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Unlocking the potential of employee stock purchase plans

July 14, 2025 / 7 min read

Employee stock purchase plans may provide an opportunity to buy stock at a discount and can lead to significant financial benefits and participation in your company’s success. Learn about their key functions and whether they’re the right choice for you.

Employee stock purchase plans (ESPPs) have emerged as a powerful tool for aligning the interests of employees and employers, fostering a culture of ownership, and driving long-term organizational success. By allowing employees to purchase company stock at a discount through payroll deductions, ESPPs offer a unique blend of financial benefits and motivational incentives. Is an ESPP right for you?

What is an ESPP?

An ESPP is a stock plan that enables employees to buy company shares at a discounted price using after-tax payroll deductions. The plans are classified into two categories: qualified and nonqualified. Qualified ESPPs, governed by Internal Revenue Code (IRC) Section 423, offer significant tax advantages but come with certain restrictions. Nonqualified plans, while more flexible, don’t provide the same tax benefits. This article focuses on qualified plans.

Qualified ESPPs, governed by Internal Revenue Code (IRC) Section 423, offer significant tax advantages.

How ESPPs work

The operation of an ESPP involves four key steps:

1. Enrollment

Participation is voluntary. Once you enroll in the plan, you’ll be eligible to participate in the upcoming offering period and purchase company shares at an agreed discount for the length of that offering period. The maximum discount is 15%, but it can vary based on the plan. 

2. Payroll deductions

Within an offering period, accumulated contributions from your paychecks (post-tax) are set aside to purchase shares at the purchase date.

3. Purchase of shares

Typically at the end of the purchase period (i.e., on the purchase date), you’ll officially purchase the shares. Shares that are purchased through this program are immediately “vested,” and you’re free to do as you please with them after they’re acquired. These shares also receive dividends and voting rights, similar to if the shares were purchased on the open market.

4. Sell or hold shares

You can choose to sell your shares immediately to take advantage of the discount. Alternatively, you can wait until after certain holding period requirements are met to receive more favorable tax treatment.

Key terms and features

There are several terms you need to understand when evaluating your company’s ESPP.

Chart showing a 1-year ESPP offering period.

Taxation of ESPP shares

ESPP shares are taxed at the time the stock is sold. The applicable tax rate is dependent on whether the disposition is qualified or nonqualified.

Timeline from Jan. 15, 2023 to Jan. 2, 2025 showing offering and holding periods.

To summarize, the discount is always treated as ordinary income and the gain after the stock has been purchased is taxed at capital gains rates. The tax treatment on the lookback value is determined by whether a qualified disposition occurs. Additionally, keep in mind that in the event the stock goes down after it’s purchased, you will have a capital loss position in the stock but must still pay ordinary income on the discount benefit.

While it could be more beneficial to sell shares through a qualified disposition, the tax advantages should be balanced against other considerations such as diversification and the outlook for the stock. The taxation of stock plans can be complex, so confirm the tax consequences of participating and selling stock with your CPA before you enroll.

The tax advantages should be balanced against other considerations such as diversification and the outlook for the stock.

Benefits of ESPPs

ESPPs offer significant benefits to both employees and employers. For employees, the benefits include:

Benefits for employers include:

Strategic considerations

When contemplating participating in an ESPP, you should consider several factors.

Work with your financial advisor to review your personal balance sheet and create a personalized plan that mitigates risk.

Summing it all up

ESPPs offer substantial advantages but require strategic planning to make sure your company’s offering is right for you. Work with your financial advisor and tax professionals to understand the intricacies of your ESPP, understand the risks, and address potential challenges upfront to maximize the benefits when it’s time to sell.

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