Why do you care about Employee Stock Purchase Plans (ESPP)? If you enroll in the employee stock purchase plan offered by your company you can make more money! ESPP is a benefit offered by some publicly traded companies to their employees. ESPP is the ability to purchase company stock through payroll deductions at a discounted rate.
The effort required is minimal and requires enrolling in ESPP and selling the shares to realize gains (or losses). You have a guaranteed return if you sell the day you receive the shares. If you decide to hold the shares for longer, and the shares increase in value, it will help you accumulate wealth. Companies can offer a maximum discount of 15% on company shares. With current savings accounts interest rates at best at 1.5% APY, and average stock returns at 5-7% a year, but not guaranteed, this is a great deal.
If you’re considering enrolling in ESPP here are the terms you should know, the benefits of ESPP and approximately how much extra income you may be able to make.
Employee Stock Purchase Plan Terms To Know
- ESPP Enrollment Period: defined set of dates where you can sign up to participate and select the % election amount. If you miss this enrollment period you will have to wait for the next enrollment period (either 6 months or 1 year later depending on the terms)
- ESPP Purchase Period: Timeframe in which company shares are purchased on your behalf through payroll deductions. There may be two purchase periods a year, one beginning Jan 1st and ending on June 30th, with the second starting July 1st and ending Dec 31st. You do not have access to the money you’ve contributed during this time.
- ESPP Purchase Price: Usually, the purchase price is the price of the stock on the last day of the offering period, with the discounted rate applied. In the example above, it would be the ending stock price on June 30th and December 31st.
- ESPP Holding Period: You can sell your ESPP shares at any time, even the same day you get the shares. However, in order for the sale to be taxed as a capital gain it must be considered a qualifying disposition.
- ESPP Qualifying Disposition: A qualifying disposition refers to a sale, transfer or exchange of stock that qualifies for favorable tax treatment. ESPP falls within this definition. To be a qualifying disposition, the employee must sell their position at least one year after exercising the stock or two years after the beginning of the ESPP offering period. As long as you hold your ESPP shares for this time period you are taxed at a capital gains rate. If you sell prior to this period, it is considered a disqualifying disposition. A disqualifying disposition is taxed at the income tax rate.
Employee Stock Purchase Plan IRS Limits
The IRS imposes a limit of a maximum market value of $25,000 per year. However, companies can decide to impose lower limits. That means if your company grants you shares at a 15% discount, the max you can contribute is $21,250. The purchase discount also tops out at 15%, but your company could choose to offer less than that as well. Every plan can vary so be sure to look into the details around what plan your company offers.
Employee Stock Purchase Plan Tax Rules
The stock discount price (up to 15%) is considered additional compensation and taxed as ordinary income. If you sell that day, it is disqualifying and will be taxed as a short term gain / ordinary income. If you hold shares for at least 2 years from the first day of the offering period and at least one year from the purchase date, the additional income is considered a “qualifying dispositioned” and will be taxed as a long-term capital gain (15% tax rate for most taxpayers).
Additional Income Earned with Employee Stock Purchase Plan
The tables below offer a guide to how much additional income you can make after taxes if you sell that day per year. If you decide to hold onto the stock for the time period outlined below, your taxes will be 15% (for most taxpayers) for the discounted amount + any gains you made while holding the stock. Remember, it is always possible for the stock to lose value.
**Assumes all income would have been taxed at the rate of that bracket
**Assumes all income would have been taxed at the rate of that bracket
It’s hardest to maximize the program when you make less money, but that’s when this is actually the most valuable! When your tax rate is only 22%, you could make almost $2,500 after taxes. If you’re in the highest tax bracket you make only $2,000 after taxes. The first purchase period is always the toughest. You’re used to getting that money in your paychecks every pay period. After the first purchase period is done, if you sell all your shares immediately you have everything you’ve invested from the past 6 months plus the additional income you made as soon as the sale settles!
If you work for a public company, check out your internal benefits page and see if this is one of the benefits your company offers!
See Also: Company 401(k) Match and Why You Should Max Out Your 401(k)
