ESPP Tax Examples With Calculation Breakdowns
Understand the tax implications of selling ESPP stock. Our guide uses clear calculations to show how your holding period determines your final tax liability.
An Employee Stock Purchase Plan (ESPP) is a company-run program that allows you to purchase company stock, often at a discount. The amount of tax you owe upon selling these shares depends heavily on how long you hold them. The holding period determines whether the sale is a qualifying or disqualifying disposition, each with different tax calculations that impact your financial outcome.
Key Concepts for ESPP Taxation
Most company stock plans are “qualified” under Section 423 of the Internal Revenue Code, which allows for specific tax treatment. A sale is considered a qualifying disposition if it occurs at least two years after the offering date and one year after the purchase date, which results in more favorable tax treatment. Any sale not meeting both requirements is a disqualifying disposition.
To understand the tax calculations, you must be familiar with several values: the offering date, the purchase date, the Fair Market Value (FMV) on both of these dates, and the purchase price discount.
Tax Calculation for a Qualifying Disposition
When you meet the holding period requirements for a qualifying disposition, your profit is split into ordinary income and long-term capital gain. Long-term capital gains are taxed at lower rates than ordinary income. For example, your company’s ESPP has a six-month offering period starting January 1 with a 15% discount. The stock’s Fair Market Value (FMV) is $50 on the offering date and $60 on the June 30 purchase date. Your purchase price is $42.50 per share, and you sell 100 shares on July 1 of the next year for $75 per share.
For a qualifying disposition, the ordinary income is the lesser of two amounts: the purchase price discount on the offering date or the actual gain on the sale. The discount is $7.50 per share ($50 FMV x 15%), totaling $750. Your actual gain is $32.50 per share ($75 sale price – $42.50 purchase price), totaling $3,250. The lesser amount, $750, is what you will report as ordinary income.
The remaining profit is a long-term capital gain. This is calculated by taking the total sale proceeds ($7,500) and subtracting both the stock’s cost ($4,250) and the ordinary income ($750). The result is a $2,500 long-term capital gain, taxed at rates of 0%, 15%, or 20%, depending on your income.
Tax Calculation for a Disqualifying Disposition
A disqualifying disposition occurs when you sell shares without meeting both holding period requirements. This sale results in a larger portion of your profit being taxed as ordinary income. Using the same data from the previous example, assume you sell the shares on December 15 of the same year for $75 per share. This is a disqualifying disposition because the shares were not held for at least one year after purchase.
The ordinary income is the full “bargain element” on the purchase date. This is the difference between the FMV on the purchase date ($60) and your purchase price ($42.50), which is $17.50 per share. For 100 shares, your total ordinary income is $1,750.
Next, you calculate the capital gain. This is your sale price ($75) minus the sum of your purchase price ($42.50) and the ordinary income per share ($17.50). The capital gain is $15 per share ($75 – $60), for a total of $1,500. Because the stock was held for less than one year, this is a short-term capital gain taxed at your regular income tax rates.
Reporting ESPP Transactions on Your Tax Return
After the tax year you purchase shares, your employer provides Form 3922, which contains the offering date, purchase date, and fair market values needed for your calculations. When you sell the shares, your brokerage will issue Form 1099-B, which reports the gross proceeds from the sale. The cost basis reported on Form 1099-B is often just your purchase price and does not account for the ordinary income component of your gain.
You must report the sale on Form 8949, Sales and Other Dispositions of Capital Assets. On this form, you will adjust the cost basis from Form 1099-B by adding the amount of ordinary income you calculated. This adjustment is necessary to avoid being taxed twice, as the ordinary income portion is also included as compensation on your Form W-2.
The totals from Form 8949 are then carried over to Schedule D, Capital Gains and Losses.