Employee Stock Purchase Plan Tax: How ESPP Taxes Work
ESPP taxes depend on your purchase discount, your profits from selling the shares and how long you held the shares.
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Investing in your company’s stock through an employee stock purchase plan (ESPP) can be a valuable workplace benefit that boosts your compensation. But ESPPs come with their own set of tax rules.
ESPP taxes generally consist of taxes on profits from the sale of shares you purchase through the ESPP, as well as taxes on the price discount you may have received through the ESPP when you bought the shares.
You’ll have to report any ESPP-related income in your annual tax return. Understanding how ESPPs are taxed may help you make smart choices with your investments — and avoid any surprise tax bills.
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How ESPP taxes work
ESPP taxes can be complex because there are so many factors to account for. The first is whether you’re enrolled in a qualified plan.
Qualified ESPPs have to meet regulatory requirements, which unlocks certain tax advantages described below. Participants in qualified plans typically won’t owe any taxes until they sell their shares.
Non-qualified ESPPs have more flexibility but don’t provide the same tax benefits. Typically, participants in non-qualified plans owe taxes on the discount they receive at the time the ESPP purchases the shares. Then, they owe taxes on any gains they earn when they sell their shares.
For qualified plan participants, your ESPP taxes depend on three key pieces of information.
1. The discount you got on the price of your company’s stock
The discount is the difference between the fair market value of the stock and the price you paid for it. For example, if your ESPP provides a 15% discount on stock purchases and the stock is trading at $15 per share on the day of the purchase, you get to buy the shares for $12.75, for a discount of $2.25 per share. If you bought 100 shares, your total discount was $225.
The discount ($225, in this example) is usually taxed as ordinary income, which means it’s taxed at your marginal income tax rate.
But there’s a caveat: The discount that’s used to determine your tax liability may differ from the discount you actually received. That’s because the share price that is used to calculate your discount for tax purposes could be either the price of the stock on the offering date or the price of the stock on the purchase date. And which one is used will depend on how long you held the stock. More on that below.
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If your ESPP has a “lookback” feature, the price you pay (and receive a discount on) could be either the market price on the offering date or the market price on the purchase date — whichever is lower.
2. How much you sold the stock for
If the stock increased in value after you purchased it, you may owe taxes on the gain (the profit) when you sell the shares. (Alternatively, if the value decreased, you may be able to deduct the loss on your taxes.) The gain is the difference between what you paid for the stock and what you got from the sale.
Picking up our previous example, let’s say you decide to sell those shares when the price reaches $20 (up from $15 on the purchase date). Your capital gain is $5 per share, or $500 for 100 shares.
The actual capital gains tax rate you pay depends on how long you’ve held the stock (more on that below), as well as your tax-filing status and other taxable income.
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3. How long you’ve held the stock
When you sell, your ESPP taxes may depend on whether you meet two holding-period requirements:
You held the stock for at least a year. The one-year mark is based on the purchase date, which is the day the ESPP used your accumulated contributions to buy the stock.
It’s been two years or more since the offering date. The offering date is the start of your plan’s offering period. It may also be called the grant date or the enrollment date.
If you meet both holding-period requirements, the IRS typically considers the sale a qualifying disposition, and you may get a more favorable tax treatment.
Your discount is calculated based on the offering date or the purchase date stock price — whichever is lower. It’s considered ordinary income and taxed at your marginal tax rate.
Your gain is taxed at the typically lower capital gains tax rate.
If you don’t meet both holding requirements, the IRS considers the sale a disqualifying disposition, and your tax liability changes.
Your discount is calculated based on the purchase date stock price. If the stock price on the purchase date was higher than the stock price on the offering date, it may mean a larger portion of your income is taxed at the marginal tax rate.
Your gain could be taxed as ordinary income unless you’ve held the stock for more than a year (meeting the first of the two holding period requirements). If you have, it’ll be considered a long-term capital gain that’s typically taxed at a lower rate.
Understanding ESPP taxes
Understanding how time affects tax rates can be complicated, so here’s another way of looking at it.
Discount tax treatment | Gains tax treatment | |
|---|---|---|
Disqualifying sale, short-term capital gains | What gets taxed: The difference between the discounted price you paid and the stock price on the ESPP purchase date. Tax rate: Ordinary income. | What gets taxed: The difference between the fair market value of the stock on the purchase date and what you got from the sale. Tax rate: Short-term capital gains. |
Disqualifying sale, long-term capital gains | What gets taxed: The difference between the discounted price you paid and the stock price on the ESPP purchase date. Tax rate: Ordinary income. | What gets taxed: The difference between the fair market value of the stock on the purchase date and what you got from the sale. Tax rate: Long-term capital gains. |
Qualifying sale | What gets taxed: The difference between the discounted price you paid and the stock price on either the ESPP offering date or the ESPP purchase date — whichever is lower. Tax rate: Ordinary income. | What gets taxed: The difference between the fair market value of the stock on the purchase date and what you got from the sale. Tax rate: Long-term capital gains. |
