How Leap Year Affects Equity Awards

In celebration of leap day, I have a few tidbits on how leap years affect tax holding periods and other considerations for equity awards.

ISO/ESPP Holding Period–365 Days or 12 Months?

For tax purposes, 365 days does not always equal a year. When tax-related holding periods encompass a leap year, employees will need to hold the stock for an extra day. In the context of ISOs and qualified ESPPs, this applies to both the two-year period that starts at grant and the one-year period that starts at exercise/purchase.

For example, let’s say that an employee enrolls in an ESPP offering on February 1, 2023 and purchases stock under the offering on July 31, 2023. The two-year period that begins at grant will end on February 1, 2025 (a total of 731 days) and the one-year period that begins at purchase will end on July 31, 2024 (a total of 366 days). Because a qualifying disposition requires the stock to be held through both these time periods, the employee will have to hold the stock for a total of 731 days for his or her disposition to be treated as qualifying.

Now let’s back everything up a year: say the employee enrolls in the ESPP on February 1, 2022 and purchases stock under the offering on July 31, 2022. In this scenario, both holding periods elapse before leap day (February 29, 2024). The two-year period that begins at grant will end on February 1, 2024 (a total of 730 days) and the one-year period that begins at purchase will end on July 31, 2023 (a total of 365 days). In this scenario, the employee can hold the stock for one less day (i.e., a total of 730 days) and still have the sale treated as a qualifying disposition.

Treas. Reg. §1.421-2(b)(1)(ii) provides an example of the above principles. Although the example involves an incentive stock option, the same principles apply to shares acquired under qualified ESPPs.

What about transactions that occur on February 28 or 29 of a leap year?

In both cases, whether the transaction occurs on February 28 or 29 of a leap year, the holding period will be the same. For example, let’s say that employee A exercises an ISO on February 28, 2024, and employee B exercises an ISO on February 29 (and let’s assume that both ISOs were granted more than a year before the exercises, so that the employees only have to hold the stock for a year after the exercise date for a qualifying disposition). Both employees will have to hold the stock acquired upon exercise until March 1, 2025.

How can this be? Well, let’s look at how the holding period is calculated. As noted, in both scenarios, the end of the holding period is one year after each exercise date. Employees have to hold through the end of the holding period for their disposition to be qualifying. Thus, to calculate the first date that a disposition will be qualifying, you add one year and one day onto the exercise date.

Because there is no February 29 in 2025, adding a year and a day to February 28, 2024, brings us to March 1, 2025. But the same is true for the exercise on February 29, 2024: adding a year and a day to that date also brings us to March 1, 2025.

The same concept applies to ISOs granted February 28 and 29 of a leap year (and ESPP enrollments on these dates) for purposes of calculating when the two-year holding period lapses.

What about an exercise or purchase that occurs on February 28 of the year before a leap year (or an grant/enrollment on February 28 two years before a leap year)?

In these scenarios, February 29 of the subsequent leap year will be the first day that shares acquired under the arrangements can be sold in a qualifying disposition (assuming both the two-year and one-year periods have been met by that date).

Long-Term Capital Gains

The holding period for sales to be treated as a long-term capital gain works the same way. Shares must be held for a full year from the date they were acquired for a sale to be treated as long-term. To determine the first day on which a sale will be treated as a long-term capital gain or loss, you add one year and a day to the date the shares were acquired.

To meet the long-term capital gains holding period:

• Shares acquired on February 28 of a leap year must be held until March 1 of the following year.
• Ditto for shares acquired on February 29 of a leap year; they also must be held until March 1 of the following year.
• Shares acquired on February 28 of the year before a leap year must be held until February 29 of the following year.
• Shares acquired on February 28 of any year other than the year immediately preceding a leap year must be held until March 1 of the following year.

Income Allocation for Mobile Employees

When employees live or work in multiple tax jurisdictions during the life of their equity awards, leap day can also affect how income is sourced to each jurisdiction. Many tax jurisdictions (both countries and US states) stipulate that income is sourced to the jurisdiction based on the number of days worked therein, as a percentage of the total days in the vesting schedule or life of the award. If either time period includes February 29, that can change the amount of income taxable to the jurisdiction as compared to periods that do not include leap day.

Unlike tax-related holding periods (where every day matters, no exceptions), here there may be a materiality threshold. A calculation that is off by a day because you forgot to include leap day in your formula likely isn’t worth losing any sleep over.

Expense Recognition

When recording expense for equity awards, most companies calculate a daily accrual rate (meaning that a small amount of expense is accrued for each day in an award’s service period). In this approach, if the service period includes leap day, this will add a day to the service period and result in a slightly smaller daily accrual rate.

For example, assume an RSU with a three year service period and aggregate expense of $300,000. If the RSU is granted on March 1, 2024, the expense accrued per day is $273.97 ($300,000 divided by 1,095 days). But if the RSU is granted on February 28, 2024, the expense accrued per day is $273.72 ($300,000 divided by 1,096 days).

What about an award granted on February 29? In my example of an award with a three-year service period, there won’t be a February 29 at the end of the three-year vesting period. When granting the award, the company will have to decide whether the award will vest on February 28 or March 1 of the third year after the grant. The daily expense accrual for the award will vary depending on the company’s decision.

Finally, where an award vests in equal increments, the expense for each vesting increment should be the same, even if the daily accrual rate per increment varies. Let’s return to my example of an RSU granted on February 28, 2024, with a three-year service period. If the award vests in three equal annual increments, the company should record $100,000 of expense for each vesting increment. If expense is recorded on a straight-line basis, the daily accrual rate for the first vesting increment is $273.22 ($100,000 divided by 366 days) and the daily accrual rate for the second two vesting increments is $273.97 ($100,000 divided by 365 days for each). (To keep things simple, I am ignoring the effect of forfeitures.)

With all things accounting, there is a materiality threshold. In my example, the expense attributable to any one day during the award’s service period is just .09% of the total expense for the award (i.e., less than a tenth of a percent, not 9%). So long as you record the appropriate amount of expense for each award, using a daily accrual rate that fails to consider leap day probably won’t trigger any concerns from your auditors.

A Simpler Solution?

As you can see, leap year can make things complicated. 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 sets their calendar back 24 hours. It’s like a do-over day. This day should always happen on a weekend, so the extra day is a day off (people who work weekends should get to take a different day off). And no one wants an extra day in February, so let’s do this in a summer month—maybe July or August. Who’s with me?