Employee stock purchase plans (ESPP) enable employees to buy company stock at a discount.  The details can vary for each company, so please consult your company’s ESPP documents for your particular situation.  I was recently asked how to calculate taxes for stock sold from the Varian Semiconductor (VSEA) ESPP, so I’ll use this company as an example.  Many companies use a similar plan.

At Varian, the employee buys stock at a 15% discount from whichever is lower: the stock price at the beginning or end of the offering period.  If you sell within two years from the beginning of the offering period, your gain is the difference between the sale price and the fair-market value of the stock on the day it was purchased.  If you’ve held it longer than one year, you pay tax on the gain at the lower long-term capital gains rate; if you hold it less than one year you pay tax at ordinary income tax rate.  You should also know about the Non-Qualifying Disposition (NQD).  This is the difference between the fair market value of the stock on the day you purchased it and the discounted price that you paid.  The NQD is reported by Varian on your W2 as the “ESPP Non-Qualifying Disposition,” and it is included in your W2 Box 1 as regular wages and other compensation.  It is taxed as ordinary income.

If you hold the stock more than two years, as measured from the beginning of the offering period, Varian reduces the amount that they report as an NQD, but you must report more of it as Capital Gains.  The formulas are in the accompanying VSEA ESPP Plan Document, and I’ve created a spreadsheet to simplify the calculation.  Just follow the instructions on the spreadsheet.

How long should I hold company stock? To minimize the tax impact of selling the shares, it’s best to hold it more than 18 months (two years from the beginning of the offering period).  But, you should also consider the uncertainty and volatility of the stock price and the general stock market.  For most investors, holding individual stocks has greater risk than holding mutual funds, since mutual funds average out the fluctuations of individual company stocks to reduce the overall volatility.  In addition, an employee shouldn’t have too much of their personal net worth tied up in company stock, since much of their security already is (through their paycheck, health insurance…).  Just ask those Enron employees.

Tags: capital gains, Employee Stock Purchase Program, ESPP

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