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Taxation of Employee Stock Purchase Plans, Part 1 - Ep 37

Today we're going to talk in a bit more detail about the taxation of ESPps, better known as employee stock purchase plans. I've mentioned before that ESPs are my favorite form of equity compensation. This is for a few reasons, but before I jump into the reasons, just a quick reminder of what an ESPP is. In its simplest form: employee stock purchase plans allow employees to purchase company stock through payroll deductions. I did an early podcast episode focusing just on ESPPs. I think it's episode 7. You may want to go back and listen to that episode for general details on employee stock purchase plans but please overlook any audio issues. It was an early episode and some of those sound a bit echoey.

You will want to hear this episode if you are interested in...

  • How do I love thee? Let me count the ways [0:58]
  • Holding periods for ESPPs [4:50]
  • Long and short term capital gains [7:37]
  • This week’s FLASHBACK [8:58] 

A few reasons I love ESPPs

One reason I love ESPs is that it's so easy to participate. You buy company stock through payroll deduction, just like contributing to your 401k. ESPP participation is simple to set up and easy to execute. Most plans offer a discount on the stock purchase through the ESPP. The maximum discount allowed is 15% and most employers go to this maximum discount. If they offer a discount. The maximum ESPP amount you can buy this year is $25,000. The final reason that I love ESPs is that just about every full-time employee of the company is able to participate. This is unlike restricted stock awards or restricted stock units and even stock options. Those can be limited to certain employees. While it's easy to participate in an ESPP and acquire that company stock, the taxation of ESPPs can be much more complex.

Tax treatment for ESPPs

Just like accumulating assets for retirement is relatively straightforward, the distribution of those retirement assets— including ESPPs— has to be treated properly to make them last longer and to avoid tipping Uncle Sam. To get into taxes we first need to know which form ESPP option you have. ESPPS can be qualified or non-qualified. Qualified plans are more common, but non-qualified ones are simpler. 

There is no special tax treatment for non-qualified ESPPs. If you pay full price for the shares in this type of plan they're treated as if you bought them in the stock market. Nothing to report and gains and losses are treated as capital gains or losses. If you paid less to acquire the shares than their actual value at the time of the purchase, this difference is treated as compensation income. This compensation income will be reported as wages on your W-2 and there will be withholdings. 

For qualified ESPPs, there is nothing to report when acquiring the stock, even if you bought it at a discount. Additionally, there is no income on your tax return and no alternative minimum tax either. Your employer will provide you a 3922 form for the year of the ESPP stock purchase. You don't have to do anything with the form until you dispose of the shares.

This week’s FLASHBACK: Riding with rain gear

I was originally hired to work on one of the water rides at Cedar Point. Unfortunately, when I arrived, they were overstaffed and I was moved to the Jr Gemini area of the park. Truth be told I was disappointed until I realized it was me and about a dozen girls. A responsibility of Jr Gemini workers was test riding a couple of the coasters in the back of the park. For me, that meant Mine Ride and Gemini. The Mine Ride always felt like it was going to fall apart but riding the Gemini was fun and woke you up!

Jr Gemini crew chiefs had worked at the park for several summers and after a shift one of them told me to wear my full rain gear the next day. The next morning she told me to wear it even though it was a beautiful morning and once I was on the Gemini train heading up the first hill, flip the hood up, cinch it as tight as I could, and put my head down. I thought she was crazy but she told me to trust her. I'm glad I did. 

Every year during the early part of the summer, Cedar Point gets covered in Mayflies, little bugs that hatch around the lake and just cover everything. They nested on the timbers of the Gemini at night. When our test cars went through in the morning it rattled the beams and the Mayflies woke up, flew off the timbers, and we coasted through their hoards. I couldn't tell you how thick it was as I had my head down, but I saw the results afterward. When we made it back to the station, I lifted my head up to find most of my co-test riders picking Mayflies out of their hair, mouths, eyes, and all over their faces. This was in 1990 and there was big hair which apparently doubles as a great bug catcher. There was a handful of us that had good crew chiefs so we were spared. The next morning every single person had their rain gear on.

I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.