What is an 'Employee Stock Purchase Plan - ESPP'

An employee stock purchase plan (ESPP) is a company-run program in which participating employees can purchase company shares at a discounted price. Employees contribute to the plan through payroll deductions, which build up between the offering date and the purchase date. At the purchase date, the company uses the accumulated funds to purchase shares in the company on behalf of the participating employees.

BREAKING DOWN 'Employee Stock Purchase Plan - ESPP'

With employee stock purchase plans, the discount rate on company shares depends on the specific plan but can be as much as 15% lower than the market price. ESPPs may have a “look back” provision allowing the plan to use a historical closing price of the stock. This price may be either the price of the stock offering date or the purchase date – often whichever figure is lower.

Qualified Vs. Non-qualified Plans

ESPPs are categorized in two ways: qualified and non-qualified. Qualified plans require the approval of shareholders before implementation and all plan participants have equal rights in the plan. The offering period of a qualified ESPP cannot be greater than 3 years and there are restrictions on the maximum price discount allowable. Non-qualified plans are not subject to as many restrictions as a qualified plan. However, non-qualified plans do not have the tax advantages of after-tax deductions like qualified plans.

Important Dates

Participation in the company ESPP may only commence after the offering period has begun. This period begins on the offering date, and this date corresponds with the grant date for the stock option plans. The purchase date will mark the end of the payroll deduction period. Some offering periods have multiple purchase dates in which stock may be purchased.

Eligibility

ESPPs typically do not allow individuals who own more than 5% of company stock to participate. Restrictions are often in place to disallow employees who have not been employed with the company for a specified duration – often one year. All other employees typically have the option but not the obligation to participate in the plan.

Key Figures

During the application period, employees state the amount to be deducted from their pay to be contributed to the plan. This may be subject to a percentage limitation. In addition, the Internal Revenue Service restricts the total dollar amount to be contributed to $25,000 per calendar year. Most ESPPs grant employees a price discount of up to 15%.

Dispositions

The taxation rules regarding ESPPs are complex. In general, qualifying dispositions are taxed during the year of the sale of stock. Any discount offered to the original stock price is taxed as ordinary income, while the remaining gain is taxed as a long-term capital gain. Unqualified dispositions can result in the entire gain being taxed at ordinary income taxation rates.

RELATED TERMS
  1. Qualifying Disposition

    Qualifying disposition refers to a sale, transfer or exchange ...
  2. Stock Compensation

    Stock compensation refers to the practice of giving employees ...
  3. Non-Qualified Plan

    A non-qualified plan is a tax-deferred, employer-sponsored retirement ...
  4. Non-Qualified Stock Option (NSO)

    Non-qualified stock options are an alternate way of compensating ...
  5. Unit Benefit Plan

    A unit benefit plan is an employer-sponsored pension plan with ...
  6. Unit Benefit Formula

    Unit benefit formula is a method of calculating an employer's ...
Related Articles
  1. Personal Finance

    Don't Overlook Employee Stock Purchase Plans

    Employee Stock Purchase Plans are a benefit that shouldn't be overlooked.
  2. Personal Finance

    Employee Stock Purchase Plans Come With Certain Risks

    Those who do the following with their employee stock purchase plan put themselves in financial peril.
  3. Personal Finance

    Selling Employee Stock Purchase Plan Shares

    An in-depth look at how qualified sales of employee stock purchase plan shares work, and the tax consequences under different scenarios.
  4. Retirement

    A Guide to Employee Stock Option Plans

    Stock option plans are among the ways employers can compensate employees. Here's how they work.
  5. Managing Wealth

    Get The Most Out Of Employee Stock Options

    Stock options can be lucrative for employees who know how to avoid unnecessary taxes.
  6. Retirement

    5 Lesser-Known Retirement And Benefit Plans

    These plans aren't widely used, but they fill a specific niche for employees in certain situations.
  7. Retirement

    Is Your 401(k) Administrator Competent?

    The more that employees know about their employee 401(k) plans, the better. But what doesn't your administrator know?
  8. Small Business

    Companies That Offer Unique Employee Discounts

    These companies offer employees great discounts and unique incentives you don't find with your average employer.
RELATED FAQS
  1. How can I purchase stock directly from a company?

    There are a few circumstances in which a person can buy stock directly from a company, including direct stock purchase plans, ... Read Answer >>
Trading Center