Understanding Stock Plan Purchase Plans

E*TRADE Securities2

Understanding Employee Stock Purchase Plans

 

Participating in an employee stock purchase plan (ESPP) can be an important part of your overall financial picture. Understanding what these plans are, including some of their potential tax ramifications can help you make the most of the benefit they provide.

 

How Does an ESPP Work?

 

An Employee Stock Purchase Plan (ESPP) is a stock ownership plan that allows you to purchase shares of your company’s stock, usually at a discount. ESPP shares are yours as soon as the stock purchase is completed. You can hold onto the shares as part of your portfolio or sell them at your discretion. Typically, only full-time, permanent employees  are eligible to participate in an ESPP program. In addition, with few exceptions, shares must be offered to all employees of the company.

 

Know the Types of ESPPs

 

Qualified – An employee stock purchase plan that qualifies under Section 423 of the Internal Revenue Code (IRC) allows employees to purchase company stock at a discount and postpone recognition of tax on the discount until the shares are sold. Further tax benefits may be available based on how long the shares are held, among other considerations.

Non-Qualified – A non-qualified employee stock purchase plan also allows participants to purchase company stock, but does not offer the employee-related tax advantages described above. Unlike a qualified plan, applicable taxes on non- qualified ESPP shares are due at purchase.

 

Things to Know About Your Company’s ESPP

 

Enrolling in Your Company’s ESPP

 

During the enrollment period you will be able to specify your contribution, either a fixed dollar amount or a percentage of your paycheck, depending on your company’s plan. Your contribution will be automatically deducted from your paycheck. Depending on the design of your company’s ESPP, certain earnings may not be included when calculating your ESPP contribution. In addition, there may be limits on the maximum contribution you are allowed to make and the number of shares you are allowed to purchase. Information on the limitations and structure of your plan should be contained in    your company’s plan documentation. Check with your company’s plan administrator if you have questions.

 

Offering/Purchase Period

 

The offering/purchase period is a predetermined length of time during which after-tax contributions are collected via a payroll deduction.

 

Periodic Share Purchases

 

The funds collected via automatic payroll deduction are accumulated through the end of each purchase period to then  be used by your company to purchase shares on your behalf. Under most plans, the purchase price is set at a discount to the stock price on the purchase date (at the company’s discretion) of up to a maximum of 15% for qualified plans. Some companies also offer a “look-back” provision, which compares the share price at the beginning and end of the purchase period and uses the lower value to calculate your purchase price. Shares will be purchased at predetermined points  either during or following the offering/purchase period. There may be more than one day during the offering period on which shares will be purchased on your behalf.

Example: $1,000 contribution with a 15% discount on the purchase and a look-back provision

  • Contribution: $1,000
  • Discount:  15%
  • Purchase Price: $17 per share (15% discount from lower price of $20)
  • Participant Purchases: 58 shares ($1,000 ÷ $17 per share)

 

Flexibility to Choose

 

Most plans allow you to modify your contribution during the offering period. Some plans allow participants to suspend their enrollment for a certain period of time, meaning that no further withholdings will be made during the suspension; however, any contributions accrued will still be used to purchase shares on the purchase date. Some plans may allow you to withdraw after enrollment. Each plan is unique, so please refer to your plan document for details.

 

U.S. Tax Considerations

 

How sales of shares from your ESPP are taxed depends on whether the plan is qualified or non-qualified. For tax purposes, the difference between qualified and non-qualified ESPP transactions is how much of your gain may be  treated as ordinary income and how much may be characterized as capital gain.  Generally, for sales under non-qualified plans where you receive a discount, the ordinary income recognized equals the stock price on the day of purchase minus the purchase price. For disqualifying dispositions under qualified plans, ordinary income recognized equals the stock price on the day of sale minus the purchase price. For a qualifying disposition under a qualified plan, the amount of ordinary income recognized equals the lesser of the difference between the grant price and the purchase price (with the discount) or the actual gain (stock price minus the purchase price).

The sale of shares purchased as part of an ESPP is categorized as either Qualifying or Disqualifying based on a holding period, among other requirements. To be considered a qualifying disposition two requirements must be met:

  • The disposition occurs more than two years after the grant date and
  • The disposition occurs more than one year after the purchase date

Qualifying Disposition

  • Sell, transfer, or gift your shares after the end of the specified holding period
  • A portion of the gain (if any) is taxable as ordinary income and the rest as long-term capital gain
  • In most cases, more of the gain will be taxable as a long-term capital gain and less will be taxable as ordinary income than would occur in a disqualifying disposition
  • Typically offers benefits to the taxpayer because the capital gain tax rates may be lower than the rate at which the ordinary income is taxed

Disqualifying Disposition

  • Sell, transfer, or gift your shares prior to the end of the specified holding period
  • Ordinary income equals the difference between the stock price of the shares on your purchase date and the purchase price
  • Any additional gain is typically taxable as short-term or long-term capital gain

Consult with a tax professional for details on your specific situation.

 

Capital Gains and Losses Holding Period

 

A gain/loss will typically be treated as short term if the stock has been held for one year or less and long term if the stock has been held for more than one year.

 

Selling Your Shares

 

Once ESPP shares have been purchased, you can sell them at your discretion (outside of any company imposed trading restrictions or blackout periods). Follow these steps to create an order to sell your shares:

1.   Create Order

A.    Log on to etrade.com. From the Stock Plan Overview page, click the Sell tab

B.    Choose your price type by selecting one of the following:

    a.    Market: “I want to sell at the next available price”

    b.    Limit: “I’m willing to wait until the stock hits the price I want”

C.     Enter the number of shares you would like to sell from each of your tranches

D.    Select how you would like to receive your cash proceeds

 

2.   Preview Order

E.   Estimate your proceeds by clicking the Preview Order button

F.   From the Preview Order page, click Place Order; or change it using the Change Order button

 

3.   Confirm Order

G.   You will receive a confirmation that your order has been placed

 

We’ll alert you when your order has been executed and when settlement occurs.

You can also track your order status on the Orders screen (My Stock Plan > My Accounts > Orders) on etrade.com.

 

Have Questions?

Visit our Customer Service Online at etrade.com/service or call us at 1-800-838-0908, 24 hours a day, weekdays.  From outside the U.S. or Canada, call +1 650 599 0125. One of our dedicated professionals will be happy to assist you.