Employee Stock Purchase Plans
Understand ESPP tax implications and how your Employee Stock Purchase Plan affects your taxes. Learn about qualifying vs. disqualifying dispositions, tax reporting, and how to calculate the tax on your ESPP discounts and gains.
Key Takeaways
- ESPPs let you buy your employer's stock at a discount, often up to a 15% reduction.
- You'll contribute to a stock purchase fund through payroll deductions over a set period.
- The stock is bought at the lower of the stock price at the start of the contribution period or at the time of purchase.
- Taxes on the discount are owed when you sell the stock, and the discount is taxed as regular income or capital gain depending on how long you hold the shares.
Buying company stock at a discount
Many large companies offer Employee Stock Purchase Plans (ESPP) that let you buy your employer's stock at a discount. These plans are often offered as an employment incentive, giving you an opportunity to share in the growth potential of your company's stock (and by implication, work hard to keep the stock price moving ahead).
Usually, you make contributions to a stock purchase fund for a certain period of time through payroll deductions. At designated points in the year, your employer then uses the accumulated money in the fund to purchase stock for you.
In many plans, the price that you pay for the stock is the stock price at the time you started contributing to the fund, or the stock price at the time your employer purchases the shares on your behalf, whichever is lower, with a discount of up to 15%.
- Either way, you get to buy the stock at a price that's lower than the market price.
- Your discounted price is known as the offer or grant price.
The company keeps the stock in your name until you decide to sell it. At that point you have to begin thinking about taxes.
TurboTax Tip:
ESPPs can increase your compensation from your employer by allowing you to purchase stock at a lower price than the market value and then sell it for a gain.
But what about taxes?
When the company buys the shares for you, you do not owe any taxes. You are exercising your rights under the ESPP. You have bought some stock. So far so good.
When you sell the stock, the discount that you received when you bought the stock is generally considered additional compensation to you, so you have to pay taxes on it as regular income.
- If you hold the stock for a year or less before you sell it, any gains will be considered compensation and taxed as such.
- If you hold the shares for more than one year, any profit will be taxed at the usually lower capital gains rate.
How much of the stock sale price is compensation and how much is capital gain?
That depends on whether your stock sale is a qualifying disposition or a disqualifying disposition.
Disqualifying disposition:
You sold the stock within two years after the offering date or one year or less from the exercise (purchase date).
- In this case, your employer will report the bargain element as compensation on your Form W-2, so you will have to pay taxes on that amount as ordinary income.
- The bargain element is the difference between the exercise price and the market price on the exercise date.
- Any additional profit is considered capital gain (short-term or long-term depending on how long you held the shares) and should be reported on Schedule D.
Qualifying disposition:
You sold the stock at least two years after the offering (grant date) and at least one year after the exercise (purchase date).
- If so, a portion of the profit (the “bargain element”) is considered compensation income (taxed at regular rates) on your Form 1040.
- Any additional profit is considered long-term capital gain (which is be taxed at lower rates than compensation income) and should be reported on Schedule D, Capital Gains and Losses.
Situation 1: Disqualifying disposition resulting in short-term capital gain
In this situation, you sell your ESPP shares within one year or less after purchasing them.
Example:
| Offering date: 1/01/2023 | Market price: $30 |
| Exercise (purchase) date: 6/30/2023 | Market Price: $25 |
| 15% discount | Actual cost: $21.25 |
| Actual sale date: 1/20/2024 | Market price: $50 |
| Commission paid at sale $10 | |
| Number of shares: 100 |
This is a disqualifying disposition (sale) because you sold the stock less than two years after the offering (grant) date and a year or less after the exercise date.
Because this is a disqualifying disposition, your employer should include the bargain element in Box 1 of your 2024 Form W-2 as compensation. The bargain element is calculated this way:
- Subtract the actual price paid from the market price at the exercise date
- Multiply the result by the number of shares: ($25 - $21.25) x 100 = $375
Even if your employer didn't include the bargain amount in Box 1 of Form W-2, you report this amount as compensation income on your Form 1040.
