When you purchase stock under an Employee Stock Purchase Plan, there is no taxable income at the time of purchase. Income will be recognized when the stock is sold. The income can be either ordinary or capital gain. The sale will qualify for capital gain treatment as long as the stock is held:
At least 2 years after the option is granted, and
At least 1 year after you buy the stock.
Also, the individual must remain an employee of the company until at least 3 months prior to exercising the option.
When stock purchased via an ESPP is sold, and the requirements stated above are met, there are 2 types of taxable income recognized:
Ordinary income - depends on the option price:
If the option price is less than the fair market value of the stock on the date it was granted to the taxpayer, the taxpayer has ordinary income to the extent fair market value exceeds the option price. This income is reported as wages on line 7 of Form 1040. The basis of the stock includes the ordinary income recognized in the year of the sale.
If the option price is not less than the fair market value of the stock on the date it was granted to the taxpayer, the income is treated as long-term capital gain. This is reported as capital gain on Schedule D. The basis of the stock is the option price.
Capital gain - for any income in excess of the ordinary income determined above.
If the holding period requirement is not met (disqualifying disposition), the taxpayer recognizes ordinary income. The amount of ordinary income is the excess of the fair market value of the stock on the date it was transferred to the taxpayer (exercise date) less the amount paid for the stock (option price). The ordinary income may exceed the gain on the sale. The basis in the stock is the sum of the amount of ordinary income and the option price of the stock. The amount of ordinary gain is reported as wages on line 7 of Form 1040.
Losses on the sale of ESPP stock are capital losses.