26 U.S.C. § 423 — Employee stock purchase plans

(a) General rule When an employee exercises a stock option granted under an employee stock purchase plan (defined in subsection (b)), the tax break in section 421(a) applies — but only if two things are true. First, the employee must not sell the stock within 2 years of the date the option was granted, or within 1 year of receiving the stock. Second, from the date of the grant until 3 months before exercising the option, the employee must have worked for the granting corporation, its parent or subsidiary, or a corporation that later took over the option in a section 424(a) transaction. (b) Employee stock purchase plan For a plan to count as an "employee stock purchase plan," it must meet all of these rules: (1) Options can only go to employees of the employer corporation, or its parent or subsidiary, to buy stock in one of those companies. (2) Stockholders of the granting corporation must approve the plan, either within 12 months before or after it was adopted. (3) No employee can get an option if, right after getting it, they would own 5 percent or more of the company's total voting power or stock value. Special attribution rules from section 424(d) apply when figuring this out, and stock the employee could buy under other outstanding options counts too. (4) Options must go to every employee of any company whose workers get them at all — with narrow exceptions. The plan can leave out: employees who have worked less than 2 years; employees who normally work 20 hours or less a week; employees who normally work 5 months or less a year; and highly paid employees, as defined in section 414(q). (5) Every employee who gets an option must have the same rights and privileges. Two things don't break this rule: the plan can size each employee's purchase limit based on their pay, and the plan can set one overall cap on how much stock any employee may buy. The election rules in section 83(i) apply to who can make that special election. (6) The option price cannot be less than the smaller of two amounts: 85 percent of the stock's fair market value when the option is granted, or an amount that the option itself says can never be less than 85 percent of the stock's value when the option is exercised. (7) The option must be used within a set time. If the price is allowed to float down to 85 percent of value at exercise, the limit is 5 years from the grant date. Otherwise, the limit is 27 months from the grant date. (8) No employee can build up the right to buy more than $25,000 worth of stock (valued at grant) under all the employer's such plans, for each calendar year an option is active. The right builds up when the option first becomes usable that year. It builds up at the rate set in the option, but never faster than $25,000 worth per year. Unused buying power from one option cannot roll over to a different option. (9) The option cannot be transferred, except by will or inheritance. Only the employee can exercise it, and only during their lifetime. For rules (3) through (9): if a specific stock offering under the plan adds extra terms, those extra terms count as part of the plan for options granted under that offering. (c) Special rule where the option price is between 85 percent and 100 percent of value Sometimes the option price was set below 100 percent of the stock's value on the grant date. If so, when the employee later sells the stock (after meeting the holding-period rules) — or dies still owning it — part of the value counts as pay, not as investment gain. That taxable amount is the smaller of two numbers: the gain over what the employee paid, measured at the time of sale or death; or the built-in discount, measured as the stock's value at grant minus the option price. If the option's price was not fixed at the time of the grant, it is figured as though the option had been exercised right then. The employee's cost basis in the stock goes up by whatever amount gets counted as pay this way. No tax withholding is required on this amount. (d) Coordination with qualified equity grants If an employee makes a special election under section 83(i) for stock received by exercising an option, that option is not treated as granted under an employee stock purchase plan.