Will Stock Purchase Plans Be Subject to Withholding?

In an employee stock purchase plan (ESPP), employers typically allow employees a discount of up to 15% of the purchase price of the shares. Often, employees have a choice of the price of the shares, minus 15%, at the time they enroll in the program, or the price at exercise (often again with a discount). No tax is due on exercise, and if the employee holds onto the shares for two years after grant and one year after exercise, gains made above the discount price are taxed as capital gains, while the discount is taxed as ordinary income. If the terms are not met (a disqualifying disposition), the ordinary income tax is dues on the entire amount.

Under current practices, employers generally do not withhold taxes on the discount element of the option when an employees exercises the option to buy shares. Employers theoretically should always withhold on an amount equal to the discount plus any subsequent gain in the case of disqualifying disposition, but employers do not always know a departed employee has made a disqualifying disposition.

A ruling by the IRS could change this. In a review of Micron Technology, the IRS ordered the company to pay withholding taxes for FICA and income tax purposes both on the discount element at the time of exercise and the entire spread on disqualifying dispositions under its ESPP. Micron is appealing the decision to a U.S. Court of Federal Claims.