2. What Is an Employee Stock Purchase Plan?
3. Some Key Dates and Definitions
4. Who Is Eligible?
5. What Determines a Tax Treatment?
6. Dispositions of Tax Treatments
7. Advantages of an Employee Stock Purchase Plan
8. Mistakes to Avoid in Managing an Employee Stock Purchase Plan


What Is an Employee Stock Purchase Plan?

An employee stock purchase plan (ESPP) is a simple form of a company run program in which employees who take part can buy company shares at a marked down price. Are you interested in gaining some extra income for those things you never seem to get around to affording such as paying off a student loan? An ESPP might be an option you want to investigate. An employee who plans on participating can conveniently contribute by using after-tax payroll deductions.

Employee stock purchase plans belong in one of two groups:

  • Qualified Employee Stock Purchase Plan - The most typical type of plan in which the rights of all participants are equal. This plan requires the go ahead by shareholders before it begins. It offers a plan no longer than 3 years, or not exceeding 27 months, and restrictions on the highest price discount may go above 15 percent.
  • Nonqualified Employee Stock Purchase Plan - This plan does not follow the same rules as qualified plans. For example, they do not have the same tax advantages of after-tax deductions as qualified plans do.

Some Key Dates and Definitions

  • Offering Period - Period in which employee must participate in ESPP. It Coincides with the grant date for the stock options plan. There are two kinds of offering periods:
    • Overlapping Period - Period in which stocks have varying purchase prices because of continuing purchase dates.
    • Consecutive Period - Period in which purchase dates occur when several purchase periods finish.
  • Purchase Period - The day the stock is bought and payroll deductions for employees commence.

Who Is Eligible?

  • Individuals who own more than 5 percent of the company stock are most often unable to take part.
  • Individuals employed for a specified duration, usually after one year, commonly have the option to take part but are not obligated to do so.

The employee must choose the sum that they intend to pay into the plan. The limit set out by the Internal Revenue Service is $25,000.00 annually despite any restrictions made by the employer. Most ESPP grant employees a price discount of up to 15 percent from its market value. The discount instantly allows employees a capital gain when the employee sells his or her stocks. Employers can set their own policies about fund withdrawals from the plan in between purchase dates or modify their levels in which they contribute.

What Determines a Tax Treatment?

The factors determining a tax treatment on the sale of an employee stock purchase plan are as follows:

  • The amount of time the stock is held.
  • The cost the stock sells for, taking the discount into consideration.
  • The stock's closing price upon offering date.
  • The stock's closing price upon purchase date.

A qualified ESPP stock held for a minimum of one year later than the purchase date and two years beyond the offering date will receive positive tax treatment.

Dispositions of Tax Treatments

There are two types of dispositions when it comes to tax treatments:

  • A Qualifying Disposition - Employees who meet the expectations for qualifying dispositions will experience two kinds of taxable income or losses reported the year the sale takes place.
    • Ordinary income - The amount of the discount assigned in the plan such as 15 percent.
    • Long term capital gain - The rest of the amount after discount used.
  • A Disqualifying Disposition - The disqualifying disposition counts a considerable amount more of its sale proceeds as ordinary income. The difference between the stock's closing price as of the purchase date and discounted purchase price as ordinary income must be counted by the seller.

Advantages of an Employee Stock Purchase Plan

An ESPP is a helpful means to motivate the workforce and provide employees with extra funds that do not come exclusively out of the company's own resources. Also, money paid into these plans are protected from social security and Medicare tax.

Some examples of what employees profiting on employee stock purchase plans have been found to spend their money on are as follows:

  • Paying off bills and debts
  • Reinvesting into things like retirement accounts
  • Using it for home improvements, buying a car, or second house
  • Adding to emergency funds
  • Paying for a wedding
  • Paying college bills or paying off student loans

Mistakes to Avoid in Managing an Employee Stock Purchase Plan

  • Allowing 'in the money' stock options to expire. An "in the money" stock option means it is trading higher than the original strike price. Putting off the trade in hopes that the company's stock price continues to go up is not a good idea as an employee may miss out on the opportunity to buy the stock at the strike price.
  • Not knowing what the stock plan rules are about when an employee leaves an employer due to a new job, layoff, or retirement. It is important that one must not leave the stock option grant behind.
  • Investing into only to one company puts the financial well-being of the employee at risk because if the company's fortune takes a turn for the worse, an employee may find themselves jobless with no health insurance and less savings in the bank.
  • Failing to update information about who the assets will go to when the employee dies. Then none of the employee's family will gain from the investment.

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