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November 17, 2022



Understanding Employee Stock Purchase Plans (ESPP)

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An employee stock purchase plan, or ESPP, is an employee benefit offered by many large companies that allows an employee to purchase company stock via payroll deductions. Most companies that offer an ESPP allow you to purchase shares at a discounted price.

Some publicly traded companies offer employee stock purchase plans as a way to let employees enjoy the success of the company as a whole through discounted shares. The discount varies based on each company, but often ranges between 5-15%. ESPPs are offered as a compensation benefit and are often confused with Restricted Stock and Employee Stock Options.

While ESPPs are a great way to build wealth over time, it is important to understand the basics of how ESPPs works, what the benefits may be, and what you should think about from a tax perspective.

How Do Employee Stock Purchase Plans Work?

ESPPs gives employees the ability to purchase discounted shares of stock through their payroll. Before opting into any savings plan, it is important to understand the details of your specific plan. The details can often be obtained via a plan document that can be provided by HR. Once you read the plan document and enroll in the plan, you can begin making contributions to your ESPP through payroll deductions using after-tax dollars.

When you enroll, your company begins taking contributions from your paycheck until the last day of the current purchase period. At that point, the company uses the funds to buy company stock on your behalf. In most cases, you can contribute anywhere between 2 percent and 15 percent of your salary, or up to $25,000 per year. Depending on the terms of your plan, there might also be a minimum contribution.

When your shares are purchased, they’re usually deposited into a brokerage account. Once the shares are deposited in your account, they can be treated like any other stock/investment you own. Unlike Restricted Stock, there is no vesting period for when you can sell the stock.  

I Enrolled in My ESPP, Now What?

There’s typically an enrollment period, and during this time you can decide how much company stock you want to purchase. Most companies provide a 12-month or an 18-month offering period. That includes a couple of 6-month purchase periods. Employers can give plan participants an advantage on price compared to buying those same shares on the open market. Specifically, they can offer one or both of the following:

– A discount from fair market value

– A look-back provision

To determine exactly how your ESPP works, check your plan document.

If yours offers a discount from the fair market value, then it might allow you to buy shares at a lower price than what you can on the open market. For example, if you can buy shares at a 10% discount you can buy company stock worth $50 at $45 a share.

Some companies make the ESPP even more attractive by doing more than just offering discounted stock. Some plans offer what’s called a lookback provision.

That lets you choose to buy the company’s stock based on its closing price on the first day of the offering period or the last day of each purchase period — whichever is lower. If you have a look-back provision, things get a little more complicated, but can offer a much better value in the long run

To understand how this works, say the fair market value (FMV) of the stock price on the purchase date is $50. We then need to “look back” at the FMV on the offer date to see which FMV is lower. Let’s assume the FMV on the offer date was at $40 per share. On the purchase date of the stock, you can buy shares through your ESPP at the lower of the two prices (in this example, that would be $40 per share). Not only would you get the lower of the two prices, you ALSO getthe 10% discount! In this case, that would mean purchasing the stock at $36 per share, as opposed to the current market value of $50 per share. A total discount of 28% in this example.

If the fair market value of the stock goes down in value between the offer date and the purchase date, the plan participants would buy shares at the purchase date price, as illustrated below:

How Do Taxes Work with My ESPP?

Buying company stock through an employee stock purchase plan requires after-tax dollars. Therefore, you pay nothing in taxes when you purchase stock.  You also use after-tax dollars to make the purchase.

Taxes come into play when you sell the stock. Upon selling the stock it is possible that you will owe ordinary income taxes on the total amount of gain. This would be the difference between the discounted purchase price and the fair market value as of the date of sale (assuming you are selling at a gain).

How much you owe in taxes will depend on whether the stock sale is a qualifying disposition or a disqualifying disposition.

What Is a Qualifying Disposition?

A qualifying disposition of stock from an employee stock purchase plan must meet the following criteria:

1. The stock must have been held for at least one year from the original purchase date.

2. The stock must have been held for at least two years from the original offer date.

If your situation meets these criteria, the discount received will be taxed as ordinary income, and the gain in excess of the discount will be capital gains.

Depending on your tax bracket, this could be a significant savings in taxes due.

Continuing our example from above, we have added a line for final sale price:

Offer DatePurchase DateLookback Price10% ESPP Discounted PriceFinal Sale Price$40$50$40$36$100

Assuming that the final sale transaction meets the standards for qualifying disposition, the taxes can be calculated as followed.

The amount taxed as ordinary income: $40 x 10% =

$4 per share

The amount taxed as capital gains: $100 – $40 =

$60 per share

If we assume a 33% tax bracket for ordinary income and a 15% tax bracket for capital gains, we can calculate the tax impact to be

Ordinary Income Tax – $4 x 33% = $1.32 per share

Capital Gains Tax – $60 x 15% = $9 per share

Total Taxes = $10.32 per share

What Is a Disqualifying Disposition?

A disqualifying disposition is anything that does not meet the criteria discussed above. Meaning that one of two things happened…

The stock was sold within one year from the original purchase date.


The stock was sold within two years from the original offer date.

With a disqualifying disposition, the entire gain will be taxed as ordinary income.

Looking back on the example above, we can determine the tax impact

The amount taxed as ordinary income:

$100 – $36 = $64 per share

Assuming the same 33% tax bracket as above, we can calculate the tax impact.

$64 x 33% = $21.12 per share.

As you can see, by selling the shares early you could pay nearly twice the amount in taxes. The benefit of paying less in taxes does come with a trade-off. Holding on to the stock long enough to become a qualified disposition leaves you exposed to potential volatility and depending on your overall portfolio, you could be more overweight in company stock than desired.

Should I Participate in My Employee Stock Purchase Plan?

Participating in your ESPP can be a great way to build wealth. As with all investing, there is always the risk of losing money. ESPPs give more flexibility by making it easier to cash out as opposed to other benefit programs like restricted stock or employee stock options.

Even with the increased flexibility and the potential discount received, there are a number of things to keep in mind before participating.

How does the ESPP fit into you long term financial plan as well as your ongoing budget? Purchasing stock in and ESPP requires the money to come out of your payroll. Do you have the cash flow to afford buying the stock? As with all investing, there is no guarantee that even with the discount you will make money. Are you comfortable with the risk and volatility?

As with most financial decisions, there is not one blanket yes or no that is appropriate for everyone. It is important to forecast your financial plan with and without participating in your ESPP. From this analysis you can determine the best outcome for your particular situation.

Registered Representative of Sanctuary Securities Inc. and Investment Advisor Representative of Sanctuary Advisors, LLC.– Securities offered through Sanctuary Securities, Inc., Member FINRA, SIPC. –  Advisory services offered through Sanctuary Advisors, LLC., an SEC Registered Investment Advisor. – Theorem Wealth Management is a DBA of Sanctuary Securities, Inc. and Sanctuary Advisors, LLC. This communication has not been reviewed for completeness or accuracy, does not necessarily reflect the views of Sanctuary Securities, Inc. or Sanctuary Advisors, LLC., and is not a recommendation or endorsement of any product, service, or issuer. Third party posts do not reflect the views of Theorem Wealth Management or Sanctuary Securities, Inc. or Sanctuary Advisors, LLC., and have not been reviewed for completeness and accuracy. All further communications from this representative must be sent from and received by johnathan@theoremwm.com. For additional information, please refer to one of the following consumer websites: www.FINRA.orgwww.SIPC.org.

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