What are the tax benefits of ESPP?

The key tax benefits of an Employee Stock Purchase Plan (ESPP) involve favorable treatment of both the discount received and potential capital gains:

1. Discount Taxation: The 15% discount typically offered on the stock is treated as ordinary income for tax purposes. This means you'll pay taxes on the discount when you purchase the stock, but it can still be considered as "free money" from the employer 1.

2. Capital Gains: If the stock is held for more than two years, any gains on the stock beyond the initial discount are taxed at long-term capital gains rates, which are lower than ordinary income tax rates. This can result in significant savings 2 3.

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3. Timing and Strategy: The importance of holding onto the stock for more than a year, or ideally the full two-year period, cannot be overstated, as it ensures you benefit from the lower long-term capital gains tax rate of around 15% 1 4.

4. Diversification and Risk Management: Experts like Brad Barrett recommend selling the stock as soon as the holding period is over to avoid over-concentration in your employer's stock, which can be risky if your employment and a significant portion of your wealth are tied to that company 3.

These points underscore the tax advantages of ESPPs, making them a valuable component of an overall financial strategy when managed correctly.