ESPPs can be complex. Understanding plan types and key rules upfront can significantly reduce complexity. Our experts say, keep it simple. Keep reading for insights on essential features and functions you’ll want to consider early, helping you avoid unnecessary challenges later.

Plan types

ESPPs are generally classified into two categories – qualified and non-qualified. While qualified plans are more popular, they come with additional restrictions compared to non-qualified plans.

When choosing your plan type, consider the following:

• Will all participants have the same rights and privileges?
• Is the plan approved by shareholders?
• What is the plan discount?
• How long is your offering period?

Qualified plans operate in accordance with IRS rules, specifically 423 regulations, and offer tax advantages to participants. Non-qualified plans have fewer IRS restrictions but lack the same tax advantages as qualified plans.

Contributions and limits

Most ESPPs allow for employees to purchase shares through payroll deductions. Employees can choose a percentage amount to be automatically deducted each payroll period. Typically, this percentage ranges from 1% to 5% depending on the employee’s preference. But, depending on the plan type – qualified or non-qualified – there may be an annual contribution limit that will need to be monitored. IRS 423 rules have a contributory annual limit of $25,000 per year while non-qualified plans place no restriction on contributory limit.

Full or fractional shares

Will your plan allow for only full share purchase? Or should you consider fractional shares? Depending on your industry and share price, you may want to consider offering fractional share purchases to your participants. Fractional shares may be appealing to lower-income employees, as they allow for gradual wealth accumulation without the need for substantial upfront investments. This approach enables employees to build wealth over time, fostering a sense of ownership and financial growth.

Lookback provisions

Is a lookback provision applicable to your plan type?

If you’re offering a qualified 423 plan, then you’ll need to consider this provision. A lookback provision bases the purchase price not on the stock price at the time but, rather, on the price either at the beginning of the offering period or at the end of the purchase period, whichever is lower. Understanding plan types, features, and functionality and how they can affect the type of plan you offer is crucial to reducing complexities that can arise throughout the life of your plan. Aligning your plan with your industry and company goals can help ensure you offer a competitive plan and increase employee participation.