Employee Stock Purchase Plan (ESPP) shares are an excellent way for you to invest in the stock of your publicly traded company. You are able to buy discounted shares of your company’s stock paid for through payroll deductions you select over a certain period of time. The company purchases these shares at a discount for you. There are 5 terms you need to know when you consider participating in your company’s ESPP.
This is the period of time between when your company starts your payroll deductions and when they purchase the shares of stock for you. You start your payroll deductions at the beginning of the offering period. Your company will take the percentage you have chosen from each check and compile each deduction during the offering period. At the end of the offering period your company will purchase your shares of stock with your contributions. Offering periods can vary depending on your plan – often they are 3 – 6 months long.
The discount is the difference between the price you pay for a share of stock and the price the public pays for the same share of stock. The discount is taken off the lower of (a) the price of the shares on the first day of the offering period or (b) the price of the shares on the last date of the offering period. Alternatively some plans take the discount off the average stock price during the offering period. The maximum discount your company can offer you is 15% per share. The actual percentage can vary by plan, but 15% is the most common discount I see.
- Example: Let’s say your company’s stock is priced at $30 on the first day of the offering period and $40 on the day your company purchases your shares. The 15% discount will be taken off the $30. You will pay $25.50 per share.
In order to receive the best tax treatment when you sell your ESPP shares you want to meet the holding period requirements to ensure you are making a Qualified Distribution (see definition below). You meet the holding period requirement’s on the later of the following dates:
- The date 2 years after the first day of the offering period.
- The date 1 year after you purchased the stock.
If you meet the holding period requirements then when you sell your ESPP shares you will be making a qualified distribution. If you sell your shares before meeting the holding period requirements then you will be making a non-qualified or early distribution. You will generally pay higher taxes on early distributions. Next week we will go into further details on the tax consequences of selling ESPP shares.
You will receive Form 3922 when you purchase ESPP shares. It is crucial that you keep this form as it provides the information you will need when you sell your shares and report the income and gains on your tax return. Form 3922 includes your offering period details, which you need to calculate your holding period. It will show you the discount you received by showing the price you paid and the fair market value the date your stock was purchased.
Next week we will discuss the tax consequences when you sell your ESPP shares.
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