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Written on June 6, 2008 – 6:30 am | by PT | |

I recently started participation in my company’s Employee Stock Purchase Plan (ESPP). 

I think it’s an excellent idea, and hope to sell the stock as soon
as it’s purchased at the end of the 6-month term (called “flipping” the
ESPP). 

Then, I’ll use the ESPP stock funds to pay our property taxes,
due early 2009.  It’s basically replaced my property tax savings fund. 
Below, I present a bit more information on the ESPP, an example, and
tips on making the most of your ESPP.

What Are Employee Stock Purchase Plans?

An ESPP is a benefit that a company will offer up to employees. 
They are basically an opportunity for the employee to purchase company
stock at a discount price, up to 85% of the price of the stock.  They
do this (give you stock at a discount) simply to create incentive for
you to work hard for the company and keep you around for a while.

The way the plan is typically funded is by automatic with-holdings
from the employee’s paycheck at a percentage of your income (usually 1%
to 10%).  The funds are withheld until a certain term is met, typically
3, 6, or 12 months.  At that time, the funds are used to purchase your
company stock. 

At what price is it purchased?  Typically, the purchase price is the
price the stock was at the time you started contributing to the fund
(grant date), or the stock price at the time you purchased the shares
(whichever is lower), less that 15% discount.  You can then sell or
hold the stock.

Tax Implications of an ESPP

Your contribution to the ESPP are typically withheld from your
paycheck AFTER-tax.  Therefore, there are no tax effects to the
contribution to the plan.  Once the period ends and the shares are
purchased, you simply own the stock…no tax effect there either.

It’s when you sell the stock that you are required to pay taxes. 
If, when you sell the stock, it’s been less than a year since you
purchased the stock, it’s called a “disqualifying disposition” and your
employer will simply list the gain of the sale on your Form W-2 as
ordinary income.  If it’s been more than a year, more complex rules
apply.  Since I won’t be doing that, I’ll let you do the research. 

Example of an ESPP

Let’s look at an example ESPP transaction using the following factors:

• Term: 6 Months


• Discount: 15%


• Contribution: 10% of Salary (After-Tax)


• Annual Income: $50,000


• Stock Price at Grant Date: $30/share


• Stock Price at Purchase Date: $35/share (c’mon, let me dream big!)


• Strategy: Flip or Quick Sale

Example:

The Purchase

$25,000 (6 mo. of income) x .10 (contribution) = $2,500

$30 (”lowest of” share price) x .85 (1 - discount) = $25.50

$2,500 / $25.50 = 98.04 shares of stock

The Sale

98.04 x $35* = $3,431.40

$3,431.40 - $2,500 = $931.40 GAIN (64% Annual Yield)

*Assumes the stock price doesn’t change in the short time it takes to sell the stock.

Make the Most of Your ESPP

Everyone’s plan varies, but you can achieve the most (in terms of
security and return) from a “typical” ESPP by doing the following:

Contribute the Maximum - The more you contribute to
the ESPP, the bigger your return will be.  Do your best to contribute
at the maximum level of the plan.  The return is too big to pass up.

Flip the ESPP - Once you reach the end of the term
and the shares are purchased, immediately sell your shares of stock so
that your risk is limited.  If you can manage it, short sell the stock just prior to the end of the term and reduce your risk even further.

Have a Goal for the Funds After the Sale - Just so
that you don’t thoughtlessly blow all of your ESPP savings and
earnings, have a nice plan for using it after the sale.  Good luck.