Outside of wages and salaries, one common method of compensating employees in today’s corporate environment involves the purchase of company stock by employees through an Employee Stock Purchase Plan (ESPP). This often overlooked and potentially valuable employee benefit offers a straightforward method of allowing employees to participate in the overall profitability of the company.

 

ESPP’s allow workers to buy shares of their employer’s stock in a simple manner by using after tax payroll deductions. They are one of the simplest forms of company stock purchase plans available today. ESPP’s are only available for employees of publically traded companies.

 

There are two types of Employee Stock Purchase Plans classified by their tax status. These plans are Qualified and Non-Qualified Employee Stock Purchase Plans. The term “qualified” refers to when the stock purchased by the employee through the plan “qualifies” for special tax benefits upon exercise which can lead to long term capital gains tax treatment.

 

Qualified and non-Qualified ESPP’s must meet the following requirements:

  • Only employees of the company (or its parent or subsidiary corporations) may participate in the plan
  • The purchase plan must be approved by the shareholders of the company within the 12 months before it is adopted by the board.
  • Any employee owning more than 5% of the company stock may not participate in the plan

Qualified ESPP’S must meet these additional requirements:

  • All eligible employees must be allowed to participate in the plan, although certain categories of employees may be excluded (e.g. employees employed less than two years)
  • All employees must enjoy the same rights and privileges under the plan, expect that the amount of stock that may be purchased may be based on compensation differences
  • The purchase price may not be less than the lesser of 85% of the fair market value of the stock 1) at the beginning of the offering period, or 2) on the purchase date
  • The maximum offering period cannot exceed 27 months unless the purchase price is based solely on the fair market value at time of purchase, in which case the offering period may be as long as 5 years
  • An employee may not purchase more than $25,000 worth of stock (based on fair market value on the first day of the offering period) for each calendar year in which the offering period is in effect

 

Qualified ESPPs are a tax efficient vehicle which is particularly beneficial to the owner of the shares if the shares are held for more than one year.

 

Non-Qualified ESPPs are simple payroll deduction plans that allow employees to purchase stock, sometimes at a discount. These plans do not qualify for any special tax treatment of the proceeds, and the plan is not necessarily available to all employees.