Leap year can make things complicated. For example, if you use a daily accrual rate for some purpose related to stock compensation, such as calculating a pro-rata payout, a tax allocation for a mobile employee, or expense accruals, you have to remember to add a day to your calculation once every four years. Personally, I think it would be easier if we handled leap year the same way we handle the transition from Daylight Saving Time to Standard Time: everyone just set their calendar back 24 hours. Rather than doing this on the last day of February, I think it would be best to do it on the last Sunday in February, so that the “fall back” always occurs on a weekend.
In a slightly belated celebration of Leap Day, I have a few tidbits related to leap years and tax holding periods.
If a holding period for tax purposes spans February 29, this adds an extra day to the holding period. For example, if a taxpayer buys stock on January 15, 2015, the stock must be held for 365 days, through January 15, 2016 for the sale to qualify for long-term capital gains treatment. But if stock is purchased a year later, on January 15, 2016, the stock has to be held for 366 days, until January 15, 2017, to qualify for long-term capital gains treatment. The same concept applies in the case of the statutory ISO and ESPP holding periods–see my blog entry “Leap Year and ISOs,” (June 23, 2009).
Even trickier, if stock is purchased on February 28 of the year prior to a leap year, it still has to be held until March 1 of the following year for the sale to qualify for capital gains treatment. This is because the IRS treats the holding period as starting on the day after the purchase. Stock purchased on February 28 in a non-leap year has a holding period that starts on March 1, which means that even with the extra day in February in the year after the purchase, the stock still has to be held until March 1. See the Fairmark Press article, “Capital Gains and Leap Year,” February 26, 2008.
Ditto if stock is purchased on either February 28 or February 29 of a leap year. In the case of stock purchased on February 28, the holding period will start on February 29. But there won’t be a February 29 in the following year, so the taxpayer will have to hold the stock until March 1. And if stock is purchased on February 29, the holding period starts on March 1. Interesting how none of these rules seem to work in the taxpayer’s favor.
The moral of the story: if long-term capital gains treatment is important to you, it’s not a bad idea to give yourself an extra day just to be safe–especially if there’s a leap year involved.
– Barbara
Tags: capital gains, Disqualifying Disposition, Employee Stock Purchase Plan, ESPP, holding period, incentive stock option, ISO, leap year, qualifying disposition, Section 422, Section 423
I’ve mentioned before that you shouldn’t believe everything you read on the internet about stock compensation. This can be true even if the information comes from a source that might be expected to be reliable. Rajal Mankad of Garmin pointed out some misinformation on the Turbo Tax website about qualifying dispositions of ESPP shares.
The Turbo Tax article includes an example of a qualifying disposition in which the FMV on the purchase date ($25) is less than the FMV on the grant date ($30). The purchase price is 85% of the lesser of these two FMVs ($21.25); the FMV of the shares when they are sold is $50. According to the article, the compensation income for the qualifying disposition is $3.75 per share (the purchase date FMV of $25 less the purchase price of $21.25). But, as I’m sure my readers are aware, this is not correct. Where the purchase price is not fixed at grant, the compensation income recognized upon a qualifying disposition of ESPP shares is the lesser of:
- The discount as computed based on the FMV at grant (this can be calculated by subtracting the amount in box 8 of Form 3922 from the amount in box 3–in fact, this calculation is the reason why the amount in box 8 was added to the form in the final Section 6039 regs).
- The difference between the FMV at the time of sale and the price paid for the shares.
Thus, in the example in the article, the compensation income for the qualifying disposition should be $4.50 per share ($30 FMV at grant multiplied by 15%).
The Turbo Tax article also suggests that the brokerage and other transaction fees can be used to reduce amount #2 above. I don’t believe this is correct. The final ISO regs were clear that the compensation income recognized upon disposition should not be reduced by the transaction fees; while those regulations are specific to ISOs, I think they serve to illustrate the IRS’s position on transaction fees. Moreover, in the case of a qualifying disposition ESPP, amount #2 above is specifically defined as the difference between the FMV of the shares at the time of sale and the purchase price. I think it is reasonable to treat the sale price as the FMV of the shares, but I don’t think the IRS would view it as reasonable to reduce the FMV by the transaction fees for the sale. Those fees are the amount necessary to facilitate the trade; they aren’t part of the price a willing buyer would pay a willing seller for the shares (which is the definition of “FMV”).
Congratulations Are in Order
Congratulations to Mike Melbinger of Winston & Strawn for being selected as one of the BTI Client Service All-Stars 2011–a considerable achievement. Catch Mike’s blog on compensation at CompensationStandards.com.
John Olson of Gibson Dunn, a frequent speaker at NASPP Conferences, is also a BTI Client Service All-Star for 2011.
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
Tags: employee communication, employee education, ESPP, qualifying disposition