How the Employee Stock Purchase Plan -ESPP – Works for You

by Investing School on January 7, 2013

One of the potentially most profitable options for an employee is the employee stock purchase plan or ESPP. An employee stock purchase plan allows a company to offer its employees stock at a discounted price. The discount can be up to 15% of the market price when the offer is made. Contributions are made from the individual’s pay and the stock purchased on a specific date. How long the employee holds their stock will determine whether the purchase is eligible for tax-advantaged treatment.

The IRS restricts stock purchase plans with tax and security laws. For example, an employee must hold their stock for at least 1 year after the purchase, or 2 years after the option is granted, if they want to enjoy the tax-advantaged status. If the employee sells back their stock it is usually exempt from transaction fees. This is called a qualifying disposition. Since such sales are usually fairly small no paperwork needs to be filed during such transactions, which is another perk.

If employees are given the opportunity to purchase stock at a specific price for a certain period it is called a stock option ownership plan. These arrangements are fairly common for new businesses. The option for stock is given instead of a higher salary. Owning stock in the company gives the employees additional incentive to help the company succeed.

Options are exercised at the employee’s discretion. If the price of the stock exceeds the price offered, the employee will most likely make the purchase. If stock is offered in place of salary then the difference between the option price and the selling price will be taxed as earned income upon sale.

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