Employee Stock Purchase Plans: Getting Your Share
Under an employee stock purchase plan (ESPP), employees can buy company stock at a price below market value. This price discount can be a great way to add value to your portfolio as long as you understand how to use the program.
What They Are
Under a typical ESPP, employees deposit 10 percent or 15 percent (depending on the individual plan rules) of their pay into a pool to buy company stock. The stock is sold to the employee at three- or six-month intervals at a price discount of 15 percent. Since the employee's discount is calculated on the price at the beginning or the end of the interval, depending on which is better for the employee, the employee may realize more than a 15 percent profit. There isn't a vesting period for ESPP stock, so the employee can sell right away — called a same-day sale — to lock in his profits.
Tax laws are always changing. Be sure to check with your employer and your tax advisor to be sure you understand the details of your benefit plan before participating. Pay extra attention to the cost of plans such as ESPPs that can increase your taxable income. Higher income may reduce the value of tax deductions such as mortgage interest.
If your company's plan is a qualified ESPP — ask the plan manager if your plan is qualified under section 423 — you won't owe any tax when you buy the stock. When you sell, your price discount is taxed to you as wages and any gain in the price of the stock from when you purchased it is taxed at capital gains tax rates. Capital gains rates are lower than wage rates. If your plan is nonqualified, then you'll owe income tax on the amount by which the price was discounted.
Strategies
Many employers allow employees to sell shares they bought through their ESPP immediately after they receive them — the same-day sale mentioned in the preceding section. Selling quickly can guarantee that you don't lose your profit if the shares were sold to you at a discount. Same-day-sale profits are taxed at higher income tax rates, but the higher taxes might be worth it if you use your cash to buy more diversified investments.
Is stock flipping okay? Selling your ESPP shares on the same day you bought them in order to get the guaranteed profit of the discount your employer offers is called flipping. Many people frown on this practice because they feel the ESPP should be used to encourage stock ownership, not quick profits. But it's your money, and that's what's most important to your financial plan. Go ahead and flip!
Some employers' ESPPs don't offer a price discount and some have blackout periods that restrict how quickly you can sell your ESPP shares. If this is the case with your plan, you might decide that the risk of being in the plan and not being able to sell quickly, or not getting a guaranteed profit, makes it a bad idea to participate.
