With employee stock purchase plans (ESPPs), you’re allowed to buy company shares at a discounted price. When you purchase and sell your shares, there are a number of US ESPP tax rules you need to know so you can plan ahead to make the most out of the plan and maximize your tax savings.
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What does an employee stock purchase plan mean?
An employee stock purchase plan (ESPP) is a broad-based stock plan that allows participating employees to purchase company stock at a discount – often 5%-15% off the fair market value (FMV).
When you decide to enroll in the plan, you make contributions via payroll deductions. The accumulated contributions are then used to purchase stock in your company at the purchase date (i.e. the end of the purchase period).
ESPP tax implications
First, you have to know there are two types of ESPP – non-qualified and qualified. The main difference between them is that a qualified plan qualifies for preferential tax treatment while a non-qualified one provides flexibility in plan design.
Non-Qualified ESPP
Non-qualified plans do not meet the criteria outlined in Section 423 of the Code. It is more flexible in how you can design the plan, e.g. no ESPP discount limit.
You will need to pay tax on ordinary income at the time of purchase, and on capital gain/loss at the time of sale. This plan’s taxation is more straightforward than the qualified plan (See the table below).
- Ordinary income: The difference between the FMV of the stock at purchase and the amount you paid (i.e. purchase price)
- Capital Gain/Loss: Sales price minus FMV on purchase date
If the sales price is less than the FMV at purchase, then it’ll be a capital loss. If the sales price is greater than the FMV, then it’ll be a capital gain. This gain/loss can be either short-term or long-term depending on the holding period.
Qualified ESPP
Qualified plans are designed and operate according to Internal Revenue Section 423 regulations, resulting in a favorable tax treatment for participants, e.g. you won’t need to pay tax until you sell your ESPP shares. At the time of sale, you’d pay taxes depending on whether the sale of ESPP shares is a qualifying disposition or a disqualifying disposition.
Here are the differences in the tax consequences of non-qualified and qualified ones:
– | Non-Qualified plan | Qualified plan |
|---|---|---|
At grant | No tax event | No tax event |
Employee’s contributions | Made with after-tax dollars | Made with after-tax dollars |
At purchase | Ordinary income tax | No tax event |
At sale | Taxable capital gain (or loss):
Classified as long-term capital gains if held over 1 year from purchase date | Taxable ordinary income and/or capital gain(or loss)
[The calculations depend on the type of disposition. See below] |
Qualifying disposition vs. disqualifying disposition
There are two classifications of sales for qualified ESPPs: qualifying and disqualifying dispositions. As their tax rules are quite different, qualified ESPPs become more complicated than non-qualified ones.
Whether it’s a qualifying disposition or disqualifying disposition, taxation is deferred until sale. When you sell your ESPP shares, both ordinary income and capital gain/loss may be recognized.
Qualifying Disposition Scenario
A qualifying disposition (QD) can occur if you ensure
- a two-year holding period from date of grant (i.e. offering date) AND
- a one-year holding period from date of purchase
Ordinary income and capital gain/loss may be recognized when the stock is sold:
- Ordinary income [Element A]: The lesser of:
– A) The difference between the FMV of the stock at grant and the purchase price OR
– B) The actual gain (i.e. sales price minus purchase price)
Note: If the sales price of the stock is worth less than the purchase price, ordinary income tax is not applicable. - Long Term Capital Gain/Loss: Sales price minus Cost Basis [Purchase Price + Element A]
No income or social tax withholding is required on the ordinary income but the ordinary income will be reported on Form W-2 for the year of sale.
Disqualifying Disposition Scenario
A disqualifying disposition (DD) can occur when you sell the stock:
- Less than one year after date of purchase OR
- Less than two years after date of grant (i.e. offering date)
Ordinary income and capital gain/loss may be recognized when the stock is sold:
- Ordinary income: The difference between the purchase price and the FMV on the purchase date
- Capital Gain/Loss: Sales price minus FMV on purchase date
If the stock was held more than one year from the purchase date, the capital gain/loss is long-term and results in a favorable long-term capital gains tax treatment.
No income or social tax withholding is required on the ordinary income but the ordinary income will be reported on Form W-2 for the year of sale.
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Tax scenarios are based on the CEPI GPS-ESPP publication (2019 edition). All case studies are shown for illustrative purposes only, and are hypothetical. Any name referenced is fictional. Information is not a guarantee of future results.
JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal and accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transaction.
