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 benefits they may provide.

An ESPP is a stock ownership plan that allows you to purchase shares of your company’s stock, usually at a discount, with funds deducted from your paychecks. ESPP shares are yours as soon as the stock purchase is completed. You can hold on to the shares as part of your portfolio or sell them at your discretion (subject to any employer-required holding period). 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 eligible employees of the company.

1. 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.

2. Offering/purchase period

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

3. 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 many 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. Companies may also offer a “look-back” provision, which compares the share price at the beginning of the offering period and the share price on the purchase date 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

Many 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, at which time your accumulated cash will be returned to you. Each plan is unique, so please refer to your plan document for details.

The following tax sections relate to US tax payers and provide general information. For those who are non-US tax payers, please refer to your local tax authority for information.

Before you take action on your shares, you’ll want to carefully consider the tax consequences. The information contained in this document is for informational purposes only. Tax treatment depends on a number of factors including, but not limited to, the type of award. For advice on your personal financial situation, please consult a tax advisor.

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 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 price of the stock as if the grant date price was used to calculate the purchase price or the actual gain (stock price minus the purchase price). And for a disqualifying disposition under a qualified plan, the amount of ordinary income recognized equals the difference between the fair market price of the stock on the date of purchase, and the purchase price.

The sale of shares purchased as part of a qualified 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

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.

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:

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 (Stock Plan > My Account > Orders) on etrade.com.

Have questions?

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