Some employees that work for large companies have an employee benefit where they can purchase company stock at a discount. This is known as an Employee Stock Purchase Plan (ESPP).
How it works:
You become eligible for the plan (kind of like a grant date) and you decide how much you would like to contribute to your ESPP—usually a percentage of pay. Depending on your company plan, you start purchasing stock at a discount.
How your ESPP stock is taxed:
There are 3 dates involved that you need to know:
- Grant/eligibility date when you start participating
- Stock purchase date (this can vary-could be monthly, quarterly, semi-annually, etc)
- Sale date
There are qualifying dispositions and disqualifying positions.
- Qualifying Dispositions meet both of the following conditions
- Sale occurs 2 years or more after the grant date
- Sale occurs 1 year or more after the stock purchase date
- Disqualifying Dispositions
- Both conditions of a qualifying disposition are not met
A qualifying disposition has the most favorable tax treatment. If you hold the shares long enough to have a qualifying disposition (sale), this is how your taxes on the sale look:
Grant Price (Discounted Price that you paid): $85 Stock
Price that your Discounted price is based on: $100
- ===Bargain Element=== This is the discount you received $15 in this case; your Bargain Element is taken at ordinary income rates (no FICA taxes)
Sales Price is $125
Tax on a normal stock transaction looks like this:
Sales Price minus Purchase Price = Gain
$125 -$100 (no discount) = $25 Gain
ESPP’s are a little different
Sales Price minus Bargain Element minus Purchase Price = Gain
$125 -$15 -$85 = $25 Gain & $15 ordinary income
You still have to pay tax on the discount you received, but you are still ahead when comparing to the above example with no discount
You must keep accurate records for all of these dates and prices so they are reported correctly on your taxes and you get the full benefit of your employee benefit.
Sometimes the employer reports the bargain element in box 1 of your w2 and withholds taxes for this. Sometimes they do not and you are responsible for the reporting. For some detailed information on how to report these transactions on your tax return, TurboTax has a great article for reference.
Financial Journey LLC is a registered investment advisor offering advisory services in the state of Virginia and in other jurisdictions where exempted. Information provided is for educational purposes only and not, in any way, to be considered investment or tax advice.