If your employer offers an employee stock purchase plan (ESPP), it’s important to understand how it works and how owning stock in your company can best support your long-term financial goals. Before you decide whether to participate and, if so, how much to invest in your company, make sure you understand the answers to these questions.
An ESPP allows you to purchase shares of company stock at a discount of up to 15% via a series of after-tax payroll deductions. The period during which these deductions occur is called the offering period. As money is deducted from your paycheck, it is held in escrow until it’s used to purchase discounted shares on your behalf. Some plans contain lookback provisions, which allow employees to purchase shares at 85% of its closing price either on the first day of the offering period or on the purchase date, whichever is lower.
The majority of ESPPs are Section 423 plans, meaning they meet the requirements of Section 423 of the Internal Revenue Code. If you purchase your shares through a Section 423 plan, you won’t owe any federal taxes on the discounted amount at the time of purchase. Gains (including the discount you received) are taxable when you sell the shares, either at the ordinary income rate or long-term capital gains rate, depending on how long you hold them before selling. To qualify for the lower long-term capital gains tax rate, you must hold your shares for at least two years after the first day of the offering period (also known as the grant date) and at least one year after the purchase date.
If you participate in an ESPP that does not meet the provisions of Section 423 (also known as a non-qualified ESPP), then the discount you receive on your shares is taxable as ordinary income at the time of purchase. When you sell shares, any gains that exceed the amount of the
While investing heavily in individual companies can sometimes yield great financial windfalls, it can also result in loss. Risk of loss is always important to keep in mind when considering investment choices. When your company offers you shares of its stock, you must objectively assess the risks and potential benefits that would come with owning a piece of your company. If you didn’t work there, would you consider your company a good investment? Even if the answer is no, the 15% discount may make a stock purchase a good short-term bet—particularly if know you’ll be able to sell immediately after the purchase price is set.
If you decide to move ahead, you must also determine how much of your paycheck to invest, taking into consideration your other assets and how a purchase of company shares would affect the balance of your portfolio. If your ESPP is Section 423 qualified, then your purchase will be limited to $25,000 in stock per calendar year.
Lockup and blackout periods will limit your ability to sell shares, so it’s important to have a sales strategy to decrease your position in your company over time. You may be eligible to create a 10b5-1 trading plan, which allows you to preschedule trades at times when you’re not in possession of material non-public information about your company, regardless of blackout periods. This can give you more freedom to maintain balance in your investment portfolio.
When you’re making decisions about investing in your company, comprehensive wealth management services can be invaluable. Skillfully managing investments and growing wealth requires expertise in tax, financial planning, investment strategy, and estate planning. WRP specializes in helping employees and executives in the pre-IPO phase and beyond manage and grow their wealth to build the future they desire.