How Do You Calculate the ESPP $25,000 Limit?

Section 423 limits purchases under a qualified ESPP to $25,000 worth of stock in any one calendar year, valued as of the date the right to purchase the shares is granted (typically this is the employee's entry date into the offering). This sounds simple enough, but in practice, this limit can be more complicated that it first appears.

How is the $25,000 limit calculated?

The basic rule is that each employee cannot purchase more than $25,000 per year, valued using the fair market value on the date he/she enrolled in the current offering. For example, if a plan has a 12-month offering period beginning each January 1 and ending each subsequent December 31, and the value of the stock on a particular January 1 is $10 (assume that the offering beginning is considered the grant date), then no employee may purchase more than 2,500 shares ($25,000 divided by $10 per share) in that offering period.

The limit is applied per calendar year, not per purchase. Let’s say that the offering in our example stipulates that shares will be purchased on June 30 and December 31. If an employee purchases 1,000 shares on June 30 ($10,000 worth), she cannot purchase more than 1,500 shares ($15,000 worth) on December 31.

If our employee were to purchase all 2,500 shares ($25,0000 worth) on June 30, she would not be able to purchase any shares on December 31.

What happens when a new offering starts?

Under most ESPPs, when an offering ends and a new offering begins, all employees currently enrolled are automatically enrolled in the new offering. Every time an employee is enrolled in a new offering, the amount used to calculate the value of future purchases for purposes of the $25,000 limitation is reset.

For example, let’s say that an ESPP has a six-month offering beginning every January 1 and July 1 (with purchases occurring on June 30 and December 31). An employee enrolls on January 1 when the fair market is $10 per share and purchases 1,000 shares on June 30. The shares purchased have an aggregate value of $10,000, reducing the limit available for the employee’s next purchase to $15,000.

After the purchase, the employee is automatically enrolled in the next offering beginning on July 1. At that time the fair market value is $12 per share. The maximum number of shares the employee can purchase on December 31 is 1,250 ($15,000 divided by $12 per share).

What happens if employees don’t purchase the full amount available under the limit?

Employees accrue the right to purchase $25,000 worth of stock for each calendar year in which the offering is outstanding. Once employees have accrued the right to purchase stock under an offering, they retain that right until their participation in the offering ends (not merely until the end of the calendar year in which the right accrued).  For multi-year offerings, this can result in employees being able to purchase more than $25,000 worth of stock in subsequent years of the offering.

For example, let’s say that a 24-month offering begins on January 1, 2021, with purchases occurring every 12 months, on December 31, 2021 and 2022. An enrolled employee purchases only $10,000 worth of stock on December 31, 2021. The remaining $15,000 worth of stock that the employee still has the right to purchase for 2021 is rolled over to the second year of the offering and the employee accrues the right to purchase another $25,000 worth of stock in 2022. Thus, the employee can purchase up to $40,000 worth of stock on December 31, 2022.

How long can the unused limit carry forward?

The rights to purchase stock that are accrued under an offering can only be carried forward to future calendar years while the employee remains enrolled in that offering. Once the offering ends, the unused limit cannot be rolled over to another offering.

In our example above, once the offering ends, the employee loses the right to the amounts accrued under it. If the employee again purchases only $10,000 worth of stock on December 31, 2022, the $30,000 worth of stock left over under the limit cannot be rolled over to the next offering. When a new 24-month offering begins on January 1, 2023, the employee will be limited to purchasing just $25,000 worth of stock in the first year of the offering.

A purchase is not required for unused limit to carry forward

Employees accrue the right to purchase stock in each year that the offering is outstanding, even if a purchase does not occur during the year. Thus, even in offerings that are 12 months or less in length, employees may sometimes be able to purchase more than $25,000 worth of stock if the offering spans more than one calendar year.

For example, assume a 6-month offering begins on October 1, 2021, with the first purchase occurring on April 30, 2022. Employees enrolled in the offering as of October 1, 2021, accrue the right to purchase $25,000 worth of stock for 2021 and again for 2022 and thus will be able to purchase $50,000 worth of stock on April 30, 2022.

Each employee may be able to purchase a different number of shares under the limit

Because the number of shares each employee can purchase is based on the value of the stock on their enrollment date, their past purchases, and how long they’ve been enrolled, the number of shares each employee can purchase under the limit may vary.

Let’s say that a company offers an ESPP with six-month offerings that run from February 1 to July 31 and August 1 to January 31. The following two employees are enrolled in the offering beginning on August 1, 2022:

• Jane has just enrolled in the plan for the first time and has no prior purchases.
• John enrolled in the plan for the first time on February 1, 2022, and purchased $10,000 worth of stock on July 31, 2022.

Both employees accrued the right to purchase $25,000 worth of stock in 2022 and will accrue the right to purchase another $25,000 worth of stock in 2023. But because John purchased $10,000 worth of stock in 2022, he only has $15,000 worth of stock left under the limit to carry forward into 2023, while Jane is able to carry forward the full $25,000 worth that she accrued the right to in 2022. On January 31, 2023, John will be able to purchase a maximum of $40,000 worth of stock and Jane will be able to purchase a maximum of $50,000 worth of stock.

It’s difficult to rely on contribution limits to administer the $25,000 limitation

A common misperception is that the $25,000 limit can be administered by limiting contributions to a percentage of $25,000 commensurate with the discount offered under the plan (e.g., where a plan offers a 15% discount, by limiting contributions to $21,250 per year, or 85% of $25,000). This can be an effective approach when the stock appreciates in value over the offering, but when the stock price declines in value, this method of administering the $25,000 limit is not sufficient.

This is because when the stock price declines in value over the purchase period, the value of the shares for purposes of the $25,000 limit is based on a different fair market value than the purchase price is based on.  To effectively administer the $25,000 limit by capping employees’ yearly contributions, both the $25,000 limit and the purchase price must be based on the same fair market value.

For example, assume that an employee enrolls in an ESPP when the fair market value is $25 per share. The plan offers a look-back and a 15% discount. The employee purchases stock under the offering later that same year, when the fair market value had declined to $20 per share. If the employee is allowed to apply contributions of $21,250 (85% of $25,000) to the purchase, the employee will purchase 1,250 shares ($21,250 divided by 85% of the $20 per share fair market value on the purchase date). But these shares have a total value of $31,250 for purposes of the $25,000 limit (1,250 shares multiplied by the $25 per share FMV at the start of the offering). Thus, the purchase would exceed the $25,000 limit by 250 shares.

Where can you learn more about ESPPs?

Are you new to ESPPs or looking for a refresher? The NASPP’s newest online program, “Employee Stock Purchase Plan Essentials,” will help you build the foundation you need to successfully administer an ESPP. You’ll learn the mechanics of the $25,000 limit as well as the tax laws and accounting principles that apply to ESPPs and best practices for operating and managing an ESPP.

And check out these additional resources on the $25,000 limit:

• Understanding the $25,000 Limit in Seven Slides
• Ten Facts About the ESPP $25,000 Limitation
• Understanding the ESPP $25,000 Limit (video)