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Is An Employee Stock Purchase Plan (ESPP) Flying Beneath Your Radar?

Oct. 25, 2013
Employee Equity, Investing
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By Lyman Howard, CFP, CFA

Learn more about Lyman on NerdWallet’s Ask an Advisor

I don’t have an ESPP at work, but if I did, I’d be maxing it out! Do you work for a large company with a publicly traded stock? If you haven’t done so already, talk with the payroll department about any Employee Stock Purchase Plan (ESPP). If the following features are allowed in the plan, you should definitely consider participating.

Ask the following questions:

  • Is the plan an Internal Revenue Code Section 423 Qualified ESPP Plan?
  • Can shares be purchased at a 15% discount?
  • Is there a “lookback” period?
  • Are same day sales permitted?

If the answers are “yes” to all, things are looking good! Your employer is providing this benefit as a way to encourage long term participation in the fortunes of the company which is different than awarding stock options. In an ESPP, an employee has payroll deductions (after-taxes) set aside over a 6 month offering period. At the end of that period, your money is used to purchase company shares at a 15% discount to the market price, or else a 15% discount to the price at the beginning of the period, whichever is lower (that’s the “lookback”, which works in your favor). If the stock climbed during the preceding 6 month offer period, you buy at 15% below the lower beginning price, realizing 15% plus the gain over the period. Even if the stock price dropped during the period, you still buy it 15% below today’s price and then immediately sell it at today’s price for a gain.

You can choose to continue holding your stock for a minimum period (at least a year from purchase and two years from offering period) if you like, to get “qualified” capital gains treatment, but you should instead sell your shares the very day you purchase them, reaping the discount immediately. That little profit you make will be taxed on your W-2 as ordinary income, and you can then “reload” at the next offering period.

The company will max out your payroll deductions at 10% of your salary. Still, with a $100,000 annual salary you can buy $5,000 worth of stock over six months, and therefore gross a minimum $750 per period. You can do this twice per year. It takes some discipline and attention to detail to ensure that you sell immediately after you purchase, but your payroll department might be able to help you to automate the process. There are reasons not to participate, indeed. If you simply cannot survive without the cash from your paycheck, you won’t be able to participate. Also, if you have huge exposure to your company via stock options already, you might not want to add even more exposure through these additional stock purchases. Absent those caveats, however, opportunity knocks!

Be sure to check in with your tax adviser about ramifications to your individual situation. Your company also might not be as generous with terms as allowed, so get all details before taking action.