Employee Stock Purchase Plan (ESPP) Taxes: A Guide

If your company offers you a qualified employee stock purchase plan (ESPP), you have the opportunity to purchase company stock at a discount, which is an added employee benefit. What can be challenging is trying to navigate how ESPPs are taxed. In this guide, we'll help you understand the taxes on your ESPP and what documents you or your tax advisor will need to file in the United States.

In most ESPP plans, you make contributions to a stock purchase fund for a certain period of time through payroll deductions. Your employer then uses the money in the fund to purchase company stock for you at a discount of up to 15%. Generally, you don't pay taxes until you dispose of the shares.¹

The ESPP tax rules are complex and you should consult your tax advisor regarding your particular situation before reporting. But, in general, the tax treatment for ESPPs depends on how long you hold the shares before disposing of them. Transactions that are considered dispositions include sales, gifts to another person, or donations to charity. Depending on this time period, the sale (referred to as the "disposition") will be classified as either qualified or disqualified. 

When you sell ESPP shares, you typically will have ordinary income and capital gain or loss. At a high level, the differences between ordinary income and capital gain or loss are how you report the income on your tax return and the tax rate that applies.

How long you held the ESPP shares determines how you calculate the ordinary income and the capital gain or loss.

If you meet both of the following holding periods, then your sale is a "qualifying disposition":

• The sale must be more than one year from the date the ESPP shares were purchased, and
• The sale must be more than two years from the grant date for the ESPP shares (the first day of the offering period in which the ESPP shares were purchased, which you may see referred to as the "offering date" or "subscription date").

If you do not meet both holding periods, then your sale is a "disqualifying disposition."

You can find out whether shares purchased under the ESPP meet these holding periods by going to the "Equity Awards" tab and looking under the "IRS Qualification Date" heading. If the holding periods have not been met, the date they will be met is shown. If the holding periods have been met, you will see "Qualified."

If you have a qualifying disposition, your ordinary income is the lesser of:

1. 15% of the fair market value (FMV) on the subscription date of the shares purchased (0.15 x subscription FMV x number of shares sold), OR
2. The actual gain, which is the difference between the sale proceeds and the purchase price.

If you have a disqualifying disposition, your ordinary income is equal to the difference between the fair market value on the purchase date (Purchase FMV) of the shares, and the total purchase price.

Add the ordinary income to your purchase price to determine your "adjusted cost basis" for the ESPP shares you sold. The difference between your sale proceeds and your adjusted cost basis will be taxed as a capital gain or loss.

For qualifying dispositions, the capital gain or loss will always be long-term. For disqualifying dispositions, the capital gain or loss can be short-term or long-term, depending on how long you held the shares from the purchase date. Shares held for more than one year from the purchase date are long-term.

When you complete your tax return, you will adjust your capital gain or loss for the ordinary income rather than adjusting your purchase price, but the result is the same amount of taxable gain or loss.

Here are examples of how this works:

Example 1: Sarah sold ESPP shares for $81.00 per share. The subscription FMV was $53.00 per share, and the purchase date FMV was $65.00 per share. With the "lookback" feature in the ESPP, her purchase price was $45.05 per share, a 15% discount from the grant date FMV of $53.00 per share.

Qualifying Disposition: If Sarah's sale was a qualifying disposition, her ordinary income would be $7.95 per share (15% of the $53.00 subscription FMV), which is less than the actual gain of $35.95 per share ($81.00 sale price minus $45.05 purchase price). Her long-term capital gain is $28.00 per share ($81.00 sale price minus $53.00, which is the adjusted cost basis when you add the $7.95 of ordinary income to the $45.05 purchase price).

Disqualifying Disposition: If Sarah's sale was a disqualifying disposition, her ordinary income would be $19.95 per share ($65.00 purchase FMV minus $45.05 purchase price). Her capital gain is $16.00 per share ($81.00 sale price minus $65.00, which is the adjusted cost basis when you add the $19.95 of ordinary income to the $45.05 purchase price). This capital gain would be long-term if the shares were held for more than one year from the purchase date. Otherwise, it would be short-term.

Example 2: Mary sold ESPP shares for $58.00 per share. The subscription FMV was $60.00 per share, and the purchase date FMV was $63.00 per share. With the "lookback" feature in the ESPP, her purchase price was $51.00 per share based on a 15% discount from the subscription FMV of $60.00.

Qualifying Disposition: If Mary's sale was a qualifying disposition, her ordinary income will be the actual gain of $7.00 per share ($58.00 sale price minus $51.00 purchase price) since that is less than 15% of the $60.00 subscription FMV ($9.00). She has no long-term capital gain or loss because her adjusted cost basis of $58.00 ($7.00 of ordinary income plus $51.00 purchase price) is the same as her sale price.

