espp Archives

Tech stocks have had a terrible year thus far. So far this year, the tech-heavy Nasdaq Composite Index is down 23%. Among the worst-hit have been Amazon.com (-25%), Tesla (-32%), Meta (-42%), Zoom (-40%), and Shopify (-74%). We’ve been hearing from so many of you about whether to continue to participate in your company’s employee stock purchases plan (ESPP) when the company stock is declining.

Using the Apple ESPP to illustrate how it works

Essentially, a company that offers an employee stock purchase plan is giving its employees the option to buy the company stock at a discount. Let’s use the Apple ESPP as an example. Suppose your base salary is $200,000. You can contribute up to 10% of that salary – in this example up to $20,000 (ESPP contributions are capped at $25,000 per year, based on the full fair market value of the stock).

At the start of each purchase period, which goes for 6 months, Apple will withhold the percentage you elect. At the end of each purchase period, they will use the funds withheld over the prior 6 months to purchase stock at a discount. The amount you pay for the shares is the lower of two prices—the offering date price or the purchase date price—plus an additional 15% discount. Apple has their 2 purchase dates as January 31st and July 31st.

The amount you pay for the shares is the lower of two prices—the offering date price or the purchase date price—plus an additional 15% discount.

Here is an illustration that shows what the timeline for Apple’s ESPP looks like.

Note: Apple’s offering period and purchase period are the same, though that’s not always true.

In this example, if you had participated between August 1st, 2021 and January 31, 2022, you would be purchasing at a discount on the lower price from August 1st. On January 31, Apple would use the $10,000 withheld and purchase Apple stock at 15% less than the August 1st price of $145.52 (80 shares of AAPL. Note: Apple does not allow the purchase of fractional shares in their ESPP).

If you sell immediately, at the market value on January 31st ($174.78), you gross roughly $14,000. You’ve immediately gained almost $4,000, which will be taxed at whatever your ordinary income tax rate is. For the sake of simplicity, I’ll assume you’re in the 35% tax bracket, so you’ve netted a little more than $2,500. Not bad!

Money withheld from your paycheck	$10,000
Share price on August 1, 2021	$145.52
Share price on January 31, 2022	$174.78
# of shares purchased on January 31	80
Sales proceeds (80 shares x $174.78)	$13,982
Gain	$3,982
Estimated tax @ 35%	$1,394
Net proceeds	$2,588

What if the stock price had actually gone down from August to February?

You would still get a discount on the lower stock value, but it would be worth less when you sell and you would only gain the 15% discount. Let’s imagine the stock prices were reversed- $174.78 on August 1st and $145.52 on January 31st. You would still receive 80 shares of AAPL stock, but you would only be able to sell it for about $11,600. Again paying 35% tax on the gain, you would net about $750. Still better than nothing but quite a bit less than the first example.

Money withheld from your paycheck	$10,000
Share price on August 1, 2021	$174.78
Share price on February 28, 2022	$145.52
# of shares purchased on March 1	80
Sales proceeds (80 shares x $145.52)	$11,642
Gain	$1,164
Estimated tax @ 35%	$407
Net proceeds	$757

In a market where your company stock is trending down, the maximum gain you would realize over a 6-month period is $12,500 (50% of the annual IRS limit) less $10,625 (50% of the maximum annual contribution, assuming a 15% discount) or $1,875- and that’s before you pay taxes.

Tax Implications: Selling the shares immediately

In the above examples, I assume you sell the shares as soon as you’re able (which is very close to immediately after the end of the offering period). This is considered a non-qualifying disposition, and you’re required to pay ordinary income tax rates on whatever the discount amount is.

Tax Implications: Holding onto to the stock for more than a year

If you hold the stock for a full year from the purchase date, and 2 years from the beginning of the offering period in which you purchased shares, then the stock would be eligible for a qualifying disposition. In this instance, any gain would be taxed at long term capital gains rates, which are more favorable than ordinary income tax rates. Many people are enticed by the possibility of paying lower taxes, but holding the stock for longer is risky, and you might have no gain at all, or even a loss.

There is very little risk involved in participating in an ESPP if you sell the stock right away. If you hold the stock, your risk increases significantly.

Factors to consider

One of the most relevant issues here is- can you afford to have that reduction in every paycheck for the 6 month period before reaping the benefits at the end? For some folks, this is a fantastic way to automate savings. It enforces a certain behavior and then at the end of 6 months you can sell your company stock and invest how you see fit. In other cases, you just can’t afford to take a reduced salary. Given the limited benefit when the stock is trending downward, if the regular paycheck deductions present a challenge, I would likely not participate in the ESPP.

The other consideration is having too much exposure to your company stock. If you’re already receiving Restricted Stock Units or stock options, you may have a large portion of your portfolio in one stock. Add to this the fact that your salary and benefits are tied to this same company, it can get pretty risky.

How should I decide?

To recap, some pros of participating:

Enforced savings
Free money! Admittedly, LESS free money when the stock price is on a downward trend.

