Employee Stock Purchase Plans (ESPPs) are one of the most popular types of equity compensation plans used by companies around the world to incentivize their employees.
If you’re an ESPP Newbie, this is just the guide for you.
What is an ESPP?
An Employee Stock Purchase Plan is a mechanism for employees to purchase stock at a discount in their company through payroll deductions.
ESPPs have an upfront enrollment period where you decide what percentage of your paycheck is to be deducted, and used to purchase company stock at a discount over a period of time. Typically there are offer periods involved during the ESPP, e.g. two six-month offer periods during a one year window.
Typically, the employee receives a discount of the market value of stock on either the first or last day of the offer period. The discount is applied to the market value on whichever day had the lower value.
How do ESPPs operate?
If a company decides to operate an ESPP, they can either internally design a scheme, or work with an external partner to design a process and mechanism that allows employees to participate in the plan.
Generally, there is a maximum amount of salary that can be invested in the plan, and the employee can decide how much of their net wages they wish to contribute up to that capped amount. As there are no vesting restrictions, once an employee activates their ESPP they own the stock immediately. They can then use their stock as a short-term cash-out or a long-term investment.
Qualified vs. Non-qualified ESPPs
There are two types of ESPP - Qualified and Non-qualified. The term 'qualified' refers to a tax advantageous status.
Qualified ESPPs are tax qualified stock purchase plans, which offer several advantages to participants. The main one is that employees aren’t taxed on any discount they receive on the stock purchases.
Characteristics of a tax-qualified ESPP include
- Shareholder approval; In order to institute an ESPP, the company must first get formal approval from shareholders.
- No taxes on stock price discount; Employees do not pay taxes on the discount difference, however they do pay capital gains on any gain in the value of their ESPP stock between buying and selling.
- Limited offering period; The purchase date must be within 3 years of offering date.
Non-qualified ESPPs have fewer restrictions, however they don’t have the same benefits as tax-qualified ESPPs.
Some of the differing tax consequences for non-qualified ESPPs include:
- Non-qualified ESPPs are liable for income tax on the discount they receive when they purchase shares.
- As with a qualified ESPP, employees must pay capital gains tax on any increase in the value of their stock between purchase and selling.
What are the benefits of an ESPP?They Can Generate a Substantial Return For Employees
ESPPs offer employees the potential of a favorable return on investment as well as a way to gain ownership in their company. They also offer employees an easy and cost efficient reward for pursuing a disciplined savings plan, and allows them to build long term financial wealth.It Fosters A Long Term View
Employees who hold company stock will both think and act in the long term interest of the company. By having skin in the game, an employee is aligned with the character and vision of your company.It Helps Your Employee Retention Rate
ESPP programs typically run over a number of years, and the total amount of stock employees accumulates over the lifetime of the plan. Seeing is believing, and an employee who sees the financial benefit of their investment after the first six months is more likely to commit and remain invested in the company in the long run.
Tax and regulatory compliance
The design and deployment of ESPPs must meet the letter of the law. There are many considerations to be taken into account including variations in tax rates between states, employee mobility and transfers, an international workforce, tax liability etc - which is why many companies choose to work with external advisory partners to ensure they remain fully compliant from a tax and regulatory perspective.
Administering an ESPP
If you already have an employee stock plan, you need to ensure that your staff are engaging with it and that everything from participant enrollment to trading is taken care of and above board. If ESPPs are new to your company and something that you’re considering, speak to a company like Global Shares who can take away the headache of managing it thanks to our award-winning software platform and team of 300 equity professionals. We’re trusted by hundreds of companies across a multitude of industries in more than 100 countries across the world.
Read more about Employee Stock Purchase Plans here.
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