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What is an Employee Stock Purchase Plan?

By K.M. Doyle
Updated Feb 19, 2024
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An employee stock purchase plan is a way for a company to offer stock to its employees at a discount. The stock can be offered at up to a 15 percent discount off the market price at the time of the offer. The employees’ contributions are typically deducted from their pay, and the stock purchased for them at a later, specified date. Depending on how long the employee holds the stock, purchases made under an employee stock purchase plan may be considered qualified, or eligible for tax-advantaged treatment, by the Internal Revenue Service in the United States.

Employee stock purchase plans may be restricted or governed by tax or securities law. In the United States, employees must hold the stock purchased under the plan for at least one year from the date it is purchased and two years from the date the option is granted in order for the gain to qualify for favorable tax treatment. When an employee sells back stock that was purchased under an employee stock purchase plan, it is typically an exempt transaction in the United States, as the number of shares is relatively small. This means that paperwork is not required to be filed with the Securities and Exchange Commission. The sale of stock acquired in an employee stock purchase plan will sometimes qualify for favorable tax treatment, and is known as a qualifying disposition.

Sometimes employees will be given the option to purchase company stock at a given price for a period of time. This is known as an employee stock option ownership plan and is often used by start up companies as remuneration in lieu of a higher salary, and to give the employees the opportunity to share in the future success of the company. An employee stock option may be exercised at the employee’s discretion, and will usually be exercised if the stock price rises above the option price. Stock options typically expire when the employee leaves the company.

If an employee is given a stock option in lieu of compensation, it is usually considered to be a non-qualified stock option. In this case, the difference between the option price and the selling price is taxed as earned income when the stock is sold. The company receives a tax deduction for the earned income. This type of transaction does not qualify for favorable tax treatment as the option is considered compensation to the employee.

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