And cons:

Concentration risk
Increased tax complexity
Reduced cash flow
Potential volatility if you hold the stock
The manual process of selling and then reinvesting into some other vehicle (or as I like to call it, the “hassle factor”).

I have a bit of a love-hate relationship with ESPPs, but they are often worth doing, even in a down market. The potential benefit is quite small, but if you can afford to participate, it might be a good idea regardless of the way the stock is trending.

equity compensation espp

If you work at a large, tech company, there’s a good chance they offer an Employee Stock Purchase Plan (ESPP) as one of the company benefits. The question is, should you actually participate and if so, how do you manage it?

I’ll be honest, I have a love-hate relationship with ESPPs. Sure, they are a great benefit and they are essentially “free money”. But darn if they aren’t complicated and they do require some active management. There are plenty of cases where I do not recommend participating, despite the fact that some people think participating is a “no-brainer”.

How does it work?

First of all, I want to explain how they work and what the actual benefit is. Essentially, you can buy your company’s stock at a discount, and then turn around and sell it for the actual market value. The difference is yours to keep (less taxes due). But how it’s actually structured is a bit more complicated.

Let’s use the Salesforce plan as an example. Suppose your salary + bonus is $150,000. You can contribute between 2% and 15% of that income – Salesforce caps ESPP contributions at $21,250 (or $25,000 stock at Fair Market Value, less 15% discount). Each pay period, Salesforce will withhold that percentage which you elect and hold it until the end of the “offering period”. For most companies, the offering period is 6 months and Salesforce has their 2 offering dates as June 15 and December 15. On these two dates, they use the total amount withheld over the prior 6 months, and purchase shares for you, which are then transferred to an account in your name.

The amount you pay for the shares is the lower of two prices—the date at the beginning of the offering period or the purchase date price—plus an additional 15% discount.

In this example, if you had withheld the maximum amount, $10,625 between June and December 2020, the lower price would be that on June 15, 2020. On December 15, Salesforce would use the $10,625 withheld and purchase CRM stock at 15% less than the June 15th price of $178.61 (70 shares of CRM). If you sell immediately, at the market value on 12/15 ($220.15), you gross roughly $15,400. You’ve immediately gained over $4,700, which will be taxed at whatever your ordinary income tax rate is. For the sake of simplicity, I’ll assume you’re in the 32% tax bracket, so you’ve netted about $3,200. Not bad!

Money withheld from your paycheck	$10,625
Share price on June 15	$178.61
Share price on December 15	$220.15
# of shares purchased on December 15	70
Sales proceeds (70 x $220.15)	$15,407
Gain	$4,782
Estimated tax @ 32%	$1,530
Net proceeds	$3,252

What if the stock price had actually gone down from June to December? You would still get a discount on the lower stock value, but it would be worth less and you would only gain the 15% discount. Let’s imagine the stock prices were reversed- $220.15 on June 15 and $178.61 on December 15th. You would still receive 70 shares of CRM stock, but you would only be able to sell it for about $12,500. Again paying 32% tax on the gain, you would net about $1,300. Still better than nothing but quite a bit less than the first example.

Money withheld from your paycheck	$10,625
Share price on June 15	$220.15
Share price on December 15	$178.61
# of shares purchased on December 15	70
Sales proceeds (70 x $178.61)	$12,500
Gain	$1,875
Estimated tax @ 32%	$600
Net proceeds	$1,275

But does it make sense?

One REALLY big factor here is- can you afford to have that reduction in every pay check for the 6 month period before reaping the benefits at the end? For some folks this is a fantastic way to automate savings. It enforces a certain behavior and then at the end of 6 months you can sell your company stock and invest how you see fit. In other cases, you just can’t afford to take a reduced salary.

The other huge downside is having too much exposure to your company stock. If you’re already receiving Restricted Stock Units or stock options, you are starting to face a potentially large portion of your portfolio in one stock. Add to this the fact that your salary and benefits are tied to this same company, it can get pretty risky.

One of the tricks to successfully taking advantage of an ESPP is to manage the risk as much as possible, which often means selling the stock as soon as you’re able. There are also, as you might be wondering, some tax considerations to think about.

If you hold the shares for a full year, and two years after the plan becomes available to you, you now have a qualifying disposition. In a qualifying disposition, you still pay ordinary income tax rates on the discount amount, but you only pay long-term capital gains tax rates on the growth, if any. Your long-term capital gains rate could be as low as 0% (highly unlikely if you work in tech!) or it could be 20%, but is almost certainly lower than your ordinary income tax rate.

The huge downside to holding the shares in order to receive this preferential tax treatment is- you guessed it- again, too much exposure to company stock. There is always risk withholding any one stock due to increased volatility and in this case, having too many of your eggs in one basket. I almost never recommend that clients hold shares long enough to be a qualifying disposition.

Taxes on ESPP get very complicated and the above examples are a huge oversimplification. If you plan to participate in your ESPP, you’ll definitely want to run it past your tax preparer.

So should I participate or not?