What Is an Employee Stock Purchase Plan (ESPP)? How It Works, Examples

A plan runs in offering periods, stretches of time during which money is collected from your pay. On the first day of an offering you are, in tax terms, granted an option to buy shares. During the offering the company takes money from each paycheck and holds it. On each purchase date, it uses the money collected so far to buy whole shares for you at the plan price. The shares then land in your brokerage account. Under the regulations, the grant date is the first day of the offering.

The price is where the value sits. Section 423 lets the plan set it as low as 85% of the share price. With a lookback, it can be 85% of the lower of two prices: the price on the offering date and the price on the purchase date. If the stock rose during the offering, you buy at a discount to the old price. If it fell, you buy at a discount to the new one.

What Is ESPP Stock?

ESPP stock is ordinary common stock of your employer, bought through the plan. Once purchased, the ESPP shares are yours outright. There is no vesting, and you do not lose them if you leave. What follows them is their tax history: the offering date, the purchase date and the price paid. That history decides how the sale is taxed.

What Is ESPP Overlap?

Some plans run long offerings with several purchase dates and start a new offering before the last one ends. These are overlapping offerings. Many such plans add a reset. If the price on a purchase date is below the price at the start of your offering, you are moved into the newer, lower-priced one. Whether your plan overlaps or resets is a plan term. The law only caps an offering at 27 months, or five years if the price is never below 85% of the purchase-date value.

The ESPP deduction on your paystub is your own money, set aside to buy shares on the next purchase date. It is taken after tax. The contribution does not reduce your taxable wages. Your basis in the shares, the starting value for measuring a gain, is the price you pay for them. If you leave or withdraw before a purchase date, most plans return the money held so far.

How Is Your ESPP Contribution Set at Enrollment?

ESPP enrollment happens before an offering starts, in a window the company announces. You choose an ESPP contribution, usually as a percentage of pay, up to the plan’s cap. The legal ceiling sits above that. You may not build up the right to buy more than $25,000 of stock per calendar year, valued at the offering date. Plans may also cap the number of shares per purchase.

Not every employee may join. Anyone who owns 5% or more of the company’s voting power or value is excluded. A plan may also exclude people with less than two years of service, those working 20 hours a week or less, or five months a year or less, and highly compensated employees. Everyone else must be offered the same terms.

Under a qualified plan, nothing is taxed when you enroll or when shares are bought. The tax comes in the year you sell. How much of the gain is ordinary income depends on whether the sale is a qualifying disposition. That needs two things: more than two years from the offering date and more than one year from the purchase date.

Qualifying disposition

Ordinary income is the lesser of the discount measured at the offering date or your actual gain. The rest is long-term capital gain.

Disqualifying disposition

A sale before both periods are met. Ordinary income is the value on the purchase date minus the price you paid, even if you sold for less. The rest is capital gain or loss.

Sale at a loss after qualifying

No ordinary income at all. The loss is a capital loss.

The ordinary income appears on your W-2. But no Social Security, Medicare or income tax is withheld on it, as IRS Publication 5992 notes. The company sends Form 3922 after a purchase, which records the dates and prices you need. A plan that does not meet Section 423 is a non-qualified ESPP. In that case the discount is taxed as wages when the shares are bought.

An offering starts with the stock at $20. You contribute $10,000 over six months. On the purchase date the stock is $30. With a 15% discount and a lookback, the price is 85% of $20, or $17. So you buy 588 shares. Your limit for the year is $25,000 ÷ $20, or 1,250 shares, so the purchase fits. You later sell at $35.

The total gain is the same either way. The split differs. The quick sale turns $7,644 into ordinary income, and the patient one only $1,764. The cost of waiting is the price risk on $20,580 of one employer’s stock for well over a year.

Nothing in Section 423 requires a listed company. A private company employee stock purchase plan is possible, and a few exist. Four practical problems explain why they are rare. First, the price. Every purchase date needs a fair market value. Without a market, that means an appraisal like the 409A valuation used for option prices.

Second, securities law. A company that does not file reports with the SEC, the US securities regulator, usually relies on Rule 701 to sell shares to employees. The rule caps sales in any 12 months. Above $10 million, it requires the company to give employees risk disclosure and financial statements. Third, the shares cannot be sold. Transfer restrictions and a right of first refusal, the company’s right to buy shares first, leave employees holding stock bought with salary until a tender offer or an exit. Fourth, the plan was built around selling. The lookback discount is worth most to someone who can sell on the purchase date.

So private companies pay employees in RSUs, promises of shares that vest over time, and in options instead. The differences between option types are on ISO vs NSO. A company preparing to list can adopt an ESPP before the IPO, so that the first offering starts once there is a market price. Whether shares bought in that first offering can be sold right away depends on the lock-up agreements and the company’s trading policy. Section 423 does not decide it.

• Counting the holding period from purchase onlyA qualifying sale needs two years from the offering date as well as one year from purchase. Check both dates on Form 3922.
• Using the broker’s basisThe broker’s Form 1099-B usually shows only what you paid. The ordinary income on your W-2 must be added on Form 8949, or the same income is taxed twice.
• Expecting withholding to cover itNothing is withheld on ESPP income. A large disqualifying sale can leave a bill in April.
• Holding for tax and ignoring concentrationSalary, unvested awards and ESPP shares all depend on one company. The tax saving is small against a price fall.
• Joining a private-company plan as if the shares were easy to sellShares bought with salary may be unsellable for years. Read the transfer restrictions before you enroll.

Employee stock purchase plan (ESPP)

A plan that lets employees buy company shares from payroll deductions, usually at a discount. A qualified plan meets Section 423.

Offering period

The span over which contributions are collected under one grant. The first day is the grant date for tax purposes.

Purchase date

The day the money collected buys shares at the plan price. An offering may have several.

Lookback

A price set on the lower of the value at the offering date and at the purchase date, before the discount.

Qualifying disposition

A sale more than two years after the offering date and one year after purchase. Only the grant-date discount is ordinary income.

Disqualifying disposition

A sale before both holding periods are met. The whole purchase-date discount is ordinary income.

Basis

The starting value used to measure a gain or loss on a sale. For ESPP shares it starts at the price you paid.

Form 3922

The form the company sends after an ESPP purchase. It records the dates and prices you need for tax.

RSU

A promise of shares on vesting. It is the usual equity award at private companies that do not run an ESPP.

Every rule and limit was checked against the US Code, the Treasury regulations and the IRS on October 2, 2026. They apply to tax year 2026. Plan terms vary by company and are described as such. The worked example is illustrative arithmetic and uses no market data.