Equity compensation · Section 423
You pay ESPP taxes when you sell, and holding longer can lower them.
A Section 423 employee stock purchase plan (ESPP) lets you buy your employer’s stock at up to 15% off. When you sell, the discount is taxed as ordinary income and any further gain as capital gain. A sale more than 2 years after the grant date and 1 year after purchase is a qualifying disposition. Its ordinary part is then capped at the discount measured on the grant-date price.
Updated · Sources
Qualified plans under Section 423
- 15%
- is the largest discount a plan can give, off the lower of the grant-date and purchase-date prices.
- 2
- years must fully pass after the grant date, and 1 year after purchase, before a sale qualifies.
- $25K
- of stock a year, valued at the grant-date price, is the most you can buy across your employer’s plans.
None of these rules apply to a non-qualified ESPP. Its discount is taxed as wages when you buy, with Social Security and Medicare tax.
Does your sale meet the ESPP tax rules?
Five tests decide the tax consequences of an ESPP sale. It is a qualifying disposition only if it passes all of them.
A Section 423 plan
The plan must meet Section 423 of the tax code for these rules to apply. If your company sends you Form 3922 for a purchase, it treats the plan as a Section 423 plan.
Employed until 3 months before the purchase
You must work for the company, its parent or a subsidiary from the grant date until 3 months before the purchase. A leave counts as work for up to 3 months, or longer if law or a contract guarantees your return.
More than 2 years after the grant date
You must sell more than 2 years after the grant date, which is in box 1 of Form 3922. The grant date is the offering’s first day if a number or formula fixes your share limit that day. Otherwise, the grant date is the purchase date.
More than 1 year after the purchase date
You must also sell more than 1 year after the purchase date, which is in box 2 of Form 3922. A sale on either anniversary is still too early.
No gift or transfer before both dates
You must keep the shares until both periods end. A sale, a gift and most other transfers count as an ESPP disposition. A transfer to your spouse or in a divorce, or a pledge as loan collateral, does not.
Fail either of the first two tests and the discount is taxed in the year you buy. Selling or giving away ESPP shares before both holding periods end is a disqualifying disposition. The full discount at purchase is then ordinary income.
What waiting to sell is worth.
Here is one purchase, sold at three different times. The offering starts on January 2, 2025, and fixes your share limit that day, so that is the grant date. You buy 100 shares on June 30, 2025, for $34 each, and later sell them at $60. The plan has a lookback, so you paid 85% of the lower of the two prices: $40 at the grant date, not $50 at purchase.
10 months
$624
The sale is disqualifying, so the $1,600 discount at purchase is ordinary income. The other $1,000 is short-term gain.
13 months
$534
The sale is still disqualifying, because 2 years have not passed since the grant date. The $1,000 gain is now long-term.
19 months
$444
The sale is past both holding periods, so it qualifies. Only the $600 grant-date discount is ordinary income, and $2,000 is long-term gain.
The discount at purchase is $16 a share ($50 minus $34), and the grant-date discount is $6 ($40 minus $34). Ordinary income and short-term gain are taxed at 24%, and long-term gain at 15%. Those are the 2026 rates for a single filer with $105,700 to $201,775 of taxable income. The 2027 sale is assumed to face the same rates, since 2027 brackets are not yet published. Modified AGI stays under $200,000, so there is no 3.8% net investment income tax. There are no commissions, and state tax is separate.
ESPP tax treatment: disqualifying and qualifying sales.
The IRS taxes employee stock purchase plan shares in one of two ways, depending on when you sell. Your ESPP tax rate on the ordinary part is your income tax rate, 10% to 37% for 2026. Capital gain on shares held more than a year is taxed at 0%, 15% or 20%.
| Disqualifying | Qualifying | |
|---|---|---|
| When you sell | Inside either holding period | After both holding periods |
| Ordinary income | The full discount at purchase The purchase-date price minus what you paid | Your gain, up to the grant-date discount At most 15% of the grant-date price in a 15% plan |
| Capital gain | Short-term if held a year or less | Always long-term |
| If the price falls | The full discount is still ordinary income The drop is a capital loss | Ordinary income shrinks with your gain None if you sell below what you paid |
Either way, your ESPP income is taxable in the year of the sale. Its ordinary part is taxed like wages, with no Social Security or Medicare tax.
Where ESPP tax reporting goes wrong.
Reporting ESPP on your tax return means checking your W-2 and Form 1099-B against the dates and prices on Form 3922.
Your 1099-B basis is too low
For options granted after 2013, your broker’s Form 1099-B leaves the ordinary income out of your basis. Report that basis as it is and the ordinary income is taxed twice, as wages and again as capital gain. You fix it with an adjustment on Form 8949, the same way in TurboTax, FreeTaxUSA or any other software.