Disqualifying Disposition: If Mary's sale was a disqualifying disposition, her ordinary income will be $12.00 per share ($63.00 purchase FMV minus $51.00 purchase price). She also has a $5.00 capital loss ($58.00 sale price minus $63.00 adjusted cost basis ($12.00 of ordinary income plus $51.00 purchase price)). This loss would be long-term if the shares were held for more than one year from the purchase date. Note: in this case Mary still must realize the entire discount as ordinary income, although she may be able to offset the $5.00 capital loss against other taxable capital gains in that calendar year. If she cannot offset the loss against other capital gains, she may be able to offset up to $3,000 of capital losses against her ordinary income.

Examples are hypothetical and for illustrative purposes only.
 

Here's an overview of the documents you may need when you're filing your taxes.

After you sell ESPP shares and prepare to file your taxes, you'll need to report ordinary income and capital gains/losses. Your employer will typically include any ordinary income from the disposition of ESPP shares in box 1 of your W-2. However, your employer is not required to report ESPP income on your W-2.

If it's not included (for example, you had a qualifying disposition and your employer did not have information about the disposition), you are responsible for reporting the income on your tax return. Ordinary income from ESPP dispositions that is not included in your W-2 (Box 1) should generally be reported as "Other Income" on Schedule 1 (Form 1040), Line 8k (or line 8 in some tax software iterations). 

Each year you purchase shares under the ESPP, you will receive a Form 3922 the following year. This form will be posted to the Accounts > Statements & Tax Forms section under the Equity Award Center Account.

Form 3922 provides information about purchases under the ESPP, including the grant date (Box 1), the purchase date (Box 2), the FMV on the grant date (Box 3), the FMV on the purchase date (Box 4), the purchase price (Box 5) and the number of shares purchased (Box 6). The grant date and FMV on the grant date are labeled Subscription Date and Subscription FMV in the Equity Award Center. Keep this document as it contains important information you will need when you prepare your taxes after you dispose of these specific ESPP shares.

When you prepare your tax return, you'll use several forms to report your investment transactions and calculate your capital gains and losses. First, you will enter information from Form 1099-B into Form 8949. Next, you will use information from Form 8949 to complete Schedule D. Finally, use information from Schedule D to complete Form 1040.

Here's an illustration showing how these documents work together when reporting stock sales:

In February of each year, Schwab will provide Form 1099-B that will include information for all taxable transactions that took place in your Equity Award Center account, including sales of ESPP shares.

This Statement will be posted to the Accounts > Statements & Tax Forms> Equity Awards Center in the 1099 Dashboard. As shown in the screenshot below, this statement shows the cost basis of shares you sold as well as the proceeds from those sales.

In accordance with IRS rules, the cost basis shown on your 1099-B for shares you purchased under the ESPP will not include any ordinary income you recognized when you sold the shares, and you will need to adjust your gain or loss to avoid paying tax twice on this amount.

Below is a graphic showing what your Form 1099-B could look like and has notes to show what information you would transfer to Form 8949.

Note: Do not use the information in this example. This sample form is not a full 1099 Composite statement, and Schwab has focused on the areas where stock plan transactions will be displayed for demonstrative purposes only.

Use Form 8949 to report the details of each stock sale shown on your 1099-B and any other capital asset transactions. Form 8949 has two parts—one for short-term capital gains and losses and one for long-term capital gains and losses. You will need to file a separate copy of Form 8949 for each group of short- or long-term transactions for which you need to check a different box.

The following graphic shows how to complete Form 8949 using information from your Schwab 1099-B and year-end statement for short-term sales of ESPP shares purchased while Schwab was administering the ESPP.

The same principles apply to reporting long-term transactions shown on your 1099-B from Schwab as shown above for short-term transactions, except that you will use Part II for Form 8949 and check box D as shown below.

Schedule D reports your capital gains or losses using totals from Form 8949.

The following graphic shows how to complete Part I of Schedule D.

The same principles apply to reporting long-term transactions shown on your 1099-B from Schwab as shown above for short-term transactions, except that you will use Part II for Form 8949 and check box D.

If you gift ESPP shares or donate ESPP shares to a charity, you still recognize ordinary income at the time of the gift or donation, but you will not recognize capital gain or loss. As a result, you do not report the gift or donation on Form 8949 or Schedule D.

For both disqualifying and qualifying dispositions, the amount of ordinary income will be included in Box 1 of your W-2 from your employer, if information about the disposition is available to your employer. If your employer does not include the ordinary income in your W-2, you must still report it on your tax return. Ordinary income from ESPP dispositions that is not included in your W-2 (Box 1) should generally be reported as "Other Income" on Schedule 1 (Form 1040), Line 8k (or line 8 in some tax software iterations).

The ordinary income associated with a gift or donation is calculated as described above for dispositions of ESPP shares, except that instead of using a disposition price, the calculation uses the closing fair market value of the ESPP shares on the date of the gift or donation.

Stuck with questions? Call 800-654-2593 Monday through Friday to get answers to your equity award questions.

Schwab does not provide tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Consult a tax advisor to address your specific circumstances.

¹ Not all states recognize the federal preferential tax treatment of a qualified ESPP sale.