A type of compensatory plan that allows employees to purchase company stock, generally at a discount from the market price.

An ESPP allows employees to purchase shares of company stock through automatic deductions from their paychecks. Contributions are accumulated during a specified period (offering period), and the company uses the funds to purchase shares on the employee's behalf on pre-determined purchase dates. Under most plans, the purchase price is a discounted price, generally up to 15%. Some plans include a "look-back" feature, which compares the share price at the beginning and end of the offering period and uses the lower price to determine the purchase price.

ESPPs can be qualified or nonqualified. Under a qualified ESPP, 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. Under a nonqualified 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.

A qualified ESPP must meet certain requirements under Section 423 of the Internal Revenue Code. For example, the plan must generally cover all full-time employees with at least two years of service.