An Employee Stock Purchase Plan (ESPP) is a program that enables employees to buy company stock at a discounted price through after-tax payroll deductions.
How Employee Stock Purchase Plans Work
Types of ESPPs
- Qualified 423 Plans: These plans allow employees to purchase company stock at a discount without immediate tax obligations on the discount. They often require a minimum holding period for favourable capital gains tax treatment upon selling the stock.
- Non-Qualified 423 Plans: Similar to qualified plans but do not offer preferred tax treatment by the IRS.
Participation and Limits
Employees participating in an ESPP can contribute 1% to 15% of their compensation each pay period. Contributions accumulate during an offering period, then are used to buy company stock. For qualified 423 ESPPs, IRS rules limit purchases to $25,000 annually, and no employee can own over 5% of company shares.
After purchasing shares, employees can either hold them to potentially increase in value or sell them, adhering to any plan-specific holding periods.
ESPPs and Taxes
The tax implications of an ESPP vary based on whether the plan is qualified or non-qualified. In a qualified plan, taxes are not paid on the discount at purchase but are due upon selling the shares. The sale might incur capital gains or ordinary income tax, depending on the holding period and duration of ownership. In a non-qualified plan, the difference between the purchase price and fair market value is taxed at the prevailing rate.
Benefits of Employee Stock Purchase Plans
- Offers a retirement plan option.
- Enables savings while providing access to funds.
- Potential for tax advantages.
- Enhances workforce engagement.
- Fosters a culture of company ownership.
- Attracts top talent.
- Raises capital for the company.
- Provides a global benefit offering.
- Reduces compensation expenses with potential for corporate tax deductions.
In summary, an ESPP is a beneficial program for both employees and employers, offering a unique opportunity for investment in the company, potential tax advantages, and a way to foster a strong, engaged workforce.