The NASPP Blog

February 2, 2010

Operational Errors in Section 423 Plans

Another area of the final regulations under Section 423 that I think is significant is the guidance on the impact of various operational errors. Section 423 qualification is fragile–one inadvertent error can sometimes disqualify an entire offering.

Excluding an Eligible Employee

One error with the gravest consequences is the inadvertent exclusion of an employee that should be eligible to participate in the plan. Under §1.423-2(a)(4), if an eligible employee isn’t permitted to participate in an offering, the entire offering is disqualified under Section 423. This means that none of the purchases under the offering would qualify for preferential treatment under Section 423.

This is an error that I see happen with some regularity, especially when employees transfer between corporate entities. If you’ve experienced problems in the past with eligible employees being inadvertently excluded from the ESPP, now would be a good time to implement some controls to prevent this from happening in the future.

Inclusion of Ineligible Individuals

The flip side of excluding an eligible employee is allowing someone that isn’t eligible under the plan to participate in an offering. Here the consequence are much less dire; that individual’s purchase won’t receive preferential tax treatment, but the overall status of the offering isn’t impacted.

Purchases in Excess of Plan Limits

Another common error is allowing employees to purchase shares in excess of either the $25,000 limitation or a plan limit. The regs make it clear that where a purchase doesn’t comply with the terms of the plan or offering, that purchase is no longer under the umbrella of the ESPP, even if it would otherwise qualify under Section 423 (for example, where a purchase exceeds a plan limit but not the $25,000 limitation). Purchases that aren’t under a qualified ESPP can’t receive preferential treatment under Section 423.

The regs also clarify that where the terms of the option under which the purchase is made originally complied with both the terms of the plan/offering and Section 423 and the purchase ends up violating the original terms of the option, only the purchase is disqualified; it doesn’t impact the status of the entire offering. (By contrast, granting an option with terms that violate the plan/offering or Section 423 does likely disqualify the entire offering because the eligible employee that received the offending option now hasn’t been allowed to participate in the qualified offering.)

In the NASPP’s recent webcast on the Section 423 regs, Helen Morrison from Treasury felt that a situation where a employee is allowed to purchase in excess of a plan limit or the $25,000 limit would likely fall under this treatment. The purchase itself–the entire purchase, not just the shares in excess of the limit–is disqualified but the status of the rest of the offering is unharmed.

For more information on the final regs under Section 423, see our alert “Final ESPP Regs Issued.”

Speaking Proposals for the 2010 NASPP Annual Conference
We are accepting speaking proposals for the 2010 NASPP Annual Conference through Friday, February 26.  We begin reviewing proposals as soon as the submission period closes, so we cannot grant any exceptions to this deadline.  See our Proposal Submission Website for more information.

We aren’t yet ready to announce the dates and location of the Conference; I hope to have that information in the next month or so.   

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 

-Barbara