Qualified vs Non-Qualified ESPPs

An Employee Stock Purchase Plan (ESPP) can either be qualified or non-qualified.

Qualified ESPPs

A qualified ESPP is a plan that meets the criteria outlined in Section 423 of the Internal Revenue Code (the "Code") and allows employees to purchase stock at a discount from fair market value without any taxes owed on the discount at the time of purchase. Employees may receive favorable tax treatment if they hold the shares acquired under the ESPP for at least two years from the grant date and one year from the purchase date. If this holding requirement is met, then when the shares are sold, the excess of the sale price over the purchase price (the actual gain) is taxed as long-term capital gain. If the purchase price is less than 100% of the fair market value of the shares on the purchase date, then the discount is taxed as ordinary income.

Non-Qualified ESPPs

Non-Qualified ESPPs are plans that do not meet the criteria outlined in Section 423 of the Code. A non-qualified ESPP may be structured like a qualified ESPP, or it may offer different benefits from a qualified ESPP, but without the preferred tax treatment for employees. Under a non-qualified ESPP, when the shares are purchased, the excess of the fair market value of the shares at the time of purchase over the purchase price (the spread) is taxed as ordinary income. Any additional gain or loss when the employee sells the shares is taxed as capital gain or loss. 

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