Workplace Equity Compensation: What you need to know about Employee Stock Purchase Plans

By The Lerner Group on November 24, 2021

Welcome to the mini-series on Workplace Equity Compensation. Whether you’re at a Fortune 500 company or start-up, equity has become an important part of the total compensation conversation. Companies are increasingly using equity to attract and retain top talent while aligning the company’s goals with employees. For Millennials, 41% of their total net worth is tied to company stock, and 36% are building their retirement plans around equity compensation[1]. In the next few posts, Wealth Advisor and Head of Financial Planning, David Sokolovsky and I will be reviewing different types of equity compensation packages and what you should know about each, from acquisition to liquidations and tax considerations along the way.

A typical scenario

I was recently talking with a friend who quit his consulting job to take a financial management position at a large tech company. Outside of my friends’ excitement for exchanging New York winters for sunny California, he was thrilled that his offer included a significant amount of company stock. My advisor instincts immediately kicked in and I began to ask a few questions: “Are there any restrictions on the shares? Will you receive the shares all at once? Is there is a vesting schedule?” Like most people, my friend didn’t know the answers; he simply looked at the number of shares and skipped over the fine print.

This situation is becoming increasingly common. Companies have several methods of incorporating stock into compensation packages including direct grants, options, Employee Stock Ownership Plans (ESOPs), and Employee Stock Purchase Plans (ESPPs). Each of these methods provides employees different ways of acquiring stock which also means there are various ways these shares are treated for tax purposes. For this post, we will focus on Employee Stock Purchase Plans.

As the name suggests, Employee Stock Purchase Plans allow employees to buy shares directly from the company. If your employer does offer this type of plan, all of the details should be available in the plan document. Below are key questions to help you get a better understanding of how the plan works.

Should I participate in the plan?

The first thing to consider is whether you should participate in the plan. To answer that question, it is important to evaluate your current financial situation. Returns are not guaranteed, and if there is a need for liquidity in the short term, the investments may not be appropriate. The amount invested should also align with risk tolerance. If you are a more aggressive investor and your company stock is considered a value stock, buying shares may not fit your investment narrative. That being said, most plans offer a discount that is hard to match in the market as an individual investor.

How do I purchase shares?

The first thing to do is to complete the company’s enrollment process to enter the plan. During enrollment, you will elect either a dollar amount or percentage you want to be taken from your paycheck to buy shares.

What are key dates of the plan?

The key periods to identify are Option Dates and Exercise Dates. Option dates typically occur quarterly or semi-annually and allow employees to either elect or decline purchasing shares. This will impact how long the contributions to the plan are being made. Exercise Dates and are when shares are purchased on behalf of the employee. The purchase price may change between when you elect to participate in the plan and when shares are bought.

How many shares can I buy?

Companies will generally have either a dollar or share limit that employees can put towards share purchases. Part of this is regulatory as the IRS limits an employee’s contribution to $25,000.00 per year.

How many shares should I buy?

Once enrolled in your company’s ESPP, you will have to decide how much to invest. We recommend taking a look at your overall cash flow. While we encourage saving and investing, if putting a larger dollar amount into the plan is stretching your everyday finances a little thin, it is okay to buy fewer shares or no shares at all. If you have extra room in your budget to put away money into the ESPP, start with a figure you are comfortable with. As time goes on and your situation changes, you can always increase or decrease that amount to align with your goals.

What price do I pay for the shares?

Most ESPP’s provide a discount to employees and a common discount amount of 15%. Companies will hold shares for the ESPP and can provide discounts as an indirect cost of compensation.

When can I sell my shares?

Most plans will require you to hold on to your shares for at least one year after purchasing them. There are exceptions for company insiders and hardship that may shorten that time frame. However, holding the shares for longer than one year allows sales to be treated as long-term capital gains for tax purposes.

The excitement of a new job makes it easy to overlook these details. If you’re ever in doubt, reach out to an advisor or tax consultant for guidance.

[1] https://content.schwab.com/web/sps/sps_employee_study/