An employee stock purchase plan or ESPP allows you to invest in the corporation you work for. Public companies often offer stock as a perk to reward employees for their loyal service. Learn more about what an employee stock purchase plan is and how it could benefit you, as well as the corresponding tax implications if you sell your stock.
What Is an Employee Stock Purchase Plan?
If your employer offers an employee stock purchase plan, it allows you to purchase the company’s stock with after-tax payroll deductions. Typically, the company will discount these shares by up to 15%. An ESPP may be part of your regular benefits package or part of a one-time fundraising campaign. By agreeing to purchase stocks with money withdrawn from your paycheck, you can build your stock portfolio without opening a trading account.
Are There Benefits to ESPP?
There are several benefits associated with participating in ESPP stock options. First, you receive a discount of 5 to 10%, or whatever your company offers. So, if you work at a public company with a stock price of $100, you could buy the shares for $95 (5% discount) to $85 (15% discount). You may decide to use your nest egg to take advantage of an employee stock purchase plan with a 15% discount, buying $20,000 worth of stock for $17,000 and making a profit of $3,000 without doing any work!
Find out if your ESPP has a lookback provision. This essentially freezes the price of the stock at whatever it’s selling for when your company rolls out the ESPP. If the stock appreciates during that time, you can make a significant profit just by purchasing within the lookback period stated in the offer.
Do I Pay Taxes on an ESPP?
The answer to this question doesn’t involve a simple yes or no. While you don’t pay taxes when you buy stocks under an ESPP, you’ll typically pay when you sell the stocks. Let’s look at an example, assuming that you are in the 24% tax bracket.
Ordinary Income Taxes
If you buy stocks through an employee stock purchase plan, you have to pay income taxes if you bought them at a discount. For example, if you buy shares at $90 that are trading for $100, you receive a 10% discount. Let’s say you buy 200 shares at this price for $18,000. You have saved $2,000, which counts as income. At a 24% tax rate, you’ll pay $480 in ordinary income taxes. However, to avoid paying higher ordinary income taxes on your stock sale and take advantage of Capital Gains Tax rates (outlined below), you must hold for 1 year, under a Section 423 ESPP from the purchase date and more than two years from the grant (or enrollment) date.
Capital Gains Taxes
Most ESPP plans have a lookback period. Under this provision, you can purchase the stock at the market rate on the purchase date or pay the price of the stock at the time the ESPP plan is launched.
If the offering price is lower than the current trading price, you can choose to pay that amount. For example, stocks are currently trading at $150 per share but were worth $130 per share at the time of the offering. You wisely opt to pay $130 per share, saving $20 for each one you buy. If you sell the shares for $160 later, you make a profit of $30 per share. Let’s say you buy 100 shares, making a capital gains profit of $3,000 ($30 x 100).
Most likely, you’ll pay a capital gains tax of 15% or $450 on the sales. On the other hand, if you sell the stocks at a loss, you can deduct that on your taxes via Schedule D. A federal tax bracket can be found on www.IRS.gov
Note that you don’t have to pay Medicare or Social Security taxes on ESPP plan gains.
Where Are ESPP Purchases Reported?
If you sell your ESPP shares, your employer will usually report your ordinary income profit on your W2. However, if your employer does not report it on your W2, you have to claim the income on your 1040 under other income.