"Not qualified" means that your company's employee stock purchase plan (ESPP) does not meet the requirements under Section 423 of the Internal Revenue Code, which are discussed in other FAQs. If it is structured like a tax-qualified Section 423 plan (except for whatever feature disqualifies it), the mechanics and procedures of a purchase will be the same as those of a qualified ESPP.
General Rules
The favorable tax treatment for participants in a Section 423 ESPP does not apply to participants in a nonqualified ESPP. Instead, the taxation that applies to the value of any discount stemming from the purchase price or company match resembles the taxation of an exercise spread from nonqualified stock options.
You have three core tax rules:
- The spread is taxed as ordinary income when the purchase price is discounted from the market price on the purchase date.
- The taxes are withheld at purchase (income tax, Social Security, and Medicare).
- At sale, any change in the stock price after the purchase price is capital gain or loss. This can be short- or long-term, depending on how long the shares are held after purchase.
The tax treatment is similar for any financial contribution or for additional shares granted by your company linked to your purchase.
Example: Your company offers you a nonqualified ESPP that is available only to hourly and nonexecutive employees.
- The ESPP has an 18% discount from the stock price for purchases every three months.
- The market price on the purchase date is $30.
- With the 18% discount, your purchase price is $24.60.
- The difference of $5.40 is ordinary income.
- Taxes are withheld at purchase.
To see how the purchase is reported on IRS Form W-2, and for an additional example, see a related FAQ.
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