You also show the sale of the stock on your 2024 Schedule D, Part I for short-term sales because one year or less had lapsed between the date you acquired the stock (June 30, 2023) and the date you sold it (January 20, 2024).
The sales price you report on Schedule D is $4,990 and the cost basis is $2,500. Your short-term capital gain is the $2,490 difference ($4,990 - $2,500).
How did we come up with these amounts?
- The gross sales proceeds from selling the shares is the market price at the date of the sale ($50) times the number of shares sold (100), or $5,000.
- You then subtract any commissions paid at the sale ($10 in this example), to arrive at the sales price amount of $4,990 reported on Schedule D. Your broker will show this amount on Form 1099-B that you'll receive at the beginning of the year following the year you sold the stock.
- The cost basis is the actual price you paid per share (the discount price) times the number of shares ($21.25 x 100 = $2,125), plus the amount reported as income on your form 1040 (the $375 bargain element we calculated above), for a final cost basis of $2,500.
Situation 2: Disqualifying disposition resulting in long-term capital gain
In this situation, you sell your ESPP shares more than one year after purchasing them, but less than two years after the offering date.
Example:
| Offering date: 6/30/2022 | Market price: $30 |
| Exercise (purchase) date: 1/02/2023 | Market price: $25 |
| 15% discount | Actual cost: $21.25 |
| Actual sale date: 1/20/2024 | Market price: $50 |
| Commission paid at sale $10 | |
| Number of shares: 100 |
This is a disqualifying disposition because you sold the stock less than two years after the offering (grant) date.
As in the previous example, your employer should include the bargain element in your wages on your 2024 Form W-2. The bargain element is the same as in the first example ($375). You report this amount as compensation income on your 2024 Form 1040.
You show the sale of the stock on your 2024 Schedule D. It's considered long-term because more than one year passed from the date acquired (January 2, 2023) to the date of sale (January 20, 2024). That is good, because long-term capital gains are taxed at a rate that is lower than your regular tax rate.
- In this example, as in the previous one, the sales price you report on Schedule D is $4,990 and the cost basis is $2,500.
- The long-term gain is the difference of $2,490. ($4,990 - $2,500).
Situation 3: Qualifying disposition with stock price increase between offering date and purchase date
In this situation, you sell your ESPP shares more than one year after purchasing them, and more than two years after the offering date and the market price actually increased from the offering date to the exercise date.
Example:
| Offering date: 1/01/2019 | Market price: $15 |
| Exercise date: 6/30/2019 | Market price: $25 |
| 15% discount | Actual cost: $12.75 |
| Actual sale date: 1/20/2024 | Market price: $50 |
| Commission paid at sale $10 | |
| Number of shares: 100 |
This, is a qualifying disposition (sale) because over two years have passed between the offering date and the sale date, and over one year has passed between the date of purchase and the date of sale. And this time, the price per share increased from the offering date to the purchase date.
Again, your employer might not report anything on your 2024 Form W-2 as compensation. But you will still need to report some ordinary income on your 2024 Form 1040, as "compensation."
You report the lesser of:
- The gross sales price of $5,000 minus the $1,275 actual discounted price paid for the shares ($12.75 x 100) minus the $10 sales commission= $3,715, or
- The per-share company discount times the number of shares. ($2.25 x 100 shares = $225).
So you report $225 on your Form 1040 as "ESPP Ordinary Income."
You also report the sale of your stock on Schedule D, Part II as a long-term sale. It's long term because there is over one year between the date acquired (6/30/2019) and the date of sale (1/20/2024).
- The sales price reported on Schedule D is $4,990 ($5,000 gross proceeds - $10 commission).
- The cost basis is the actual price paid per share times the number of shares ($12.75 x 100 = $1,275), plus the amount that you're reporting as compensation income on your Form 1040 ($225).
- Therefore, your total cost basis is $1,500, and the long-term capital gain reported on Schedule D is $3,490 ($4,990 - $1,500).
Bottom line
Your employer is not required to withhold Social Security (FICA) taxes when you exercise the option to purchase the stock. Also, your employer is not required to withhold income tax when you dispose of the stock. But you still owe some income tax on any gain resulting from the sale of the stock.
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