How Employee Stock Purchase Plans (ESPPs) Are Taxed

Most technology companies offer Employee Stock Purchase Plans that allow their employees to purchase stock at a discount. These are meant to be an incentive to share the wealth when you work hard to help the company grow. Typically, the employee contributes to a stock purchase fund for a certain amount of time through payroll deductions. At different points throughout the year, the company uses the money in the fund to buy stock on the employee’s behalf at a discounted price. However, it can be complicated when tax season rolls around. Keep reading to learn how Employee Stock Purchase Plans (ESPPs) are taxed.

When the company purchases shares on the employee’s behalf, no taxes are owed. Once the employee sells the stock, the discount that was received when the stock was purchased is considered as additional compensation. This consideration requires the discount to be taxed as regular income. If the stocks are held for less than a year before selling, any gains are considered compensation and taxed that way. If stocks are held for over a year, any profit is subject to capital gains tax.

The amount of the stock sale price that is considered compensation and capital gain is determined by whether the stock sale is a qualifying disposition or a disqualifying disposition.

A disqualifying disposition is when the employee has sold the stock within two years of the offering date OR one year or less from the purchase date. In this situation, the employer will report the bargain element, the difference between the exercise price and the market price on the purchase date, as compensation on your W-2 so it is taxed as ordinary income. Any additional profit is then considered as a capital gain. Whether the capital gain is short term or long term depends on how long the shares were held before selling. This capital gain will need to be reported on a Schedule D.

A qualifying disposition is when the employee sold the stock at least two years after the offering AND at least one year after the purchase date. A portion of the profit from the sale (the bargain element) is considered as compensation, making it taxed as regular income on your Form 1040. Any other profit is considered a long-term capital gain that is taxed lower than compensation income and reported on a Schedule D.

To prepare you, the long-term capital gains tax rates for the 2021 tax year are as follows:

Married Filing Jointly:

0% – up to $80,800

15% – up to $80,800 to $501,600

20% – $501,601 and up

Married Separately:

0% – up to $40,400

15% – $40,401 to $250,800

20% – $250,800 and up

Head of Household:

0% – up to $54,100

15% – $54,100 to $473,750

20% – $473,750 and up

Single:

0% – up to $40,400

15% – $40,401 to $445,850

20% – $445,851 and up

If you have an Employee Stock Purchase Plan and are concerned how the sale of your stock will affect your taxes, contact us at Eagle Grove Advisors. Our advisors are experienced helping tech professionals handle their finances and taxes. Give us a call today to get started.

Sources:

https://turbotax.intuit.com/tax-tips/investments-and-taxes/employee-stock-purchase-plans/L8NgMFpFX
https://www.hrblock.com/tax-center/income/investments/employee-stock-purchase-plan-taxes/
https://www.bankrate.com/investing/long-term-capital-gains-tax/
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