Employee Stock Purchase Plans

Get tax information about how your employee stock purchase plan can impact your taxes.

Many
large companies offer Employee Stock Purchase Plans (ESPP) that let you
buy your employer's stock at a discount. These plans are offered as an
employment incentive, giving you an opportunity to share in the growth
potential of your company's stock (and by implication, work hard to
keep the stock price soaring).

Usually, you make contributions to
a stock purchase fund for a certain period of time through payroll
deductions. At designated points in the year, your employer then uses
the accumulated money in the fund to purchase stock for you.

In
many plans, the price that you pay for the stock is the stock price at
the time you started contributing to the fund, or the stock price at
the time you purchased the shares (whichever is lower), with a discount
of up to 15 percent. Either way, you get to buy the stock at a price
that's lower than the market price. Your discounted price is known as
the offer or grant price, because your employer has offered it to you,
or granted it to you.

The company keeps the stock in your name until you decide to sell it. At that point you have to begin thinking about taxes.

When
the company buys the stocks for you, you do not owe any taxes. You are
exercising your rights under the ESPP. You have bought some stock. So
far so good.

When you sell the stock, the discount that you
received when you bought the stock is generally considered additional
compensation to you, so you have to pay taxes on that as regular income.

Also,
depending on when you were granted the right to purchase the stock (the
grant date), and how long you have held the stock, any profit that you
make, over and above the compensation, may be considered a long-term
capital gain, which can be taxed at lower rates than the compensation.

If
you've participated in one of these plans, you probably know how it
works. Come tax time, though, trying to figure out how to report the
stock you sold through your plan can be daunting. You may wonder what
gets reported and where on your return.

That
depends on whether your sale of the stock is a "qualifying disposition"
or a "disqualifying disposition." Selling the stock is thought of as
disposing of it, but the question is, what makes the sale qualify as a
capital gain, at least in part?

• Qualifying Disposition:
  You sold the stock at least two years after the offering (grant date)
  and at least one year after the exercise (purchase date). If so, a
  portion of the gain is considered ordinary income and will need to be
  reported as earned income on your Form 1040 as "compensation." Any
  additional gain is considered capital gain and should be reported on
  Schedule D, Capital Gains and Losses. (The capital gain rate is usually
  less than the rate you pay on ordinary income.)


• Disqualifying Disposition:
  You sold the stock within two years or less after the offering (grant
  date) or within one year or less from the exercise (purchase date). In
  this case, your employer will report the bargain element as
  compensation on your Form W-2, so you will have to pay taxes on that as
  ordinary income. The bargain element is the market price at the
  exercise date minus the actual price you paid for the stock, multiplied
  by the number of shares. Any additional gain is considered capital gain
  and should be reported on Schedule D.

In this situation, you sell your ESPP shares within one year of purchasing them.

Example:

This
is a disqualifying disposition (sale) because you sold the stock less
than two years after the offering (grant) date and you sold the stock
less than a year after the exercise date.

Because this is a
disqualifying disposition, your employer should include the bargain
element in Box 1 of your Form W-2 as compensation. The bargain element
is calculated this way:

1. Subtract the actual price paid from the market price at the exercise date


2. Multiply the result by the number of shares: ($25.00 - $21.25) x 100 = $375.00.

Even
if your employer didn't include the bargain amount in Box 1 of Form
W-2, you must add this amount to line 7 on the Form 1040.

You
must also show the sale of the stock on Schedule D, Part I for
short-term sales because there was less than one year between the date
you acquired the stock (6/30/2004) and the date you sold it (1/20/2005).

The
sales price you report on Schedule D is $4,990.00 and the cost is
$2,500.00. Your net gain is the difference between these two, or
$2,490.00.

How did we come up with these amounts?

The sales
price is the market price at the date of the sale ($50.00) times the
number of shares sold (100), or $5,000.00. You then subtract any
commissions paid at the sale ($10.00 in this example), arriving at
$4,990.00. Your broker will show this amount on Form 1099-B that you'll
receive at the beginning of the year following the year you sold the
stock.

The cost is the actual price you paid per share (the
market price times the discount) times the number of shares ($21.25 x
100 = $2,125.00), plus the amounts already included in your W-2 (the
$375.00 bargain element we calculated above), for a final cost of
$2,500.00.

Because your sale did not qualify, you must pay taxes
on your net gain ($2,490.00) at your regular tax rate, rather than the
lower rate available for long-term capital gains.

In
this situation, you sell your ESPP shares more than one year after
purchasing them, but within two years of the offering date.

Example:

This
is a disqualifying disposition because you sold the stock less than two
years after the offering (grant) date. As in the previous example, your
employer should include the bargain element in your wages on Form W-2.
The bargain element is the same as in the first example ($375.00). You
must add this amount to line 7 on the Form 1040.

You must also
show the sale of the stock on Schedule D, Part II for long-term sales.
It's considered long-term because more than one year passed from the
date acquired (1/01/2006) to the date of sale (1/02/2007). That is
good, because long-term capital gains are taxed at a rate that is
usually lower than your regular tax rate.

In this example, as in
the previous one, the sales price you report on Schedule D is
$4,990.00, and the cost basis is $2,500.00. The net gain is the
difference of $2,490.00.

In
this situation, you sell your ESPP shares more than one year after
purchasing them, and more than two years after the offering date, and
the market price decreased during the period from the offering date to
the exercise date. You have a qualifying disposition here.

Example:

This
sale is a qualifying disposition because over two years have passed
between the offering date and sale date, and more than one year has
passed between the date of purchase and the date of sale. But the price
per share decreased from the offering date to the purchase date.

Because
this is a qualifying disposition, your employer may not report anything
on your Form W-2. But you need to report some ordinary income on line 7
on the Form 1040, as "compensation". You report the lesser of:

• The
  sales price per share minus the actual price paid per share times the
  number of shares. ($50.00-$21.25) x 100 shares = $2,875.00, or


• The
  offering price per share times the company discount, if any, times the
  number of shares. ($35.00 x .15) * 100 shares = $525.00

You report $525.00 on line 7 on the Form 1040 as "ESPP Ordinary Income".

Report
the sale of your stock on Schedule D, Part II, as a long-term sale.
It's long term because there was over one year between the date you
acquired it (6/30/04) and the date you sold it (1/02/2007).

For
reporting on Schedule D, the sales price is $4,990.00, and the cost
basis is $2,650.00. The net gain is the difference of $2,340.00.

The
sales price is computed as in the previous examples. The cost, however,
is the actual price paid per share times the number of shares ($21.25 x
100 = $2,125.00) plus the amount ($525.00) that you're reporting on
Form 1040. Thus, your total cost is $2,650.00.