Tax Center Global Tax Guide / Glossary / Discussion / Newsletters / About Us
Register Log In
myRecordsmyToolsmyClients
   ESPPs   
Basics   
Rules   
Advanced   
Taxes   
Taxes Advanced   

Annotated diagram of Schedule DTax errors can be costly! Don't draw unwanted attention from the IRS. Our Tax Center explains and illustrates the tax rules for sales of company stock, W-2s, withholding, estimated taxes, AMT, and more.

ESPPs: Basics

What makes a Section 423 ESPP a good deal?

What makes this employee benefit attractive is that you can purchase company stock at a discount (up to 15%, depending on your company's ESPP structure) with special tax treatment when you hold the shares long enough. It's an even better deal when your ESPP has a lookback provision. This bases the purchase price discount on the lower price at the start of the offering after the stock price has substantially jumped by the purchase date. You profit even if the stock price has fallen by the purchase date, as an ESPP cannot go underwater, because with a lookback the discount comes off the lower price of either the offering or the purchase-date market price.

Example: Your company uses a 15% discount with a six-month lookback.

  • The offering date price is $10.
  • The stock market price on the purchase date is $20.
  • Your purchase price is thus $8.50.
  • If instead the stock price had fallen to $8 on the purchase date, your purchase price would be $6.80.
  • In the price-gain situation, your increase is 135% ($11.50 spread at purchase divided by $8.50 purchase price).
  • Even in the price-drop example, you gain by 17.64% ($1.20 spread at purchase divided by $6.80 purchase price).

Example with 10% discount: Your company uses a 10% discount with a six-month lookback.

  • The offering date price is $10.
  • The stock market price on the purchase date is $12.
  • Your purchase price is thus $9.
  • If instead the stock price had fallen to $8 on the purchase date, your purchase price would be $7.20.
  • In the price-gain situation, your increase is 33% ($3 spread at purchase divided by $9 purchase price).
  • Even in the price-drop example, you gain by 11% (80 cents spread at purchase divided by $7.20 purchase price).
  • Plus, this is the appreciation on your money for just six months!

Example without lookback: Your company still uses a 10% discount and a six-month offering period.

  • When the stock market price on the purchase date is $12, your purchase price is thus $10.80.
  • If instead the stock price had fallen to $8 on the purchase date, your purchase price would be $7.20.
  • In the price-gain situation, your increase is almost 11% ($1.20 spread at purchase divided by $10.80 purchase price).
  • In the price-drop example, you gain by 11% for six months (80 cents spread at purchase divided by $7.20 purchase price).
  • In the down market, the pre-tax gain is identical to an ESPP with a lookback.

Another advantage of an ESPP is that you can easily sell the shares for immediate or long-term savings needs; by contrast, company stock in your 401(k) plan can be sold only for other investments in the plan. Of course, your final net gain in these examples depends on the stock price when you sell the shares and on the taxes. The special tax requirements and treatment pertaining to Section 423 ESPP shares are detailed in the FAQs of the section ESPPs: Taxes. For more on the possible financial gains from ESPPs, see a related article.

Alert: A study of behavior among ESPP participants found that ESPPs can help to improve employees' financial well-being. Elsewhere, in a research paper, two academics reported that the average employee "loss" for not participating in an ESPP is $3,446 ($3,079 after taxes and other costs). They estimated that this nonparticipation loss across all employees in the companies they studied totals about $7 billion. A survey of more than 2,000 ESPP participants by Fidelity Investments shows how they used funds from ESPP stock sales to improve their financial wellness.
Print this FAQ: Printer icon
Share this FAQ:
Share this article on LinkedIn Share this article on Facebook Share this article on twitter
Prior FAQ in list Return to list Next FAQ in list