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Employee Stock Purchase Plan: How Your Employer Can Help You Grow Your Wealth



Are you working for a publicly traded company? A company whose stock trades on an exchange? If so, are you taking advantage of one of the best benefits offered by these companies? The Employee Stock Purchase Plans offered by public companies can be a great way to get your feet wet in investing, build a portfolio, and put something aside for retirement, a rainy day, future education cost, or a major purchase like a house. An Employee Stock Purchase Plan allows employees of a corporation to purchase the company's stock often at a discount. If done correctly an investor can put together a nice investment position over time.

How Does an Employee Stock Purchase Plans (ESPP) Work

A portion of an employee's paycheck is deducted and used to purchase the company's stock at a discount. The company sets an offering date and a purchase date. During the offering date is when an employee would elect to have deductions made from his or her paycheck and put into a fund by the employer. The purchase date is when the money in the fund is used to purchase the company's stock.


Home Depot's Employee Stock Purchase Plan

The Benefits of ESPPs

The most considerable benefits of ESPPs are the discount that can be applied to stock purchases and the look-back provision granted to ESPPs. The discount can be as much as 15% of the stocks value which could allow an ESPP participant to be in a profitable investment at the time of purchase. The look-back provision allows the company to purchase its stock at the stock price on the close of the purchase date or the close of the offer date, whichever is lower. In addition, the discount is applied to the lower stock price.

So for example, if Pear Tech Company offers an ESPP to it's employees, and on the offer date of January 2 Pear's stock closes at $20 per share and on the purchase date of July 2 the stock closes at $35 per share, the plan can purchase the stock at the offering date price of $20 per share, and apply the 15% discount. The employee will have purchased a $35 stock for $17.00 ($20 stock price x 15% discount).

ESPPs can provide employees with a way to increase their overall income, especially if the company's stock is in an uptrend. It also provides a way for employees to invest without having to make complex investment decisions.


Qualified and Non-Qualified ESPPs

An employer has a choice of offering a qualified or non-qualified Employee Stock Purchase Plan. Below is a list of characteristics for Qualified and Non-Qualified ESPPs, but it's best to check with your employer to find out which one they offer. Characteristics of a Qualified Employee Stock Purchase Plan are...

- Equal rights are guaranteed to all participants.

- Offering periods cannot exceed 27 months.

- Discounts on stock purchases cannot exceed 15% of the current price.

- Employees who own more than 5% of the voting stock of the company may not participate in the plan.

- No employee cannot purchase more than $25,000 worth of stock in the plan in a calendar year.

- The plan must be voted in by the majority of shareholders.

- The plan can only be offered to actual employees of the company.

These are just a few of the provisions that must be in place for a Qualified ESPP. For a Non-Qualified ESPP the plan must be voted in by the majority of shareholders and board of directors, but none of the other provisions listed above apply to a Non-Qualified ESPP.

Rules and Restrictions

The amount of stock an employee can purchase under a plan is restricted. In a Qualified ESPP it is restricted to $25,000 per calendar year. The $25,000 is divided by the share price on the offering date, thus giving the employee a max share count allowed per calendar year. Even if the stock price decreases, the original amount of shares calculated on the offering date is the max number of shares the employee can purchase.

Some plans also have restrictions on when you can sell your stock, sometimes six to twelve months. Employers set the policy on an employee's ability to increase or decrease their contribution to the plan.

Taxes and ESPPs

ESPPs are broken down into two separate tax categories, a Qualifying Disposition and a Disqualifying Disposition. To be considered for a Qualifying Disposition the employee must have held the stock for at least one year from the purchase date or at least two years from the offer date. If these conditions are met, then the amount discounted will be taxed as regular income, and if you sell the stock for a profit, this will be considered a long-term capital gain and taxed as such.

Using our Pear Tech Company Employee Stock Purchase Plan as an example.

A Qualifying Disposition.

Offer date January 2, 2017, stock price closed at $20 per share.

Purchase date July 2, 2017, stock price at $35 per share.

15% discount applied and stock is purchased for $17 ($20 x 15%).

Employee sells stock on July 5, 2019 for $60.

The $3.00 discount received at purchase is considered compensation income.

Long-term capital gains tax would apply to the $40 profit ($60 sale price - $20 offer date price).


A Disqualifying Disposition.

Offer date January 2, 2017, stock price closed at $20 per share.

Purchase date July 2, 2017, stock price closed at $35 per share.

15% discount applied and stock is purchased for $17 ($20 x 15%).

Employee sells stock on December 2, 2017 for $60.

The $18 difference between the share price on the purchase date and the discounted price the stock was purchased for ($35 - $17) would be recognized as compensation income.

The $25 difference between the purchase date price $35 and the price the stock was sold for $60 is subject to short-term capital gains tax.

We would like to stress that we are not CPAs nor do we moonlight as accountants. To get a better understanding of the tax ramifications we suggest that you speak with your accountant or the person or company that files your taxes. You can also find out more here about the Employee Stock Purchase Plans Under Internal Revenue Code Section 423.

DRIP and ESPP

DRIP stands for Dividend Re-Investment Plan and we've established what ESPP means. When these two are used in combination you are really allowing your money to work for you. If you participate in an ESPP and the stock of your company pays a dividend, the dividend payouts will be reinvested and used to purchase more stock. As your payroll deductions are being used to buy stock, so is the money that you're making from your already invested money.

Diversification is the Key to Success

One drawback to ESPPs can be that you have all of your eggs in one basket, especially if you're only investing through your company's employee stock purchase program. It is better to be diversified in other places to hedge your self against any issues that your company might face in the future, like new competition, new technology, or a changing environment; things that may cause the company to lose value. If you have a 401K plan or IRA or personal investment account it is probably a good ideal to not use those vehicles to invest in your company's stock if you are already participating in the company's ESPP.

The Difference When You're an Owner

Whether you're doing exactly what you've always wanted to do at your dream job or you're working a 9 to 5 just to get by, getting involved in your company's ESPP can be a great benefit. The ability to buy stock at a discount and develop an ownership stake can have a big impact on your life, assuming the stock goes up. According to Fidelity only a third of employees who have access to Employee Stock Purchase Plans use them, these plans are definitely an underutilized investment tool. If you've never invested before this is a great way to get your feet wet. If you invest regularly, this is another tool to help you reach your investment goals.

This is just an overview of how Employee Stock Purchase Programs work. For a better understanding speak with your employer.

We hope that this was of value to you, thanks for checking out the Seville Report, and may your next investment be your best investment.



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