Employee Stock Purchase Plan (ESPP) Overview

It’s everyone’s favorite topic – Employee Stock Purchase Plans (ESPPs)! You have a great opportunity to participate in the success of your company by purchasing your own company’s stock at a potentially discounted price. This is a great opportunity like stock options, but much more common. Especially in larger companies. Let’s jump in and begin by looking at the structure:

Enrollment Period Begins: You’ll first be asked to enroll into the ESPP. This is done by completing a subscription form or grant agreement specifying the rules of the ESPP. Every ESPP is different in how it handles administrative matters, so it’s important to retain a copy for your records. The grant agreement will ask you how much you would like to purchase over the offering period. Your participation is based on payroll deductions and happen on an after-tax basis which are deducted as a percentage of your overall salary (usually 1-10%).

Election Period: ESPPs happen in rolling periods, typically 6 months. You have a window of opportunity to sign up for your company’s ESPP, similar to open enrollment with other company benefits such as health insurance. This period for your ESPP is called the election period. You ELECT to participate in the program in this election period.

Enrollment Deadline: This is the final day allowable to enroll in your ESPP. ESPPs are offered regularly so if you miss your company’s deadline, you can more than likely enroll in the next offering.

Offering Date: This is also called the grant date. This is the date your payroll deductions to purchase company stock begin. Your contributions into the ESPP to purchase company stock are not immediately transacted upon. In that, your contributions will initially go into an escrow fund until the purchase date arrives.

Purchase Period: This is the amount of time your payroll deductions will accumulate. You can backout of the ESPP at this point and have your money sent back to you. Remember, this is after-tax money, so no taxable situation having the funds returned to you. Your money likely won’t earn any interest when in the escrow fund.

Purchase Date: This is the date your shares are purchased. The actual price you pay to purchase the shares will depend on whether or not there’s a lookback provision or discount offered.  

Offering Date Ends: This concludes the offering of the ESPP. Your company more than likely has rolling ESPPs that will automatically enroll you into the next ESPP offering.

ESPP Features

Discount: As mentioned previously, your company can offer a discount to entice your participation into the ESPP. The maximum discount is 15% in qualified plans but can be less (or more in non-qualified plans) depending on your company’s ESPP rules.

Lookback Provision: This is the possibly the biggest benefit of an ESPP, if your company includes one. A lookback provision allows you to base your purchase price (possibly discounted) on either the offering date stock price or purchase date price, WHICHEVER IS LOWER. This can be a big benefit in a up market. In fact, ESPPs can never be underwater come purchase price time. You’re always purchasing at the market price and with a discount you’re given a guaranteed return should you immediately sell after the purchase date (I’m always incredibly reluctant to use the word ‘guaranteed’, but in this case it makes sense).

Both the lookback provision and allowable discount will help determine the basis and purchase price in your ESPP and ultimately the taxable ramifications.

Qualified (Section 423 plans) vs. nonqualified: ESPPs that are qualified have special tax treatment and privileges. With the special tax privileges though come special rules the qualified ESPP must follow, such as:

-The discount cannot be more than 15%

-You cannot purchase more than $25,000 of stock per calendar year (valued at the undiscounted stock price on first day of the offering period).

-Must be offered to all employees non-discriminately (some eligibility rules apply, but generally a qualified plan cannot, for example, only be offered to executives)

Plans that do not meet the requirements are considered nonqualified and are taxed very similarly to non-qualified stock option plans. The majority of ESPP plans 

Basic Taxes

No taxes are owed in an ESPP until you sell. After you complete the purchase of ESPP shares, you’re considered the owner of the stock and you can participate in your company’s voting and dividends. So, technically, there COULD be taxes owed on dividends, but in terms of the purchasing transaction involved, there are no taxes due.

Qualified Disposition: When you sell your shares is incredibly important as that will determine whether you’re eligible for the tax benefits mentioned earlier. You receive favorable tax treatment when you meet the requirements of a qualified disposition. A qualified disposition is met by selling your shares more than one year from the purchase date and more than two years from the offering/grant date. Anytime before this and you lose favorable tax treatment, and it is considered a disqualifying disposition.

Disqualifying Disposition: When you sell your shares less than two years from the offering date and less than one year from the purchase date, you have a disqualifying disposition. When in a disqualifying disposition, you must pay ordinary income tax on the difference between the market value of the stock at the purchase date and your actual purchase price. This can result in paying much more ordinary income tax as compared to a qualifying disposition.

Conclusion

That’s it, you’re now an ESPP expert! Well, not quite but you’ve at least got the basics down. An ESPP can be a huge benefit if understood and acted upon properly. 

As always, it’s best to consult with a professional who understands the complexities that arise with equity compensation. Contact us today for a free evaluation!

As always, remember to consult with your tax, legal, and investment professionals.

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Jeff Branson, MBA, CFP® – Jeff is the founder of Branson Financial Planning. He spends his time acting as a personal CFO to households across the United States. He believes that financial advice should be clear, objective, and delivered in a fiduciary manner. When he’s not working, Jeff spends his time exploring beautiful Maine with his girlfriend Bianca and his golden retriever Mavrick.