Participating in an Employee Stock Purchase Plan (ESPP) offers many benefits. However, it's important for participants to understand the tax implications associated with ESPPs. When participants buy stock through an ESPP, the income is not taxable at the time of purchase. Instead, taxes are triggered when the stock is sold. At that point, income will be recognized either as ordinary income or as a capital gain.

What is ordinary income?

Ordinary income includes any earnings that are taxed at regular income tax rates. This typically includes wages, salaries, tips, bonuses, and similar compensation. Additionally, it can also include short-term capital gains, non-qualified dividends, and interest income.

What is capital gain?

A capital gain is the profit realized from the sale of an asset that has increased in value. In the context of ESPPs, when shares are purchased at a discount and later sold at a higher price, the difference between the purchase price and the sale price is considered a capital gain.

Tax implications to consider

To fully understand and determine tax obligations related to an ESPP, participants should consider several important factors, including:

• The discounted purchase price at time of stock acquisition
• Whether the plan is classified as qualified or non-qualified
• The length of the required holding periods

Participants should also understand how the share price at various dates, such as the offering or grant date, purchase date and sale date can impact their tax responsibilities.

Qualifying disposition and ESPP tax rules

A qualifying disposition happens when a participant sells shares at least two years after the grant date and at least one year after the purchase date. While ordinary income tax may still apply, under ESPP tax rules, taxes are typically limited to the amount of ordinary income recognized at either the grant date or the purchase date, depending on the plan's specifics.

Disqualifying disposition and ESPP tax rules

A disqualifying disposition occurs when the required holding periods are not met. In these cases, participants must pay ordinary income tax on the difference between the stock's purchase price and the market price at the time of purchase. After this point, any additional gain may be subject to capital gains tax rates. Understanding ESPP tax rules is essential for supporting the financial well-being of participants. Stay informed and contact us today to ensure you and your participants are up to date on the latest tax regulations.