Weighing the Benefits of an Employee Stock Purchase Plan

December 17, 2019 Sara Pinkus

Have you been circling the idea of adopting an employee stock purchase plan (ESPP)?  While there’s more that needs to happen to get you from the initial consideration through to plan execution (board approval, for example), gathering as much information in the initial stages can only benefit you in the long run.

So, why an ESPP? This specific plan type has been gaining popularity over the last few years. In Deloitte’s 2020 Employee Stock Purchase Plan survey, over half of respondents said their company offers an ESPP to their employees, with financial/insurance (63%) and computer related industries (69%) leading the way – and an additional 21% were considering implementing a plan.[1]  But before we exploring the why, let’s look at the what.


What is an ESPP?

At a basic level, an ESPP is an equity program offered to eligible employees that gives them an opportunity to buy company stock at a price that is more advantageous than what is offered to the general public. This can be accomplished in several ways, including a discount on the share price, a dollar match from the employer (you contribute $X, the company matches with $Y) or a stock match (you buy X shares, the employer matches with Y shares). Dates are important in an ESPP: there’s the enrollment date, when employees enroll in the plan.  The enrollment date is followed by the offering date, which signals the start of the payroll deductions that allow participating employees to contribute funds to the plan. The purchase date is when the employee’s accumulated funds are used to make the stock purchase.

In the US, there are two different types of employee stock purchase plans: qualified plans, and non-qualified plans. The differences can get complicated but, generally speaking, qualified plans offer an incentive to keep shares longer (for preferential tax treatment), whereas a non-qualified plan isn’t subject to as many restrictions. A non-qualified plan may be a better choice for companies with no or limited US participants as the tax advantages of a qualified plan are limited to US taxpayers.

A qualified plan must meet Section 423 requirements (a specific part of the tax code), so if you’ve heard someone say ‘a 423 ESPP’ they’re referring to a qualified plan.  These plans typically include a discount on the purchase price of the shares for participating employees, lookback provisions, and additional restrictions on what’s considered a qualifying disposition of shares. 

Benefits of an ESPP

There are many benefits to an ESPP, regardless of the type of plan you choose (qualified vs. non-qualified). A primer on the main benefits is included below but see what else you find as you research the plan with your company’s specific needs in mind.

  • Increasing Employee Investment: Generally speaking, a purchase plan is a great way for employees to gain or increase ownership in their company, and it can be an easy way to help employees dip their toe into the world of investing and stock ownership. According to Deloitte’s survey, the majority of participants hold the shares for an average of one year or longer, indicating that the shares are part of a longer-term strategy.[1]
  • Increased Employee Retention: Increased ownership typically means an increase in loyalty, helping with employee engagement and retention efforts.

Benefits of a Qualified ESPP

The restrictions surrounding a qualified plan can seem daunting – they control how long shares must be held prior to sale in order to gain the preferential tax treatment. However, many companies with US participants are finding it a successful way of engaging their employees due to the benefits outlined below:

  • Share Purchases at a Discount: Depending on the specifics of the plan (e.g., the discount rate, any lookback provisions), employees may be able to purchase shares at well below the market rate.  This leads them to potential gains further down the road (as part of their overall financial strategy). 
  • Tax Advantages: Under a qualified plan, no US federal income tax is due when the shares are purchased.  Tax is due when the shares are sold. If the participant meets the holding requirements, the amount of ordinary income (versus capital gain) is limited – which may be a significant tax savings under the right circumstances.
  • Potentially eliminate uncertainty in volatile markets:  2020 brought a great deal of uncertainty to the market, and employees may be reluctant to participate in an ESPP.  A 423 plan with a discount and a lookback can provide participants a path to an almost certain return on their investment. By selling shares immediately after the purchase, the market volatility is eliminated, and the participant earns the “discount” as ordinary income. Although this quick selling (a disqualifying disposition) eliminates the long-term tax advantage of a 423 plan, it is one way for participants to earn a definitive rate of return – a comforting thought in an uncertain environment.

As you can see, the benefits are significant, but don’t forget the associated restrictions – this is why comprehensive research is needed before plan launch. 

Benefits of Non-Qualified Plans

Some people like to operate more freely – if that’s you, then a non-qualified plan might be a good choice for the benefits described below:

  • Less Administrative Risk: Since non-qualified plans aren’t subject to the same restrictions as a qualified plan, there may be less of an administrative burden on the administrator, permitting creative alternatives such as using a match instead of a discount.
  • Tax at Purchase: All relevant taxes on a share purchase made through an ESPP purchase are due at purchase; this eliminates the need for tracking or for uncertainty for participants when they do eventually decide to sell.

A second but equally important component of any ESPP (qualified or non-qualified) is employee communication and education – because the plan will likely be unfamiliar to many of your employees, a concentrated education effort is necessary to ensure they understand the plan and what they need to do to gain the benefits.  

Depending on your goals and your employee population, an ESPP may be a perfect fit for your company. However, before you implement, you should consider all of the facts, using this overview as your starting point.

Looking for technology to help you manage an ESPP, or any other equity type for that matter?  Shareworks can help!  We simplify plan management for companies of all sizes, helping ensure a smooth and secure workflow for all involved.  Take a tour and learn more today.


[1]Source: 2020 Domestic Stock Plan Administration Survey, cosponsored by the NASPP and Deloitte Consulting LLP



About the Author

Sara Pinkus

Sara is a content marketing manager at Shareworks by Morgan Stanley, with over five years of experience in the equity compensation space. She helped redesign the Shareworks Certification program in 2016, and is excited to help share the organization's knowledge expertise with the industry.

Previous Article
Your Equity Plan Management Checklist
Your Equity Plan Management Checklist

Find out which equity plan solutions suit your company's needs with our free equity plan management checklist.

Next Article
What to Consider When Globally Expanding Your Company’s Equity Plan
What to Consider When Globally Expanding Your Company’s Equity Plan

Shareworks by Morgan Stanley, Morgan Stanley Smith Barney LLC, and its affiliates and employees do not provide legal or tax advice. You should always consult with and rely on your own legal and/or tax advisors. Shareworks by Morgan Stanley services are provided by Morgan Stanley Smith Barney LLC, member SIPC, and its affiliates, all wholly owned subsidiaries of Morgan Stanley.

CRC 3425089 (02/21)