Employee Stock Purchase Plans (ESPP), can be an important benefit for clients. These programs can allow the purchase of employer stock at a discount which creates an incentive for employees to increase their ownership stake with their employer.
The tax impact upon the sale of shares within an ESPP varies based on how long the shares were held and at what price they were sold. The tax treatment depends on whether a sale is a qualifying disposition or a disqualifying disposition.
The following sections will address the tax consequences your clients will face when participating in their ESPP and map the tax calculations upon the sale of employer stock acquired through their plan.
(ESPP) Employee Stock Purchase Plan
Did you sell shares that you purchased under an Employee Stock Purchase Plan (ESPP)?
- If your answer is ‘No’ then you have no tax due until you sell the shares.
- If your answer is ‘Yes’ then …
Did you hold the ESPP shares for more than two years after the option grant date (start of the offering period) and for more than one year after the option exercise date end of the offering period? If so, then the sale is a qualifying disposition.
Was the bargain (i.e., discount given by your employer) greater than your profit upon the sale of the shares?
- If ‘Yes’, you will pay ordinary income tax on the amount that the shares’ FMV on the disposition date exceeds the amount you paid for the ESPP shares under the option.
- If ‘No, you will pay ordinary income tax on the amount that the shares’ FMV on the option grant date exceeds the option price.
Regardless, your cost basis in the ESPP shares will be adjusted to include the amount taxed as ordinary income.
Did your disposition price exceed your cost basis?
- If ‘Yes’, the difference between your disposition price and your cost basis will receive long-term capital gain treatment.
- If ‘No’, the difference between your purchase price and disposition price will receive long-term capital loss treatment.
So, if you don’t hold the ESPP shares for more than two years, the sale is a disqualifying disposition.
- Hence, you will pay ordinary income tax on the amount that the shares’ FMV on the option exercise date exceeds the amount you paid for the shares under the option.
THAT brings us to the next question…
Did you hold the shares for more than one year after the exercise date?
- If ‘Yes’, the difference between your disposition price and your cost basis will receive long-term capital gain/loss treatment.
- If ‘No’, the difference between your disposition price and your cost basis will receive short-term capital gain/loss treatment.