All About Employee Stock Purchase Plans (ESPP)

ESPPsI 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.

Thanks for letting me tackle this subject.  Do you have any other thoughts on ESPPs?  Share them in the comments below.



Last Edited: February 17, 2011 @ 1:43 am
About Philip Taylor

Philip Taylor, aka "PT", is a husband and father of two. He created PT Money back in 2007 to share his thoughts on money and to meet others passionate about managing their finances. All the content on this blog is original, and created or edited by PT. Read more about Philip Taylor, and be sure to connect with him on Twitter, Facebook, or view the Philip Taylor+ Google profile.

Comments

  1. Great post and ESPP are a good idea. Unfortunately I work in the financial services sector and my company’s stock price has been falling faster than the low point I get to buy the stock at (including the 15% discount). Still it is also a good way to dollar cost average one’s way into a stock.

    It is important to make sure though you don’t put all your investments into your comapny’s stock (remeber what happened to Enron and Worldcom employees?)

  2. So…you’re down with ESPP?

  3. @ Mrs. PT – Yeah. You know me.

  4. Isn’t this kind of a risky way to try to earn a few extra dollars on your property taxes? If the stock drops, than you will have to actually pay more in taxes. If the stock price goes up, which will not be much in 6 months (conservatively) you owe taxes on the amount. Unless they are treated differently than normal stocks and the standard capital gains rule doesn’t apply, you would still be forced to pay taxes at your current income tax rate (probably around 25%).

    So even a gain 4% gain on a 6-month investment of 2k (which is somewhat reasonable) would be $80.00. Take another 25% off of that for taxes and you are up about $60.00. All while, hedging your stock won’t go down, in which case your tax bill increases.

    Do I understand this correctly? Seems like a risky game to play to earn a couple bucks. Also, are their costs associated with buying and selling?

    Thanks for the post! I have never heard of ESPP, as you can tell, I’m very curious.

  5. That One Caveman says:

    Unfortunately, my employer only gives a 5% discount – not enough for me to justify doing a flip. They withhold money from my paycheck in a 0-interest account and purchase on a certain date. They want us to hold onto the stock, but I (honestly) don’t feel like owning any of my company’s stock.