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Employee stock purchase plans allow companies to offer discounted stock to employees, with contributions deducted from their pay. Depending on how long the stock is held, it may qualify for preferential tax treatment. Employee stock ownership plans are used by start-ups to compensate employees and give them a stake in the company’s success. Stock options may be exercised at the employee’s discretion and are taxed as earned income when sold. Non-qualified stock options do not qualify for favorable tax treatment.
An employee stock purchase plan is a way for a company to offer stock to its employees at a discount. The shares can be offered at a discount of up to 15% off the market price at the time of the offer. Employee contributions are typically deducted from their pay and stock purchased for them at a later, specified date. Depending on how long the employee has held the stock, purchases made under an employee stock purchase plan may be considered qualified, or eligible for preferential tax treatment, by the Internal Revenue Service in the United States.
Employee stock purchase plans may be restricted or regulated by tax or securities law. In the United States, employees must hold the shares purchased under the plan for at least one year from the date of purchase and two years from the date the option is granted in order for the gain to qualify for favorable tax treatment. When an employee resells shares purchased under an employee stock purchase plan, it is typically an exempt transaction in the United States, because the number of shares is relatively small. This means you do not need to file with the Securities and Exchange Commission. The sale of shares acquired in an employee stock purchase plan will sometimes qualify for favorable tax treatment and is known as a qualifying disposition.
Sometimes employees are given the option to buy company stock at a certain price over a period of time. This is known as an employee stock ownership plan and is often used by start-up companies as compensation in lieu of a higher salary and to give employees the opportunity to share in the company’s future success. An employee stock option may be exercised at the employee’s discretion and will usually be exercised if the stock price exceeds the option price. Stock options typically expire when the employee leaves the company.
If an employee is awarded a stock option in lieu of compensation, it is usually considered a non-qualified stock option. In this case, the difference between the option price and the sale price is taxed as earned income when the stock is sold. The company receives a tax deduction for earned income. This type of transaction does not give the right to favorable tax treatment as the option is considered a compensation to the employee.
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