Employee Stock Purchase Plans and Options
Employee stock purchase plans offer employees a way to invest in the company for which they work. There are many benefits with these plans, including the pride that comes with ownership in the company. According to Fidelity (see Resources below), employees who own stock in their company tend to take better care of the business since they have a personal investment in how the company performs.
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Function
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Employee stock purchase plans begin with the "offering," which is the company announcement that employees may purchase stock. During the offering, the employee chooses a portion of her salary withheld to buy the shares of stock. Any employee may participate and may choose to set aside from 1 to 10 percent of her salary. The government limits contributions to no more than $25,000 per year.
Types
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The two main types of employee stock purchase plans are qualified and non-qualified. Qualified, or Section 423 Plans (named for the IRS code that treats these plans), have a list of rules (see Resources below) that must be followed or the income from this plan will be treated as ordinary income. If one follows the rules, then all of the money is taxed at capital gains or losses rates, except the discounted portion of the investment. This portion only is taxed as ordinary income. Non-qualified plans simply allow employees to buy stock through payroll deduction and no special taxation process is available for them.
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Benefits
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Employees benefit by regularly saving money through a payroll deduction. Even though the money they use to buy the stock is taxed at the regular rate, the company usually discounts the stock, sometimes as much as 15 percent. Some companies provide another benefit called a "look back feature." In this scenario, the company looks at the stock on the day the employee is to buy it and compares this with the price on the day the offering was made. The employee buys the stock at the lower price and the discount still applies.
Considerations
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Keep in mind that employees can change the amount deducted from their paychecks at any time during the offering period. Employees can also change their minds about the investment and elect to have their money returned to them anytime prior to actually purchasing the stock. The company may have a cut-off date to do this, typically a week before purchase, so ask if that applies to your program.
Warnings
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Do not rush into an employee stock purchase plan because you think it is a good deal. Make sure you know the tax implications in cases where you sell the stock too soon or otherwise break the rules. Consult with your tax advisor and the human resources manager at your company before making the purchase. If you go into the program with knowledge, it can be beneficial to your overall portfolio.
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