How does the IRS $25,000 purchase limit carry-over work for ESPP?

Question

My company offers an ESPP program. For completeness's sake, the basic details are as follows:

• There is a 15% discount on purchase.
• There are always two simultaneous offerings.
  • Employees may participate in only one of the offerings, not both simultaneously.
  • One offering begins in May and the other begins in November.
  • Each offering has two purchase dates: in May and November.
  • Each offering has a look-back provision to the beginning date of the offering.
• Employees may contribute up to 25% of their salary to the ESPP program through payroll deductions, subject to the IRS limit of $25,000 worth of stock purchased per year.

My understanding is that the IRS participation limit has some kind of carry-over provision when an offering period crosses over year boundaries, as my company's offerings do. I'm having a hard time finding relevant information online. Could someone please explain how this carry-over provision works?

The way I understand it, if the amount of stock purchased in year X is less than the $25,000 limit, the purchase of stock in year X+1 as part of an offering which began in year X counts first toward the year X limit and then to the year X+1 limit. Is this understanding correct? If so, could multiple purchases in year X+1 as part of the same offering which began in year X count toward year X's limit (from my example, the offering beginning in November of year X which purchases shares in May and November of X+1)? Examples of how the rules apply would be very helpful.

Edit:

I found the following which is very difficult to understand the legalese:

(vi) No employee may be granted an option that permits the employee's rights to purchase stock under all employee stock purchase plans of the employer corporation and its related corporations to accrue at a rate that exceeds $25,000 of fair market value of the stock (determined at the time the option is granted) for each calendar year in which the option is outstanding at any time (see paragraph (i) of this section); and

Source: https://www.law.cornell.edu/cfr/text/26/1.423-2

Answer 1

It appears to me that your Cornell citation includes an example that confirms your understanding. Shortly after the paragraph titled "Annual $25,0000 limitation," the following comment describes your hypothetical scenario:

Thus, the employee may purchase only the amount of stock that does not exceed the limitation of this paragraph (i) for the year of the purchase and for preceding years during which the option was outstanding. Thus, the amount of stock that may be purchased under an option depends on the number of years in which the option is actually outstanding.

Then example 5.1 shows how purchases in years X+1 and beyond are applied to previous years' shortages below the $25K limit. The only difference between your hypothetical scenario and the example is that you'll have two purchases -- one in May and one in Nov -- per year rather than the single purchase described in the example.

Answer 2

I found the you YouTube Video "Understanding the ESPP $25000 limit" from the National Association of Stock Plan Professionals extremely helpful in understanding this! Much easier to understand than reading the tax code. She explains that you can carry over any unused portion of the $25k limit when the offering period crosses over the year, but once that offering period ends the previous year carry-over expires. Example: I am new to the ESPP program and enter an offering period on Oct 1 2021 that ends on March 31 2022. I can carry over the $25k from 2021 but if I only purchase $15K on March 31st 2022 that carry over from 2021 dies. However, I've still got my full $25k left over for 2022!

Answer 3

Have you tried reading the tax code? All the information should be there. Here's a snip of the code regarding the ESPP.

Section 423(b)(8) provides that an employee stock purchase plan must, by its terms, provide that no employee may be permitted to accrue the right to purchase stock under all the employee stock purchase plans of his or her employer corporation and its related corporations at a rate which exceeds $25,000 in fair market value of the stock (determined on the date of grant) for each calendar year in which an option granted to the employee is outstanding. Section 423(b)(8)(A) provides that the right to purchase stock under an option accrues when the option first becomes exercisable.

In drafting the proposed regulations, the Treasury Department and the IRS were aware that taxpayers were interpreting the $25,000 limitation inconsistently. Certain taxpayers interpreted section 423(b)(8) to mean that the limit increases by $25,000 for each calendar year during which the option is outstanding and exercisable; other taxpayers interpreted the sections to mean that such limit increases for each calendar year during which the option is simply outstanding. Consistent with comments received by the Treasury Department and the IRS in response to Notice 2004-55, 2004-2 C.B. 319 (August 23, 2004)), (see §601.601(d)(2)(ii)(b)), the proposed regulations adopted an approach that was generally consistent with the $100,000 limitation for incentive stock options and interpreted section 423(b)(8) to mean that the limit increases by $25,000 for each calendar year during which the option is outstanding and exercisable.

In response to the proposed regulations, several commenters suggested that the Treasury Department and the IRS reconsider the calculation of the $25,000 limitation in section 423(b)(8). Commenters suggested that the regulations adopt an approach that permits an option to accrue at a rate of $25,000 for each calendar year that the option is simply outstanding. Specifically, even though section 423(b)(8)(A) provides that the right to purchase stock actually accrues when the option first becomes exercisable during a calendar year, the first sentence of section 423(b)(8) provides that the limit on accruals is $25,000 “for each year in which such option is outstanding.” Upon further consideration and in response to the foregoing comments, these final regulations modify §1.423-2(i) of the proposed regulations to provide that the limit increases by $25,000 for each calendar year that an option is outstanding. Example 5 in §1.423-2(i)(5) of these final regulations has been modified to illustrate this principle.

Source: https://www.irs.gov/irb/2009-49_IRB