What is an Employee Stock Ownership Plan (ESPP)?

  • An Employee Stock Purchase Plan (ESPP) allows employees of publicly traded companies to purchase company stock at a discounted price.
  • Employees can enroll in an ESPP by making contributions that are automatically deducted from their pay to save up to the date of purchase.
  • How ESPPs are taxed depends on whether they qualify or not – and whether to sell your shares later.

Landing a new job at a publicly traded company can be exciting. In addition to a 401(k) match and health insurance, publicly traded companies may also offer an employee stock purchase plan (ESPP).

What is an employee share ownership plan?

An ESPP allows employees to buy stock for the company they work for at a reduced price, usually up to 15% off. Some companies offer the ESPP as soon as you start, while others wait until you’ve been there for at least a year.

If you truly believe in the mission of the company and its value will increase, it might be beneficial to own stock – another word for stock or ownership – in the company you work for.

According to Charly Kevers, CFO of Map, a stock and property management company. “The IRS currently does not allow the employee to purchase more than $25,000 of stock per calendar year through the ESPP,” he adds.

How does an employee stock ownership plan work?

An ESPP lets you buy stock in the company you work for through automatic after-tax payroll deductions. Up to 15% of your salary after taxes and retirement deductions is automatically deposited into an account held by your employer during the offer period, the period between the start of the ESPP and the date of purchase. At the end of the offer period, all the money you have saved will be used to buy the shares at the agreed price.

“Similar to a 401(k), you choose how much you want to contribute. Your company takes that amount out of your after-tax pay and keeps it. Then, on designated purchase dates, your employer uses that money to buy and you hand over shares,” Kevers says.

The IRS limits you to a maximum contribution of $25,000 for 2022, although your employer may further cap your contributions or even as a percentage of your income.

Example of how an ESPP works

For example, suppose you start working at Company ABC Inc. and they offer their employees an ESPP, and their stock is currently trading at $100. If you choose to participate, the ESPP could allow you to buy 100 shares at $85, which is 15% less than the current price of $100. No matter how much the stock price increases on your purchase date, you will still be able to get 100 shares at the price of $85.

If you plan to buy 100 shares of ABC Inc. Company at $85 and your purchase date is two years from now, you can ask your employer to hold $177.08 per month from your paychecks to cover the $8,500 you need to buy those 100 shares. .

How are ESPP shares taxed?

How your ESPP is taxed depends on the type of plan you have. “There are two types of ESPPs, which affect tax treatment,” Kevers explains. He recommends checking with your employer to see if they offer Section 423-qualified ESPPs or non-qualified ESPPs..

Here are the main differences:

You could pay less tax with a qualified ESPP, but there are more restrictions

Kevers explains: “If you have qualifying ESPPs and you hold your shares for at least one year after the date of your purchase and two years after the date of your offer, you will pay ordinary income tax on the difference in price. between the discounted price and the date of the offer. The difference between the price on the date of the offer and the final sale price is treated as a long-term capital gain or loss.”

According loyalty, US tax law states that employees cannot be taxed on profits due to the discount. Going back to our example of company ABC Inc., if the stock price of the company is $125 at the time of your purchase date, you are looking at a total profit of $4,000. However, only $2,500 of your total profit may be taxed.

If the stock was valued at $100 on the date of your bid and you sold your shares at $125, you will only be taxed on the difference between those two prices. However, a holding period will be required to benefit from these tax advantages.

If you hold onto those shares for a year after your purchase date and two years after your offer date, Kevers says, you’ll have to pay in the long run.

capital gains

taxes on the $2,500 profit you made. Depending on your income, long-term tax gains are usually lower than ordinary

income tax


“If you don’t hold qualifying shares for at least a year, you pay ordinary income tax on the difference. The difference between the sale price and the fair market value on the date of purchase is treated like short-term capital gains,” says Kevers.

Unqualified ESPPs are less restrictive, but you pay more taxes

On the other hand, unqualified ESPPs aren’t as complicated or restrictive as qualified ESPPs, but you might end up paying more taxes.

“If you have non-qualifying ESPPs, you pay taxes on the difference between the value of the shares when you bought them and the price you paid when you bought the shares,” says Kevers.

Using the ABC Inc. company example again, you will have to pay taxes on the total profit of $4,000, although the main advantage over a qualified Section 423 ESPP is that you can sell the shares at any time. moment.

ESPP vs. 401(k)s

Generally, an ESPP does not replace a traditional retirement plan, such as a 401(k) or a Roth IRA. An ESPP is similar to buying individual stocks in the market to resell them at any time, while a 401(k) or Roth IRA is specifically intended for retirement purposes to be withdrawn later in life.

“Employees might consider consulting a financial advisor for their particular situations. A 401(k) or IRA tends to be invested in a basket of stocks – it’s more diverse – whereas an ESPP only allows employees to ‘buy stock in their employer,’ says Kevers.

About Barbara J. Ross

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