Before answering this question, it’s important to understand what an Employee Stock Purchase Plan (ESPP) is. An ESPP is a company sponsored benefit plan that allows employees to make after-tax deferral contributions that can be used to purchase shares of the company they work for. Employees defer payroll contributions throughout an offering period, typically 6 months. At the end of the offering period, employees can buy shares at a discount from the current market value. The purchase price is based upon the lesser of the share price at the start of the offering period compared to the end of the offering period. The IRS allows eligible employees to contribute up to $25,000 per year (including discounts).
Benefits of an ESPP
If your employer offers an ESPP, this gives you a unique opportunity to build ownership in the company and potentially profit off the discounted shares you purchase. Similar to a 401k matching contribution where your employer is contributing money to your account, an ESPP is your employer giving you money in the form of a discount on purchased shares. Additionally, ESPP shares are usually not subject to vesting rules.
Example
Assume company XYZ offers eligible employees’ access to an ESPP. The company discount is 15%. Offering periods are 6 months, and the discount is based on the lower of the share price at the beginning compared to the end of the offering period. At the start of the offering period, XYZ stock was trading at $25 per share. At the end of the offering period, XYZ stock is trading at $35 per share. Based on the 15% discount, an eligible employee would purchase the shares at $21.25 – a 39.29% discount off of the current market value of $35.
Price on Start Date:______________________$25.00
Price on Purchase (End) Date:____________$35.00
Purchase Price (After 15% Discount):_____$21.25
Total Effective Discount:__________________39.29%
In this example, the eligible employee would have $13.75 per share of profit on the purchase date. Multiply this by the number of shares purchased, and the value can quickly add up.
ESPP Tax Implications
When deciding whether to participate in an ESPP, it’s important to understand several important ESPP tax rules. Employee contributions to an ESPP are not tax-deductible. Employees typically get to purchase shares at a discount, and this discount is not taxed up front. Taxes are due once the shares are sold.
Conclusion
Generally speaking, ESPPs are a great benefit for employees; however, there are a number of factors to consider, including but not limited to: discretionary cash flow, financial goals and tax implications. When appropriate, the inherent potential to purchase company shares at a significant discount can make participation in an ESPP an attractive opportunity.
Danny McAuliffe, CFP®
danny@perigonwealth.com
Danny McAuliffe is a financial planner and wealth advisor with Perigon Wealth Management.
