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ESPP tax treatment in the US  – what your employees need to know


It’s amazingly easy to avoid conversations about tax, even though tax itself is unavoidable. When it is talked about, it’s usually as throwaway remarks about them being too high or not high enough, but people rarely actually talk about them.

Well, let’s talk about tax. It’s important, and it also doesn’t have to be that complicated (we’re only half lying there).

When it comes to Employee Stock Purchase Plans (ESPP) and taxation in the US there are a few things you need to know, mainly so you can tell your employees about them. You don’t want people to be surprised at having to pay tax or be underwhelmed at their rewards post-taxation because they had never taken it into account in the first place.

Besides becoming a qualified tax expert, the secret to success in this area is communication. This article will cover what you need to communicate with your employees when it comes to taxation and their ESPP and how best to do it.


Tax treatment of ESPPs in the USA

At the outset, it’s important to recognize that you will need expert help when it comes to employee stock plans and ensuring they are tax compliant. There are no shortcuts here and plenty of landmines if you aren’t careful.

In saying that, you are not a qualified tax expert (although if you are – welcome) so what you need to know is the answers to the questions your employees may ask you about. In general, when we strip all the complexity away, an employee will be taxed based on four factors:

  • The length of time the stock is held
  • The price the stock is purchased at, factoring in the discount
  • The closing price of the stock on the offering date
  • The closing price of the stock on the purchase date

That’s really it. Tax and stock options boil down to the price a participant bought them at, the price they sell them at, how long they’ve held them, and any discount they may have received from their organization as part of the plan.


Qualified and Non-Qualified ESPPs

But you didn’t think it’d be that easy, did you? Before we go any further, you should know the difference between Qualified and Non-Qualified ESPPs.

A qualified ESPP is a plan which is designed and operates according to Internal Revenue Section 423 regulations. Non-qualified ESPPs are plans that do not meet the criteria outlined in Section 423 of the Code (although perfectly legal).

What does that really mean?

Well, essentially, non-qualified ESPPs are a bit more flexible in how you can design the plan whereas a qualified ESPP gives more tax benefits to the participant.

If you want to know more we talked about Qualified and Non-Qualified ESPPs before.


The importance of time


  A lot of the tax rules come down to how long the person has held (and been offered) the stock options

Let’s look at the length of time a participant holds the stock options for and what implications that has on tax. There are two big factors here – when they received the offer of shares and when they have rewarded the shares themselves.

Let’s look at what happens when a participant holds onto their options for more than one year and more than two years after they were offered the shares.

  • For qualified ESPPs, the stock that is sold at least one year after the purchase date and two years after the offering date will receive favorable tax treatment.
  • Stock sales that meet these criteria are known as ‘qualifying dispositions’.

Participants whose stock options meet the criteria to be ‘qualifying dispositions’ will pay tax in two ways:

  • The amount of discount they receive from your company on the ordinary share price is reported as ordinary income. In other words, that discount becomes part of their salary in tax terms.
  • The profit (or loss) on the share sales is classified as long-term capital gains tax.
  • Both of these tax events are triggered only in the year of the sale of the stock.

Let’s now look at what happens if a participant sells their options within one year of receiving them or within two years after the offer. These are known as ‘disqualifying dispositions’.

  • To start with the main headline, the participant will pay in line with ordinary income tax if they sell their options within one year of receiving them (or within two years of being offered them).
  • You as the employer will report it as compensation on a Form W-2, including the discount given over the ordinary share price, and the participant will have to pay taxes on that amount the same as any other monetary compensation.


The stock price itself

You’ve seen how time plays a role in taxation, but what about the stock price itself? It’s worth covering again.

  • If a participant sells their shares at least two years after the offer and one year after receiving the share options, they will receive tax benefits. These benefits will be in line with long-term capitals gains: typically, a lower rate of tax compared to ordinary income.
  • If the participant sells their share within one year of receiving the share options, they will be taxed at normal income tax rates.

So, in essence, the tax authorities will reward a participant for keeping their investments for more than one year after they receive the share options and two years after they received the initial offer.


Communicating the tax benefits of ESPPs to your employees

Communicating your IPO plans to your employees

 Good communication will both ease any worries people have and also bring more people into the conversation

The fact of the matter is that people don’t like to talk about tax, even when it can financially benefit them because it can be a dense topic to understand.

As a business leader though, non-communication is a non-starter. So, what are the techniques to use to let your employees understand their ESPP and tax implications?


Talk about the benefits, not the complications

Your overriding principle when talking about employee stock purchase plans and tax is that there are significant tax benefits to people investing in the scheme, particularly when compared to ordinary income tax. Reinforcing this message, again and again, will help cut through the complexity in people’s minds – by giving them a clear end goal and benefit, they are much more likely to engage.


Put a human face to it

It cannot be understated how important it is for you to put a human face to this. If possible, have past participants tell their story and break down what they paid in tax and why. Using everyday language and having a human face tell it leads to much greater understanding than even the best-written email.


Be humble

One of the most powerful things a leader can do is say ‘I don’t understand that, could you explain it to me?’ and this is very much the case here. Be involved in workshops and meetings, and don’t be afraid to ask the first few questions and therefore encourage others to do so.

In saying that, it’s important that you take on the role of conveying what may be a complicated message into more understandable soundbites. For this, you do need a certain level of understanding. So, before you ask questions out in the open, first ask them behind closed doors so you know the answer.


Real-life examples

Like putting a human face to it, using real-life examples is another great way to communicate the tax benefits of an ESPP. Send communications with scenarios about what might happen in a typical situation, and what would have happened over the previous years if this plan was in place.


FAQs (Myth Busting)

People will always have more questions and will also want to go over the information themselves in their own time. Creating an FAQ page is a heavy lift to create in the first place (we can help here) but will cut out a lot of confusion in the long run, as well as boosting enrolment rates. For a multinational, it might even be appropriate to create a dedicated microsite for your employee share plan for people to access and engage with.


The taxman is your ESPP-ecial friend

It’s as easy to get overwhelmed by taxation as it’s easy not to talk about it. Even senior business leaders will cry ‘leave it to the experts and not dive into the subject the way they typically would about any other part of their business.

The tax code (particularly in the US where different states have different rules) can be a cumbersome, unwieldy thing to understand and get benefit from, but any perceived gap in your knowledge will lead to nervousness amongst your people. A subject avoided is a subject that will grow into a problem.

So, make the taxman your friend because they are, especially when it comes to ESPPs.

So, if you want to speak with our ESPP consultant to understand more about the tax consequences or other details about ESPP, reach out to us now by clicking the button below.

Please Note: This publication contains general information only and Global Shares is not, through this article, issuing any advice, be it legal, financial, tax-related, business-related, professional or other. The Global Shares Academy is not a substitute for professional advice and should not be used as such. Global Shares does not assume any liability for reliance on the information provided herein.

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