The short answer
An employee stock purchase plan (ESPP) under section 423 lets you buy your employer's stock, often at a discount of up to 15%. You owe no tax when you buy. When you sell, part of your profit may be ordinary income (wages) and the rest a capital gain or loss. How it is split depends on whether the sale is a qualifying or disqualifying disposition.
Section 423 plans: the basics
- ESPP options are statutory stock options. You must be an employee of the company (or a related company) from the grant date until 3 months before you exercise, and the option must not be transferable except at death.
- The option price can be as low as 85% of the stock's value. Some plans use the lower of the value at the start of the offering period (grant) or at the purchase date (exercise).
- Your basis starts as the price you paid. The timing of payroll deductions does not affect basis, and your holding period begins the day after the purchase.
Qualifying vs. disqualifying dispositions
| Qualifying disposition | Disqualifying disposition | |
|---|---|---|
| When | After the later of 2 years after the grant date and 1 year after the shares were transferred to you | Any earlier sale or other disposition |
| Ordinary income (wages) | If the option was granted at a discount: the lesser of (1) the stock's value at grant minus the option price, or (2) the sale price minus what you paid | The stock's value on the purchase date minus the price you paid — not limited to your gain |
| Capital gain or loss | Sale price minus (price paid + ordinary income) | Sale price minus (price paid + ordinary income) |
| If you sell at a loss | Capital loss, and no ordinary income | You still have the ordinary income, plus a larger capital loss |
For a qualifying disposition, if the option price was not fixed at the grant date (as in a plan that uses the lower of two prices), Publication 525 says to figure the option price as if the option had been exercised at the grant date.
Examples (illustrative)
Facts for both examples: Ana's offering period starts on January 2, 2024 (the grant date), when the stock is worth $40. On June 28, 2024 (the purchase date), the stock is worth $50. Her plan price is 85% of the lower of the two values: 85% × $40 = $34. She buys 100 shares for $3,400.
Qualifying disposition: she sells all 100 shares on March 16, 2026, for $60 a share. That is after January 2, 2026 (2 years after grant) and after June 28, 2025 (1 year after purchase).
| Step | Amount |
|---|---|
| Sale proceeds (100 × $60) | $6,000 |
| Total gain ($6,000 − $3,400) | $2,600 |
| Discount at grant: $40 − ($40 × 85% = $34), × 100 shares | $600 |
| Ordinary income: the lesser of $600 or $2,600 | $600 |
| Adjusted basis ($3,400 + $600) | $4,000 |
| Long-term capital gain ($6,000 − $4,000) | $2,000 |
Disqualifying disposition: instead, she sells all 100 shares on September 15, 2025, for $60 a share — before January 2, 2026.
| Step | Amount |
|---|---|
| Ordinary income: ($50 value on purchase date − $34) × 100 | $1,600 |
| Adjusted basis ($3,400 + $1,600) | $5,000 |
| Capital gain ($6,000 − $5,000) | $1,000 |
| Holding period: June 28, 2024 to September 15, 2025 | More than 1 year, so long-term |
Disqualifying sale at a loss: if she had sold on September 15, 2025, for $45 a share ($4,500), she would still have $1,600 of ordinary income, and a capital loss of $500 ($4,500 − $5,000).
Form 3922 and your Form 1099-B
Your employer should give you Form 3922. It shows the grant date (box 1), purchase date (box 2), value per share on the grant date (box 3) and on the purchase date (box 4), the price paid per share (box 5), the number of shares (box 6), the date legal title transferred (box 7), and — when the price was not fixed at grant — the price per share figured as if the option were exercised on the grant date (box 8). For options granted after 2013, the basis on Form 1099-B will not include your ordinary income, so add it on Form 8949 with code B.
Common mistakes
- Reporting the whole gain as capital gain and leaving out the ordinary income.
- Reporting the ordinary income twice — once in W-2 wages and again as capital gain because the basis was not adjusted.
- Confusing the two tests: the qualifying test (2 years from grant and 1 year from purchase) is different from the 1-year test for long-term capital gain.
- Assuming a loss means no ordinary income in a disqualifying disposition.
- Losing Form 3922. You need its dates and values to figure the split.
Forms you will see
| Form | Use |
|---|---|
| Form 3922 | Dates, values, and prices for ESPP shares |
| Form W-2 | Ordinary income from the disposition, usually in box 1 |
| Form 1099-B | Sale proceeds and the basis the broker reported |
| Form 8949 and Schedule D | Capital gain or loss, with a basis adjustment (code B) when needed |
| Schedule 1 (Form 1040), line 8k | Ordinary income not included on your W-2 |
These rules apply to employee stock purchase plans that meet section 423. A plan that does not qualify is taxed under the nonstatutory option rules. Check your plan documents. State tax treatment is not covered.