What Is an Employee Stock Purchase Plan?

An employee stock purchase plan (ESPP) allows workers to buy shares of their employers' stock at a discounted price in an easy and convenient manner using after-tax payroll deductions. ESPPs are perhaps the simplest form of stock purchase plan in use today.

Outside of wages and salaries, ESPPs are one common method of compensating employees in today's corporate environment. The ESPP is a very straightforward method of allowing employees to participate in the overall profitability of a company over time.

How Employee Stock Purchase Plans Work

Qualified vs. Nonqualified Plans

ESPPs can be divided intoไ two categories: qualified and nonqualified.

1. Qualified ESPPs are the most common type of plan and resemble their qualified cousins in the retirement plan arena. They must adhere to prescribed eligibility criteria set by the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS).

Qualified plans must be approved by a vote of the 澳洲幸运5官方开奖结果体彩网:shareholders before they can be implemented, and all 澳洲幸运5官方开奖结果体彩网:plan participants have equal rights in the plan. Their offering periods cannot exceed 27 months, and the discount on the stock price may not exceed 15%.

2. Nonqualified plans are much simpler and are not subject toꦛ the rules that pertain to qualifie𒉰d plans. However, there is no tax advantage of any kind with these plans.

The remaining sections of this article, therefore, pertain s💞olely to qualified plans.

Key Dates and Terms for Qualified Plans

Employees who choose to participate in their company ESPP can only do so after the offering period begins. This period always begins on the offering date, which corresponds to the grant date for 澳洲幸运5官方开奖结果体彩网:stock option plans.

澳洲幸运5官方开奖结果体彩网:Payroll deductions then commence and continue for participants unti🍃l the purchase date (the day on which the company stock is actually bought). Offering pe⛎riods can be either consecutive or overlapping. If overlapping, they will often have different purchase prices because of their staggered purchase dates.

Most of𒀰fering periods have several purchase dates that come at the end of several purchase periods, such as a plan with an offering period that is comprised of four purchase periods that end with four purchase dates.

So for example, if the offering period were to begin Jan. 1, then the first purchase period would last for six months and end July 1, and the seconℱd purchase period would end Dec. 31, with this pattern continuing for the next two years.💮

Enrollment Process and Plan Mechanics

Employees must apply to enroll in the plan at the next available offering date. On the application, they will state the amount that they ꦓwish to contribute to the plaඣn. Contributions are usually limited to about 10% of their take-home pay.

Contributions are also limited to $25,000 per calendar year by the IRS, regardless of any restrictions imposed by the employer.

After each pay period, the employee deferrals are placed in separate accounts until the purchase date. The stock is then held in separate accounts for each employee by a 澳洲幸运5官方开奖结果体彩网:transfer agent or brokerage firm ꧑until they sell their shares and collect the proceeds.

Potential Gain

As mentioned, many ESPPs allow their employees to purchase company stock at a 10 to 15% discount from the stock's 澳洲幸运5官方开奖结果体彩网:market value. This can provide them with a 澳洲幸运5官方开奖结果体彩网:capital gain depending on when they sell.

Furthermore, many plans also have a "look back" provision that allows the plan to use the closing 澳洲幸运5官方开奖结果体彩网:company share price of either the offering date or the pu꧙rchase date, whichever is 🎐lower.

This can have an enormous impact on the amount of gain that participants realize. Employers can set their own policies about allowing employees to withdraw their funds from the plan between purchase♒ dates or to change their contribution levels.

Eligibility

All employees are un🅘conditionally eligible for the qualifiedꦚ ESPP except:

• Any person who owns more than 5% of the stock in the company
• Certain categories of employees, such as anyone who has worked for the company for less than one year

Tax Treatment

The rules that govern the taxation of proceeds from ESPP💧s can be quite complex in some 💝cases. A simplified version is presented here.

In general, the tax treatment ꦚof the sale of🌞 ESPP stock is governed by four factors:

• The length of time the stock is held
• The price the stock is actually purchased at, factoring in the discount
• The closing price of the stock on the offering date
• The closing price of the stock on the purchase date

ESPPs use 澳洲幸运5官方开奖结果体彩网:holding periods that 🤡closely resemble those of other stock option plans. For qualified ESPPs, stock that is held until🌳 at least a year after the purchase date and two years after the offering date will receive favorable capital gains tax treatment.

Stock sales that meet these criteria are known as 澳洲幸运5官方开奖结果体彩网:qualifying dispositions, while those that don't meet these criteria are labeled as disqualifying dispositions.

Qualifying Dispositions

Participants who meet the holding requirements for qualifying dispositions will realize two types of 澳洲幸运5官方开奖结果体彩网:taxable income (or losses), but none of it is reported until the year of the sale. The amount of discount allotted in the plan (such as 15%) is reported as 澳洲幸运5官方开奖结果体彩网:ordinary income. The remainder is classified as a long-term capital gain.

Disqualifying Dispositions

This type of 澳洲幸运5官方开奖结果体彩网:disposition counts a great deal more of the sale proceeds as ordinary income. The seller must count the difference between the closing price of the stock as of the purchase date and the discounted 澳洲幸运5官方开奖结果体彩网:purchase price as ordinary income.

Other Advantages of ESPPs

• Like all other types of employee stock ownership plans, ESPPs can help to motivate the workforce and provide employees with additional compensation that does not come entirely out of the company's own pocket.
• ESPPs are also relatively simple to administer and maintain, and can get employees in the habit of saving money regularly through their contributions (that are exempt from 澳洲幸运5官方开奖结果体彩网:Social Security and Medicare taxes).
• They also allow employees to sell the stock before retirement, which can prevent their portfolios from becoming heavily weighted in company shares.

The Bottom Line

Employers that are looking for a relatively simple way to get their employees to buy company stock should take a close look at E𒅌SPPs. They offer employees shares at discounted prices, motivation to work hard for a company, and the potential advantage of the long-term capital gains tax treatmenﷺt.

The plans also offer simplicity and 澳洲幸运5官方开奖结果体彩网:liquidity with minimal administrative costs. For more information on ESPPs, contact your tax or 澳洲幸运5官方开奖结果体彩网:financial advisor, or your HR representative.