No tax is withheld
Your employer does not have to withhold income tax on ESPP income. To avoid the underpayment penalty, pay at least 90% of this year’s tax, or 100% of last year’s, through withholding and quarterly estimates. If last year’s AGI was over $150,000 ($75,000 married filing separately), you need 110% of last year’s tax instead.
The income is missing from your W-2
The ordinary part of your ESPP income should be reported on your W-2, in box 1, for the year you sell. Some employers also note it in box 14, an optional box that becomes 14a on 2026 forms. If it is missing, you report it yourself on Schedule 1 (Form 1040).
A loss sale near a purchase date
Sell employer stock at a loss within 30 days before or after an ESPP purchase, and the loss can be disallowed. Under the wash sale rule, it is added to the basis of the new shares.
The wrong shares get sold
Each purchase is a separate lot with its own dates and basis, so which shares you sell changes the tax. Unless you name the lot with your broker by settlement, the oldest shares count as sold first. Your choice counts only if the broker confirms it in writing.
Your ESPP tax strategy, set before you sell.
Valim’s CPAs help employees with ESPP shares plan their sales, and file returns with the cost basis corrected.
- We work out the ordinary income on each sale from your Form 3922 and your plan’s terms.
- We correct the cost basis on Form 8949, so the same income is not taxed twice.
- We plan when to sell around the two holding periods and your tax bracket.
- We size estimated payments for sales that have no tax withheld.
- Individual return
- from $195
- Business return
- from $495
We quote a flat fee before work starts. We do not bill hourly.
ESPP tax questions.
How do I avoid double tax on ESPP?
Raise your cost basis on Form 8949 by the ESPP ordinary income, which is already taxed as wages. Your broker’s Form 1099-B leaves that income out of the basis. Keep the broker’s basis in column (e) and enter code B in column (f). Then enter the ordinary income as a negative number in column (g), so only the capital part is taxed as gain. Form 3922 gives the dates and prices that set the ordinary income.
How much tax will I pay on ESPP?
In a Section 423 plan, you pay tax on ESPP shares in the year you sell. Part of that income is ordinary income, taxed at 10% to 37% for 2026 with no Social Security or Medicare tax. That part is the full discount at purchase in a disqualifying sale, and at most the grant-date discount in a qualifying one. The rest is capital gain, taxed at 0%, 15% or 20% if you held the shares more than a year. The 3.8% net investment income tax (NIIT) can apply to that gain once modified AGI passes $200,000, or $250,000 for joint filers.
Should I sell ESPP shares right away?
Selling right away is the lower-risk choice, and holding saves tax mainly when the stock rose between the grant date and your purchase. A sale right away locks in the discount, but the whole discount at purchase is taxed as ordinary income. Holding more than 2 years from the grant date and 1 year from purchase caps that part at the grant-date discount. If the stock fell between those two dates instead, holding can add ordinary income. The cost of waiting is holding one stock, whose price can fall below what you paid.
What are the disadvantages of an ESPP?
An ESPP buys only your employer’s stock, so your pay and your savings depend on one company. Your contributions come out of after-tax pay, so they give you no pre-tax deduction. The better tax treatment means carrying that risk for more than 2 years from the grant date and 1 year from purchase. If the price falls after purchase, a disqualifying sale still taxes the full discount as ordinary income. The drop is a capital loss, which offsets capital gains in full but only $3,000 of other income a year ($1,500 married filing separately).
What is Form 3922?
Form 3922 is the ESPP tax form for discounted shares bought through a Section 423 plan. Your company sends it by January 31 of the year after the shares first move into your name. In a broker’s consolidated statement, the date is February 15. It shows the grant and purchase dates, the fair market value on each, the price you paid and the number of shares. You don’t file it with your return, but its dates and prices set your ordinary income and cost basis when you sell.
Sources
- 26 U.S.C. § 423, Employee stock purchase plans
- 26 U.S.C. § 421, General rules for statutory stock options
- 26 CFR 1.421-1, Meaning and use of certain terms
- 26 CFR 1.423-2, Employee stock purchase plan defined
- 26 U.S.C. § 424, Definitions and special rules
- 26 U.S.C. § 3121, Definitions of Social Security and Medicare wages
- 26 U.S.C. § 1091, Loss from wash sales of stock or securities
- 26 CFR 1.1012-1, Basis of property
- 26 U.S.C. § 1211, Limitation on capital losses
- 26 U.S.C. § 1411, Net investment income tax
- 26 U.S.C. § 6654, Failure by individual to pay estimated income tax
- IRS, Form 3922 (Rev. April 2025)
- IRS, 2026 Instructions for Form 1099-B
- IRS, Instructions for Form 8949
- IRS, Publication 525, Taxable and Nontaxable Income
- IRS, 2026 General Instructions for Forms W-2 and W-3
- IRS, Rev. Proc. 2025-32 (2026 tax rates)
Reviewed and updated September 2026. General information, not advice for your situation.