Once you make the jump in-house, and if you’re otherwise employed by a public company, you may have the opportunity, as part of your benefits package, to invest a percentage of your paycheck (after taxes) into the company’s employee stock purchase plan (ESPP).
I think this is a great benefit that is mostly unremarked upon in the context of in-house corporate counsel practice which you should take advantage of immediately upon joining a new employer.
Here is a quick ESPP primer with some insights from my experience participating in these plans:
How do ESPPs work?
An employee stock purchase plan allows you to earmark a certain percentage of your monthly paycheck towards buying shares of your publicly traded employer’s stock. Under IRS rules, these plans cap the amount you can contribute annually to $25,000.
However, the real benefit is when the employer makes the purchase for you, it is at a substantial discount to the market value of the stock – usually between 12 and 15 percent. Some plans may also “look back” and apply the discount to the lowest closing price for the stock during the course of the offering window – check your ESPP for details, as they will vary.
(Think about this for a second. You can purchase your employer’s stock at a 12 to 15 percent discount! Imagine if the stock dipped that much on a single day of trading, you had the prescience to buy it, and then it immediately bounced back the next day. That’s a big number.)
Your payroll deductions will pile up between the opening of each offering period and the purchase date (typically quarterly or every six months). On the purchase date, the company will purchase the shares on your behalf.
The opening and closing dates of each ESPP offering period are important for purposes of tax treatment – more on that below.
Who is eligible to participate in an ESPP?
It depends on the specifics of your company’s ESPP, but generally most employees are eligible to participate (unless they own more than 5% of the company’s outstanding stock.) So unless you are Jeff Bezos, odds are pretty good that you can participate in your company’s ESPP (unless you work for Amazon, which does not offer an ESPP as a benefit to employees!)
How much of your salary should you invest in an ESPP?
This is a personal question that I’ll answer from my own experience. Right now I am putting 1% of my bi-weekly salary towards my company’s ESPP. Diversification is critical to my investing strategy and putting “all of your eggs” in the corporate basket – when that company is paying your salary, your benefits, and contributing towards retirement – is inconsistent with that approach.
But with all that being said, the market discount to purchasing through an ESPP is so significant that I think it’s a mistake not to participate. In 2019, depending on how certain end-of-calendar-year items pan out, I am considering boosting my contribution rate to 2%. But more on that in a future post.
What are the tax implications of investing in an ESPP?
In short, they’re complicated, and you should discuss them with your accountant. But in general, and unlike a 401k contribution, your contributions will be taxed at ordinary income rates UNLESS you hold the shares for one year past the purchase date AND more than two years from the beginning of the offering period in which you purchased the shares.
In that two-pronged scenario, any profit above the gain from the purchase discount will receive capital gain tax treatment (either short- or long-term, depending on how long you’ve held the shares since the offering period closed). However, any “gain” you realize at sale between the discount price and market sell price will be treated as ordinary income and taxed accordingly.
Have you had success investing in your company’s ESPP? Why or why not? Let us know in the comments!