The Employee Stock Purchase Plan is Part of Your Compensation

If you work for a publicly traded company, you might have access to an Employee Stock Purchase Plan (ESPP). ESPP’s allow you to purchase your company’s stock at a discount. The stock is purchased on a periodic basis, and is funded through payroll deductions.

Sounds like a decent way to reinvest in your company, right? This is how I used to think about my company’s ESPP. But then I thought about it some more, and made a realization:

Your Employee Stock Purchase Plan is part of your compensation.

The discount you receive is literally taxed as W-2 income. In other words, if you don’t participate in your employer’s ESPP, you are leaving money on the table. Also, there is a potential ‘bonus opportunity’, depending on stock price fluctuations during the stock purchase period. That is why my ESPP is a key feature in the Investing Hierarchy that I follow on my path to financial independence.

Let’s dig into the details of the ESPP, to see why you should be taking advantage of this plan.

Disclaimer – I’m not a tax professional, I’m only speaking from my experience and understanding of how ESPP’s work. Of course, you should talk to your accountant or financial advisor if you have more questions.

Additional Disclaimer – There is an entire facet of ESPPs concerned with tax treatment based on holding period. Essentially, if you hold your stock purchase for a certain period of time, it becomes a ‘qualified disposition’ and a portion of the gains can be taxed as long-term capital gains. I am advocating selling your shares immediately after they are granted, so I will not be talking about any special tax treatment. Please see this TurboTax article on holding periods and tax treatment of ESPPs.

The Basics: what is an Employee Stock Purchase Plan?

Here’s how ESPP’s work:

  • The plan is divided into enrollment periods, each of which is typically between 3-12 months.
  • You opt into the program for an enrollment period, and choose how much you’d like to contribute. There is a contribution limit (dollar amount, or percentage of salary).
  • Each pay period, your contribution is deducted from your paycheck and held in escrow for the eventual stock purchase.
  • At the end of the enrollment period, the money set aside from your paycheck is used to purchase stock, with a discount applied (typically 5-15%).
  • The purchase price is normally based on the fair market value of the stock on either the offering date or the purchase date, whichever is lower. This your potential ‘bonus.’
  • Once the purchase is completed, you will have the option to sell your shares at any time after purchase. I’m recommending to sell immediately, which locks in your gain.

Important Terms Associated with the Employee Stock Purchase Plan


Enrollment Period: the period of time during which payroll deductions take place, spanning from the offering date to the exercise or grant date.

Offering Date: the first day of the enrollment period.

Exercise / Grant Date: the last day of the enrollment period.

Fair Market Value (FMV): the stock price on a given date (offering, exercise, sale)

Bargain Element: the value of the stock purchase discount, which is calculated as (# shares x price per share x discount %). The bargain element is taxed as ordinary income.

How to Calculate your ESPP Return

Now, the fun part. Let’s figure out what your return will be on your stock purchase, and show some examples covering different scenarios.

For example, if your discount is 5%, your return equals 0.05/(1-0.05), or 5.3%. If your discount is 15% (like mine), your return will be 17.6%. I repeat: a 17.6% return on investment, with essentially no risk.

To calculate the dollar value of the return, just multiply your ROI by the maximum allowed contribution. I can invest $10,000 in my company’s ESPP yearly, which means my return is ($10,000 x 17.6%) = $1,760. If my salary was $50,000, this would represent a 3.5% increase in compensation. Not bad!

However, make sure to mind transaction fees. My first ESPP broker charged $30 to sell shares, plus an additional $0.10 per share sold. What a ripoff! Thankfully, we are now with a larger broker that charges a flat $4.95 fee per sale.

Stock Price Fluctuations – Your ‘Bonus Opportunity’

As mentioned above, your purchase price is normally the lesser of the FMV on the offer date and exercise date. If the stock price falls during the enrollment period, you get it for the exercise date price + discount. If it appreciates, you get it for the lower offer date value + discount.

Let’s look at three scenarios, which cover the 3 outcomes ESPP investing.

3-month enrollment period, $2,500 maximum contribution per enrollment period, 15% purchase discount

#1: stock price decreases 20% during enrollment period

#2: stock price doesn’t change

#3: stock price appreciates 20% during enrollment period

The effect of stock price change on ESPP return

Basically, if your company stock price declines during the enrollment period, your return is unchanged. However, if the stock appreciates during the same period, the increase goes directly to your bottom line.

The following profit/loss chart illustrates more clearly the effect of stock price change on total return.

ESPP Return vs. Stock Price Performance (15% discount)

Again, the base-case scenario is the calculated return, but the upside is not capped. This is part of the draw of ESPP’s: no meaningful downside, with upside potential.


Previously, I thought of my Employee Stock Purchase Plan as a way of investing in my company. The company probably looks at it the same way. I’m literally invested in the future success of the corporation.

However, I think this is the wrong mindset. If the company wants to tie part of my compensation to a stock purchase discount that is (almost) immediately redeemable, then I can play the game. I contribute the maximum each enrollment period, and sell on the first day after the shares are purchased to lock in my gain. On top of this, I have a chance at a ‘bonus’ with no additional risk taken.

I hope you this post helps you to understand Employee Stock Purchase Plans better, and I hope it will encourage you to claim this part of your compensation from your employer. Make your ESPP part of your investing hierarchy. Cheers!

4 thoughts on “The Employee Stock Purchase Plan is Part of Your Compensation”

    • Agreed! My favorite comment is when people say, “yeah, but I have to pay taxes on all of the earnings” when referring to ESPPs or bonuses. Unless your effective tax rate is 70%, who doesn’t mind earning more and paying taxes on it??


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