Employee Stock Purchase Plan – What You Should Know
The Employee Stock Purchase Plan (ESPP) is a program in which employees at a company can purchase the company stock at a discount. Let us walk you through everything you should know when participating in the ESPP at your company.
With ESPPs, the discount varies from company to company, but it can be as low as 15% less than the market price. Once you purchase your shares at the discounted price, you can sell immediately if your company offers a Quick-Sale option. This is a sure-fire way to guarantee a small profit.
However, you should know that an ESPP is subjected to a timeline, guidelines, and limitations so that the company stock continues to be profitable despite offering employees a discount. Let’s get into the fine print of ESPPs.
When you decide to participate in your company’s ESPP, you will be alerted of your Enrollment Period – the time when you decide how much you would like to defer from your salary and bonus and contribute to the ESPP per pay period. The amount you contribute per pay period will be subject to the Contribution Limit of $25,000 per year as deemed by the IRS. Your company can also instill other contribution limits like a max percentage of your pre-tax salary or a flat amount like the IRS instilled. After abiding by the contribution limits, your contributions will then be taken each pay period directly from your paycheck and held in an ESPP account.
When your Enrollment Period expires (also known as the purchase date), your contributions will be taken from your ESPP account and used to buy shares at the discounted price. The discounted price is one of two prices: the share price at the beginning of the Enrollment Period, or the share price at the end of the Enrollment Period. Whichever one is lower. This is great for you because if the stock has gone up since the beginning of the Enrollment Period, your purchase price will be the lower price giving you more upside. The beginning to end of the Enrollment Period is called the Lookback Period.
Taxes and ESPP
Taxes only come into play once you decide to sell your shares, and the taxes you are subjected to depends on the disposition – Qualified or Disqualified.
In a Qualified disposition, shares must be held at least 2 years from the beginning of the Enrollment Period (the offering date) and one year from the end of the Enrollment Period (the purchase date). The tax treatment is split on Qualified dispositions – the purchase price is treated as income, while the gain above purchase price is treated as capital gains and taxed at a lower rate. This could be seen as an advantage, however, the time constraint of keeping the stock for a year after purchase risks the stock price going down during that year, and you will have no gains at all.
In a Disqualified disposition, there are no shareholding time requirements as with a Qualified disposition. However, there is no apparent tax advantage either. When you sell, you will pay the normal income tax rate on the gains from your discounted purchase price and current market price. Those gains will also be subject to standard Federal and State tax treatments.
Before You Participate
If your company offers an ESPP benefit and it is something you want to participate in, ask yourself a couple questions first:
- What is my cash-flow and how much can I contribute each pay period?
- How much of my company stock do I realistically want to own?
If you want to talk through your ESPP strategy, please feel free to schedule time below to discuss. We will be happy to talk through the considerations with you.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.