering period.

      A Plan participant who chooses to obtain a Loan ------------------------------------------
       ------------------------------------------------------------------------------------------------------------
       ------------------------------------------------------------------------------------------------------------
       ------------------------------------------------------------------------------------------------------------
       ---------------------.

Specifically, Taxpayer is requesting a ruling that offering the Loan (on the conditions
described above) to Plan participants will not prevent the Plan from meeting the
requirements under section 423(b) of the Code, and specifically sections 423(b)(5) and
423(b)(6) of the Code. Furthermore, Taxpayer is requesting a ruling that the terms of ---
----------------------------------- will not prevent an option granted under the Plan from
qualifying as a statutory option as defined in §1.421-1(b)(1) of the Income Tax
Regulations (Regulations), which provides, in part, that the term statutory option means
an option granted under an employee stock purchase plan under section 423(b) of the
Code.

Section 421(a) of the Code provides, in part, that if a share of stock is transferred to an
individual in a transfer in which the requirements of section 423(a) are met, no income
shall result to the individual at the time of the transfer, no deduction shall be allowable to
the employer corporation at any time with respect to the share transferred, and no
PLR-119721-18                                3

amount other than the price paid under the option shall be considered as received by
the issuing corporation for the share transferred.

Section 423(a) of the Code provides that section 421 will apply to the transfer of a share
of stock to an individual pursuant to the exercise of an option if no disposition of the
stock is made by the employee within 2 years after the date the option is granted nor
within 1 year after the exercise of such option, and at all times during the period
beginning with the date of the granting of the option and ending 3 months before the
date of exercising the option, the individual to whom the option was granted remains an
employee of the granting corporation, a parent or subsidiary corporation of such
corporation, or a corporation (or a parent or subsidiary corporation of such corporation)
issuing or assuming a stock option to which section 424(a) applies.

Section 423(b) of the Code provides that the term “employee stock purchase plan”
means a plan which meets the requirements in sections 423(b)(1) through 423(b)(9).

Section 423(b)(5) of the Code provides that, under the terms of the plan, all employees
granted options shall have the same rights and privileges, except that the amount of
stock which may be purchased by any employee under an option may bear a uniform
relationship to the total compensation, or the basic or regular rate of compensation, of
employees, the plan may provide that no employee may purchase more than a
maximum amount of stock fixed under the plan, and the rules of section 83(i) shall apply
in determining which employees have a right to make an election under such section.

Section 423(b)(6) of the Code provides that, under the terms of the plan, the option
price is not less than the lesser of (A) an amount equal to 85 percent of the fair market
value of the stock at the time such option is granted, or (B) an amount which under the
terms of the option may not be less than 85 percent of the fair market value of the stock
at the time such option is exercised.

Section 1.423-2(f)(1) of the Regulations provides that an employee stock purchase plan
or offering must, by its terms, provide that all employees granted options under the plan
or offering shall have the same rights and privileges. Thus, the provisions applying to
one option under an offering (such as the provisions relating to the method of payment
for the stock and the determination of the purchase price per share) must apply to all
other options under the offering in the same manner. If all the options granted under a
plan or offering do not, by their terms, give the respective optionees the same rights and
privileges, none of the options will be treated as having been granted under an
employee stock purchase plan for purposes of section 421.

Section 1.423-2(g)(1) of the Regulations provides that an employee stock purchase plan
or offering must, by its terms, provide that the option price will not be less than the
lesser of (i) an amount equal to 85 percent of the fair market value of the stock at the
PLR-119721-18                                           4

time the option is granted, or (ii) an amount that under the terms of the option may not
be less than 85 percent of the fair market value of the stock at the time the option is
exercised.

Section 1.421-1(b)(1) of the Regulations provides that the term statutory option, for
purposes of §§ 1.421-1 through 1.424-1 of the Regulations, means an option granted
under an employee stock purchase plan, as defined in §1.423-2 of the Regulations.

In relevant part §1.421-1(b)(2) of the Regulations provides that an option qualifies as a
statutory option only if the option is not transferable (other than by will or by the laws of
descent and distribution) by the individual to whom the option was granted, and is
exercisable, during the lifetime of such individual, only by such individual. Furthermore,
a pledge of the stock purchasable under an option as security for a loan that is used to
pay the option price does not cause the option to violate the nontransferability
requirement.

Therefore, based solely on the facts presented, we rule as follows:

    1. A Plan participant’s ability to use Loan proceeds to purchase shares pursuant to
      the Plan will not prevent the Plan from meeting the requirements under section
      423(b) of the Code.

    2. The inability of a Plan participant to obtain a Loan to purchase shares pursuant to
      the Plan due to the applicability of 402 of Pub. L. 107-204 (commonly referred to
      as the Sarbanes-Oxley Act of 2002) will not prevent the Plan from meeting the
      requirements of section 423(b)(5).

    3. The requirement that a Plan participant -------------------------------------------------------
      ------------------------------------------------------------------------------------------------------------
      ------------------------------------------------------------------------------------------------- will not
      prevent the Plan from meeting the requirements of section 423(b)(5).

    4. A Plan participant’s use of Loan proceeds to purchase shares pursuant to the
      Plan will not prevent the Plan from meeting the requirements of section
      423(b)(6).

    5. The requirement -------------------------------------------------------------------------------------
      ------------------------------------------------------------------------------------------------------------
      ----------------- will not prevent an option granted under the Plan from qualifying as
      a statutory option as defined in §1.421-1(b)(1) of the Regulations, which
      provides, in part, that the term statutory option means an option granted under an
      employee stock purchase plan under section 423(b) of the Code.
PLR-119721-18                                  5

    6. The terms ----------------------------------------- will not prevent an option granted
      under the Plan from qualifying as a statutory option as defined in §1.421-1(b)(1)
      of the Regulations, which provides, in part, that the term statutory option means
      an option granted under an employee stock purchase plan under section 423(b)
      of the Code.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, no opinion is expressed or implied concerning (i) the tax
consequences of any other provision of the Plan, (ii) whether the Plan qualifies as an
employee stock purchase plan within the meaning of section 423(b) of the Code, and
(iii) the tax consequences of the Loan.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                       Sincerely,



                                       Thomas D. Scholz
                                       Senior Counsel, Executive Compensation
                                       (Employee Benefits)
                                       (Tax Exempt & Government Entities)

Enclosures:
Copy of letter
Copy for section 6110 purposes