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Tax Implications of Employee Stock Purchase Plans
The Employee Stock Purchase Plans (ESPP), also known as Section 423 plans, is a kind of employee stock option (ESO) that obtains a favorable tax treatment from the government. Any ESO can be an ESPP provided that the ESO meets the restrictions and requirements set forth by Section 423 of the United States Internal Revenue Code. Like any other stock option, the ESPP gives the holder of the option, in this case the employee, the right to buy shares of the company's stocks at a specified option price, within a specified period. This option price cannot be less than 85% of the stock price of the corporation at the time of grant nor the period of exercise longer than five years or 27 months, depending on the option price, from the time of grant.
Part of the ESPPs tax benefits is that there is no tax levied on the employee upon the grant of the ESPP or upon the exercise of the option. However, a tax is levied if (a) the option price is less than the current market value of the corporation's stock at the time of grant of the ESPP and (b) the stock option was sold by the employee or the employee dies while the ESPP can still be exercised. This tax shall be treated as ordinary income tax and computed from either: (1)the difference of the option price and market value of the corporation's stock at the time of grant or (2)the difference between the exercise or option price and the stock price at the time of disposition or death of the employee, whichever of 1 or 2 is lower.
Like in ISO, ESPPs will also be taxed if it is disposed within the time of the statutory holding period which is two years from the time of grant or one year from the time of exercise of the option, whichever is later. If the stocks are disposed within the statutory holding period then this is called a disqualifying disposition. If the stocks were sold after the holding period then this is called a qualifying disposition.
In a disqualifying disposition the employee faces two kinds of taxes: the first one is an ordinary income tax from the difference of the option price and the prevailing market stock price at the time of exercise and the second one is the capital gains tax computed from the amount by which the option price exceeds the proceeds of the disposition. Like in ISOs, disposition includes the sale, legal transfer, exchange or gift of the stock option or stocks.
If the stocks were disposed of after the holding period then this is a qualifying disposition and lesser tax is imposed than in a disqualifying disposition. In qualifying disposition only capital gains tax is levied on the amount by which the option price exceeds the proceeds of the disposition.
In general, employers have no tax deductions for ESPPs except when there is a disqualifying disposition by the employee. Such tax deduction by the employer will be equal to the ordinary income tax of the employee because of the ESPPs and the deduction shall happen in the year of disposition of stocks by the employee.
Part of the ESPPs tax benefits is that there is no tax levied on the employee upon the grant of the ESPP or upon the exercise of the option. However, a tax is levied if (a) the option price is less than the current market value of the corporation's stock at the time of grant of the ESPP and (b) the stock option was sold by the employee or the employee dies while the ESPP can still be exercised. This tax shall be treated as ordinary income tax and computed from either: (1)the difference of the option price and market value of the corporation's stock at the time of grant or (2)the difference between the exercise or option price and the stock price at the time of disposition or death of the employee, whichever of 1 or 2 is lower.
Like in ISO, ESPPs will also be taxed if it is disposed within the time of the statutory holding period which is two years from the time of grant or one year from the time of exercise of the option, whichever is later. If the stocks are disposed within the statutory holding period then this is called a disqualifying disposition. If the stocks were sold after the holding period then this is called a qualifying disposition.
In a disqualifying disposition the employee faces two kinds of taxes: the first one is an ordinary income tax from the difference of the option price and the prevailing market stock price at the time of exercise and the second one is the capital gains tax computed from the amount by which the option price exceeds the proceeds of the disposition. Like in ISOs, disposition includes the sale, legal transfer, exchange or gift of the stock option or stocks.
If the stocks were disposed of after the holding period then this is a qualifying disposition and lesser tax is imposed than in a disqualifying disposition. In qualifying disposition only capital gains tax is levied on the amount by which the option price exceeds the proceeds of the disposition.
In general, employers have no tax deductions for ESPPs except when there is a disqualifying disposition by the employee. Such tax deduction by the employer will be equal to the ordinary income tax of the employee because of the ESPPs and the deduction shall happen in the year of disposition of stocks by the employee.
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