Employee Stock Purchase Plans

Employee Stock Purchase Plans (ESPPs): Stock Ownership While You Work.

While not all employees are granted stock, Employee Stock Purchase Plans (ESPPs) provide all eligible employees a way to benefit from the success of their company. ESPPs are a convenient way for you to accumulate company stock. Through payroll deductions, similar to a 401(k), cash is set aside to purchase shares of your companies stock typically at a discount of 5%-15%. This provides an opportunity for employees to accumulate company shares at preferential pricing.

How ESPPs Work

ESPPs have three key components employees should understand, as these directly affect the share purchase price and potential future tax implications.  The major components of an ESPP are:

• The Offering Period/Window – This is the duration that the ESPP plan will run.  These windows can vary from company to company and are anywhere from 3 to 24 months long.  When you enroll in the ESPP plan, this is the period where deductions from your paycheck will take place and be set aside for future share purchases.
• Offering Date – This is the date at which the offering period/window begins.
• Purchase Date – The date at which the cash that has been set aside is used to purchase shares of company stock. This often split up into 6-month increments throughout the offering period/window.

Determining the Price You Purchase At – The Look Back

Many ESPP plans offer what is known as a “look back feature.”  On the purchase date, the plan will look at the price of the stock on the offering date and the price on the purchase date. Whichever price is lower, is the price that is used to purchase the shares at a discount.

Example Assuming a 15% Discount:

In this example, the price of the stock on the offering date is $50. For the first purchase date (5/31/2025), the price is $65 and the price of the stock on the final purchase date is $35.

• First Purchase Date: Since the price of the stock on the Offering Date ($50) is lower than the price on the Purchase Date ($65), the 15% discount will apply toward the lower Offering Date price, resulting in a purchase price of $42.50.
• Second Purchase Date: Since the price of the stock on the Offering Date ($50) is higher than the price on the Purchase Date ($35), the 15% discount will apply toward the lower Purchase Date price, resulting in a purchase price of $29.75.

Selling Your ESPP Shares

When it comes time to sell the shares that you have purchased, the nuances associated with determining how you get taxed can be quite difficult. To get the most preferential tax treatment, shares must be held for more than two years from the offering date and one year from the purchase date, resulting in what is called a “qualifying disposition.”  If these conditions are not met, then the sale results in a “disqualifying disposition.” How taxes are applied for capital gains (or loss) and ordinary income vary greatly depending on when you sell your shares and the price at which you sell.

Qualifying Disposition – When Purchase Date Price is Above the Offering Price

You have held onto your shares for longer than two years from the offering date and one year from the purchase date and you are ready to sell your shares. The first tax component to figure out is if you are going to owe any income tax on the sale of the shares. This is determined by looking at the lesser of:

• The discount on the purchase
• The gain on the purchase price and sale price

You would then pay long-term capital gains tax on any gain that is more than the discount received, if any.

Based upon which scenario applies above, there could also be long-term capital gains tax applied to the sale. The major determining factor for all these potential tax implications is the eventual price that you sell that stock at.

Example using the above scenario with a purchase date of 5/31/2025:

Offering Date Price: $50

Purchase Date Price: $65

Purchase Price: $42.50 ($50 x .15)

Disqualifying Disposition – When Purchase Date Price is Above the Offering Price

If you sell your shares prior to satisfying the required holding time periods, the sale results in a disqualifying disposition. The tax implications for this type of sale are quite different than that of a qualifying disposition. When it comes to determining what is taxed as ordinary income and what is subject to capital gains, the following applies:

• Ordinary Income – calculated as the difference between the purchase date and the purchase date price
• Capital Gain or Loss – the difference between the purchase date price and actual sale price

Example using the above scenario with a purchase date of 5/31/2025:

Offering Date Price: $50

Purchase Date Price: $65

Purchase Price: $42.50 ($50 x .15)

Qualifying Disposition – When Purchase Date Price is Below the Offering Price

When the purchase date price is below the offering date price, the discount will be applied to the purchase date price and determining potential taxes changes from the examples above.  The framework for determining the ordinary income component will remain the same, determined by looking at the lesser of:

• The discount on the offering date price or
• The gain on the purchase price and sale price

In addition, you would then pay long-term capital gains tax on any gain that is more than the discount received, if any.

 

Important Note – You will notice that even though the discount to purchase the shares is being applied to the lower price on the purchase date, for purposes of determining the potential Ordinary Income tax the calculation is based on discount being applied to the offering date price.

Disqualifying Disposition – When Purchase Date Price is Below the Offering Price

If you sell your shares prior to satisfying the required holding time periods, the sale results in a disqualifying disposition.  The tax implications for this type of sale are quite different than that of a qualifying disposition.  When it comes to determining what is taxed as ordinary income and what is subject to capital gains, the following applies:

• Ordinary Income – calculated as the difference between the purchase price and the purchase date price
• Capital Gain or Loss – the difference between the purchase date price and actual sale price

Example using the above scenario with a purchase date of 12/31/2025:

Offering Date Price: $50

Purchase Date Price: $35

Purchase Price: $29.75 ($35 x .15)

 

Important Note – You will notice that even though the discount to purchase the shares is being applied to the lower price on the purchase date, for purposes of determining the potential Ordinary Income tax the calculation is based on discount being applied to the offering date price.

Things to Consider When Deciding to Contribute to Your ESPP

Before committing to an ESPP, it’s important to evaluate a few key factors to determine if it aligns with your financial goals and risk tolerance. Consider the following:

• Current Concentration Risk: Assess how much of your wealth is tied to your company’s stock. If a large portion of your portfolio is already in company stock, contributing to an ESPP may increase your exposure to the performance of a single entity, which increases your risk.
• Cash Flow Management: Contributions to an ESPP come directly out of your paycheck. Ensure you have the cash flow to accommodate these deductions while meeting other financial needs and obligations.
• Other Savings and Investments: Evaluate how your ESPP contributions fit into your overall savings strategy. Are you contributing to retirement accounts like a 401(k) or an IRA? Do you have a diversified investment portfolio? Make sure the ESPP complements your broader financial goals.