Employee Stock Purchase Plan (ESPP) Taxation Explained

Employee Stock Purchase Plans (ESPPs) are a popular workplace benefit that allow employees to buy company stock at a discount—often up to 15%—through payroll deductions. While ESPPs can be a great way to build wealth and participate in your company’s growth, understanding the tax implications is key to making the most of this benefit.

What Is an ESPP?

An ESPP allows eligible employees to purchase company stock—usually every 6 months—at a discounted price. Most ESPPs are qualified plans under Section 423 of the Internal Revenue Code, which can offer favorable tax treatment if certain holding requirements are met.

How It Works:

  • You choose to contribute a portion of your paycheck to the plan (up to $25,000/year in fair market value).

  • At the end of each offering period, the company uses your contributions to buy shares—often at a discount of up to 15% off the market price.

  • Some plans offer a lookback feature, using the lower price between the start and end of the offering period to calculate your purchase price.

When Are ESPPs Taxed?

Unlike other types of equity, no tax is due at the time of purchase through an ESPP. Instead, taxes are triggered when you sell the shares. The way the sale is taxed depends on whether it’s a qualified disposition or disqualifying disposition.

Qualified vs. Disqualifying Disposition

Qualified Disposition

  • You hold the shares for at least 2 years from the beginning of the offering period and 1 year after the purchase date.

  • You pay ordinary income tax on the lesser of:

    • The discount based on the offering date price, or

    • The actual gain (sale price minus purchase price).

  • Any remaining gain is taxed as long-term capital gain.

Disqualifying Disposition

  • You sell the shares before meeting the required holding periods.

  • The discount (between FMV on purchase date and actual purchase price) is taxed as ordinary income.

  • Any additional gain is taxed as capital gain (short-term or long-term, depending on holding period after purchase).

Examples

Qualified Disposition Example:

  • Offering date price: $20

  • Purchase date price: $25

  • 15% discount applied to offering date = purchase price of $17

  • Sale price: $35

  • Ordinary income = $3 (the lesser of $20 - $17 and $35 - $17)

  • Long-term capital gain = $35 - $17 - $3 = $15

Disqualifying Disposition Example:

  • Same as above, but you sell the stock 3 months after purchase.

  • Ordinary income = $25 - $17 = $8 (FMV on purchase date - purchase price)

  • Short-term capital gain = $35 - $25 = $10

Special Considerations

No Tax at Purchase

One key benefit of ESPPs: there’s no tax due when shares are purchased—only when sold. This allows your money to grow tax-deferred.

AMT Doesn’t Apply

Unlike ISOs, ESPPs are not subject to AMT. That’s one less tax variable to worry about.

$25,000 Limit

The IRS caps the amount of stock that can be purchased under a qualified ESPP to $25,000 per calendar year (based on FMV at the offering date), regardless of whether you sell or hold the stock.

Tracking Your Basis

It’s important to track your purchase price and sale price, as well as the FMV on purchase date and offering date, for accurate tax reporting.

Planning Tips

  1. Understand your plan’s rules, especially the discount rate and lookback provision.

  2. Decide how long to hold your shares—long enough to qualify for favorable tax treatment?

  3. Plan for tax impact on sale, especially in a disqualifying disposition.

  4. Diversify if needed—don’t hold too much company stock if it exposes you to concentrated risk.

  5. Work with a CPA to understand how ESPP gains affect your overall tax situation, especially if combined with other equity like RSUs or stock options.

Key Takeaways

  • ESPPs allow you to buy company stock at a discount, typically through payroll deductions.

  • No tax is due at purchase, but taxes apply when you sell.

  • The tax treatment depends on whether the sale is a qualified or disqualifying disposition.

  • ESPPs can offer significant tax advantages if holding requirements are met.

  • Tracking and planning are key to maximizing after-tax benefits.

At Zeisei Group, we help employees and business owners make sense of complex equity compensation plans like ESPPs, RSUs, and stock options—especially for those with international or cross-border situations. Contact us for personalized guidance on your equity strategy.