Is the plan compensatory for financial accounting purposes?

Statement 123(R) defines noncompensatory plans far more narrowly than Opinion 25 and Section 423 the Internal Revenue Code. To be considered noncompensatory under Statement 123(R), a plan must meet the following conditions:

• Substantially all employees who meet limited employment qualifications participate on an equitable basis;
• The plan has no significant option features; and
• The discount from market price does not exceed the issuance costs that would be incurred in a significant public offering, with a discount of 5% or less automatically considered to qualify ("safe harbor").

The vast majority of existing broad-based employee stock purchase plans do not meet the second and third conditions. Employee stock purchase plans often provide significant option features, and they typically provide a 15% discount from market price, which is in excess of the issuance costs of a public offering. If employers do not amend these plans, then they will be treated as compensatory under Statement 123(R), with compensation expense measured based on the guidance for option plans.

Most of the press commentary about Statement 123(R) has focused on executive stock options. For some companies, broad-based employee stock purchase plans may have a bigger accounting impact than executive stock options, and review of existing plans is warranted.

How Statement 123(R) differs from Opinion 25
The criteria for noncompensatory plans under Opinion 25 came from Section 423 of the Internal Revenue Code. As a result, plans that are noncompensatory for U.S. Federal income tax purposes generally qualify as noncompensatory under Opinion 25. As the income tax rules were interpreted over the years, some noncompensatory plans became quite lucrative for employees. For example, "lookback" plans under which employees pay 85% of the lesser of market price at the beginning or end of a 12-month period result in substantial gains to employees in periods of rising share prices.

How Statement 123(R) differs from Statement 123
Statement 123(R) maintains the more restrictive noncompensatory criteria of Statement 123.

Continue Reading - Does the plan create equity interests or liabilities?

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