Introduction A summary of the range of schemes available in the US.

Profit Sharing Plans And Eligible Individual Account Plans (EIAP) An EIAP is a form of profit sharing plan which can be designed to permit up to 100% of trust assets to be invested in employer securities.

Employee Stock Purchase Plans

The second type of employee stock options that receive special treatment under the Code are options granted under an employee stock purchase plan ("purchase plan option"). Like incentive stock options, the purchase plan option gives employees an opportunity to share in the growth potential of the company's stock. Purchase plan options are used by employers as a method for employees to purchase stock, usually using payroll deductions to pay for the shares. What the option price is and when the option is granted are variables. Purchase plan options are stock option plans primarily intended for rank and file employees (unlike incentive stock options, which are primarily intended for key employees).

An employee only will receive the favorable tax treatment of Code section 421(a) if the employee stock purchase plan meets the following requirements:

• Only employees of the employer sponsoring the employee stock purchase plan and employees of parent or subsidiary companies may participate in the plan ;
  
• To receive favorable tax treatment, an employee can own no more than 5% of the voting power of the employer or 5% of the value of all shares of stock of the employer;
  
• The plan must be approved by the shareholders of the granting company within 12 months before or after the plan is adopted;
  
• The stock for which the plan offers options must be the capital stock of the employer. This capital stock can be of any class, including voting or nonvoting common or preferred stock. It may be treasury stock or stock of original issue. A special class of stock authorized and issued solely to employees also would qualify as stock for this purpose;
  
• All employees of the sponsoring employer must be included in the stock purchase plan. Employees who have been employed for less than two years, employees whose customary employment is 20 hours or less per week, employees whose customary employment is for not more than five months in any calendar year, and highly compensated employees can be excluded from participation in the plan;
  
• The stock purchase plan must provide that no employee can accrue the right at any time to purchase stock of his/her employer at a rate that exceeds $25,000 of the fair market value of such stock (determined when the option is granted) for each calendar year for which the option was. The regulations allow an employee to buy more than $25,000 of stock in a calendar year, so long as the total amount of stock which he/she buys does not exceed $25,000 in fair market value (determined at date of grant) for each calendar year in which the option was outstanding.
  
• The exercise price of the options granted under a stock purchase plan must be no less than 85% of the stock's fair market value at the time the option is granted, or an amount which under the option's terms cannot be less than 85% of the stock's fair market value at the time the option is exercised. The maximum allowable option exercise period is five years from the date of the option grant for an option which contains an exercise price at least 85% of the fair market value of the company's stock. If the option exercise is determined in any other manner, such as flat dollar amount, the option must be exercised within 27 months from the date of the grant of the option.

Many of the benefits derived from purchase plan options are similar to benefits derived from incentive stock options. Under both types of plans, there is no tax on either the grant or the exercise of an option. The employee is not taxed until he/she sells the underlying stock. The income recognized at that time generally is recognized as a capital gain. In addition, the employer is able to implement work incentives for its employees without draining valuable liquid assets.

The requirements under the Code for employee stock purchase plans are, generally, more liberal than those governing incentive stock options. A key feature of a purchase plan option is that it can offer options with an option price of between 85% and 100% of the fair market value of the stock, either at grant or exercise. Incentive stock options must be offered at an option price of the fair market value of the stock. Employees will not recognize ordinary income when an option is exercised but will recognize such income at a later disposition of the stock if the plan meets the requirements of a purchase plan option.

Generally, the granting employer may not take a tax deduction. The employer may take a deduction for any disqualifying disposition. The compensation deduction would be equal to the amount that the employee includes as ordinary income and the employer would take the deduction in the year of the disposition. The employer may not deduct the difference between the fair market value of the option stock and the option exercise price. The employer is required to withhold income tax on a disqualifying disposition from a purchase plan option. In addition, FICA and FUTA tax also should be imposed upon a disqualifying disposition.

IRS Publication 525 (2009) provides further guidelines on the tax treatment of stock options.

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