Employee stock purchase plans (ESPP) allow employees to purchase shares of their employers’ stock, up to an annual limit, and through after-tax payroll deductions. ESPPs typically have a set plan year and at the end of the plan year, you will receive shares of your employer’s stock. The price of the shares you receive is either the lower of the price of the stock at the beginning of the plan year, or the price of the stock at the end of the plan year discounted by a certain percentage; typically 15%. An ESPP is a company benefit you should take advantage of annually after maxing out your pre-tax and after-tax contributions to your 401(k).
A qualifying disposition of the company stock requires you to hold the stock for at least two years after the grant date and at least one year after the purchase date. If you have a qualifying disposition, you will pay ordinary income taxes on the discount and long-term capital gains taxes on any gain. Please see an example below:
A disqualifying disposition can happen if you sell the employer’s stock within two years of the grant date or one year less than the purchase date. If you have a disqualifying disposition, you will pay ordinary income taxes on the difference between the discounted price and the price on the purchase date. The market price on the day of purchase will then become the cost basis for the sale. Then, you will pay short or long term gains on the difference between the sale price and the cost basis. Please see an example below:
Whether you are selling your stock immediately or holding on to it for a qualifying disposition, and if your employer’s stock price is staying flat or rising, you will be able to make a profit by participating in your Employee Stock Purchase Plan. We encourage you to consider participating in your ESPP, after you max out your 401(k) contributions, if your monthly cash flow allows.
