Employee Stock Purchase Plan (ESPP) Tax Rules
An Employee Stock Purchase Plan (ESPP) allows employees to purchase company stock at a discount, typically through payroll deductions. The tax rules regarding ESPPs determine how the purchase and sale of these stocks are taxed.
Under the Internal Revenue Code, ESPPs can be classified as qualified or non-qualified.
Qualified ESPPs meet specific IRS criteria, allowing employees to receive favorable tax treatment. Employees do not pay taxes on the discount when they purchase the stock. Instead, taxes are deferred until they sell the shares. Upon sale, the gain is typically subject to capital gains tax.
Non-qualified ESPPs, on the other hand, do not meet the criteria for favorable tax treatment. Employees must recognize the discount as ordinary income in the year of purchase, and any further gain upon sale is subject to capital gains tax.
Example: If an employee buys shares worth $1,000 for $800 through a qualified ESPP, they do not pay taxes on the $200 discount at purchase. If they sell the shares later for $1,200, they would then pay capital gains tax on the $200 gain.
Understanding these rules is crucial for employees to optimize their tax liabilities and benefits from their ESPP participation.
« Back to Glossary Index