ESPP Planning/Strategy
Having/creating a plan for your ESPP improves your decision making
Developing a Strategic Plan For Your ESPP
ESPPs are different relative to other forms of stock-based compensation. ESPP plans are predominately only offered by publicly-traded companies, are generally available on the same basis and amounts to every employee, and most have a cap regarding how much you can invest/participate. Because of this, how one creates a strategic plan for an ESPP also differs significantly from other types of stock-based compensation. Most notably is that due to the capped participation size, an ESPP is unlikely to have a material impact on your financial plan.
You Have 2 Key Decisions to Make With ESPPs
Unlike other forms of stock-based compensation that are granted to you, ESPPs are optional programs you can elect to participate in (or not). And if you opt to participate, there are generally both (1) built in benefits to doing so (but not always), and (2) potential tax benefits you can strategically target (if it makes sense to do so) once shares are purchased.
(1) Should You Participate in Your Company ESPP?
ESPP plans usually have one or two unique benefits associated with them that encourage participation: (i) a lookback provision, and/or (ii) a discounted purchase price. More details are available in the links, but at a high level the lookback provision provides the opportunity to purchase stock at the lower of the price at the beginning of the offering period or the end; and the discount purchase price is exactly what it sounds like (purchasing shares at a discount to their current price).
The decision to participate in an ESPP (or not) largely hinges on the unique benefits. About 80% of ESPPs are qualified ESPP plans, and the most common of these generally (i) do have a lookback provision, and (ii) allow the IRS maximum of a 15% discount on the purchase price. While every decision depends on the circumstances, our general guidance to clients is:
You should participate if your company offers: (i) a 5% discount and a lookback, or (ii) a discount of 10% or more (a lookback as well is an added bonus). In these circumstances, the discount essentially provides an immediate return on your investment and can be very close to “free money” if you sell the shares immediately after purchasing them. And the lookback is a "free option" that may add considerably more value to you.
(2) If You Participated, Should You Hold or Sell Your ESPP-Purchased Shares?
If you participated in an ESPP plan, you will eventually own shares purchased through the plan. And this leads to your next strategic question: should you sell or continue to hold your shares? Again, while every decision depends on the circumstances, our general guidance to clients is:
| Circumstance | Recommendation | Reasoning |
|---|---|---|
(1) ESPP is a qualified plan, and (2) shares are flat or down during the period | Sell 100% of the shares as soon as they are purchased | There is minimal tax benefits to be attained from holding the shares. Selling immediately allows you to reduce concentration risk and capture proverbial "free money" from buying at a discount |
(1) ESPP is a qualified plan, and (2) shares are up notably during the period | Depends on circumstances. You may consider holding or sell immediately | In this case there may be notable tax benefits from holding the shares until you achieve a qualifying disposition. These benefits need to be considered against the investment risk of holding the shares (including your other holdings in company stock) |
ESPP is an unqualified plan | Sell 100% of the shares as soon as they are purchased | There are no additional future tax benefits associated with holding the shares; the discount upon purchase (including a lookback, if any) is taxed as ordinary income on the purchase date. |
ESPP Taxation & Strategies
How ESPP Taxation Works. An overview of how ESPP taxation works
ESPP Tax Strategies. A guide to different ESPP tax strategies that may apply, depending on your situation and plan
Income Tax Strategies. A guide to 9 different income tax strategies that may apply (given the sale of ESPP stock triggers at least some income tax), depending on your situation and plan
Related Pages
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