Employee stock purchase plan (ESPP)

A workplace program that lets employees buy company stock through payroll deductions, often at a discount to the market price.

What it means

An employee stock purchase plan collects after-tax payroll deductions over an offering period, then uses them to buy company shares on set purchase dates. Many plans offer a discount of up to 15%, and some include a lookback, which applies the discount to the lower of the share price at the start or the end of the offering period.

Qualified plans, known as Section 423 plans, offer favorable tax treatment if shares are held at least two years from the start of the offering period and one year from the purchase date. Selling sooner is a disqualifying disposition, and the discount is taxed as ordinary income. Even in a qualifying sale, part of the gain tied to the discount is generally taxed as ordinary income, with the rest treated as a capital gain.

Example

Suppose the stock is $50 at the start of an offering period and $60 at the end, and the plan has a 15% discount with a lookback. Shares are bought at $42.50. An employee who contributed $10,000 receives about 235 shares worth about $14,100 at the market price.

How it’s used

Adding to savings through automatic payroll deductions
Earning a built-in discount on employer stock
Planning sale timing for tax purposes

Strengths and weaknesses

Strengths

Discount can provide an immediate gain
Lookback provisions can increase the benefit when prices rise
Easy, automatic contributions

Weaknesses

Concentrates savings and job income in one company
Share prices can fall below the purchase price
Tax rules for qualifying and disqualifying sales are complex
Payroll deductions reduce take-home pay during the offering period

Good to know

Some employees sell ESPP shares soon after purchase to lock in the discount and avoid holding too much employer stock.

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.