Employee Stock Purchase Plans (ESPPs) are one of the most effective ways to help employees become company owners. But one IRS rule often causes confusion: the $25,000 purchase limit. This guide breaks down what the rule means, how it is calculated, and how companies can design better ESPPs that work within and around the limit.
What Is the $25K Limit?
The $25,000 limit comes from Section 423(b)(8) of the Internal Revenue Code. It states that an employee cannot accrue the right to purchase more than $25,000 worth of stock, based on the grant date fair market value (FMV), in any calendar year under a qualified ESPP. Staying within this rule is what allows the plan to maintain its qualified status and provide employees with favorable tax treatment such as income deferral and potential long-term capital gains.
The cap was created in 1964 to ensure fairness and limit the amount of tax-advantaged stock an employee could acquire each year. Because it has never been adjusted for inflation, the purchasing power of $25,000 has declined dramatically, making it a growing challenge for modern ESPP design.
How the Limit Is Calculated
The limit is based on the right to purchase stock, not on what employees actually contribute. The IRS uses the grant date price, which is the FMV of the stock on the first day of the offering period, to determine eligibility. Even if employees receive a discount, the limit is applied to the grant date FMV, not the discounted purchase price.
Example
- Grant date stock price: $100
- $25,000 ÷ $100 = 250 shares allowed
- 15% discount → Purchase price = $85
- Employee contribution = $85 × 250 = $21,250
Even though the employee contributes only $21,250, the IRS views this as the full $25,000 limit because it is based on the FMV at grant.
Multi-Year Offerings and the Stacking Effect
The $25K limit applies per calendar year, not per offering. When a single offering period spans multiple years, employees can accrue up to $25,000 for each calendar year the offering is outstanding.
For example, an offering that runs from May 2024 through April 2026 spans three calendar years. This allows up to $75,000 in total eligible value, or $25K per year.
While this structure can benefit employees, it also increases administrative complexity, especially when stock prices fluctuate or purchase dates cross fiscal boundaries. For this reason, many companies have moved to shorter six-month offerings, which simplify compliance and monitoring.
Why the Limit Matters
1. Compliance Risk
Exceeding the $25K threshold, even unintentionally, can cause the entire ESPP to lose its qualified status. That creates adverse tax implications for both the company and its employees.
2. Administration and Tracking
Longer or overlapping offering periods require careful tracking of grant date values and contribution timing. Automated systems or third-party administrators can help manage eligibility and issue refunds for excess contributions.
3. Employee Experience
Employees who hit the limit often receive unexpected contribution refunds, leading to confusion or frustration. Clear communication about how the rule works can prevent misunderstandings and build trust in the program.
When Stock Prices Drop, the $25K Limit Can Bite
Declining stock prices allow employees to buy more shares, but that also increases the likelihood of hitting the IRS limit.
Example:
- Grant date FMV: $50
- Purchase price (with 15% discount): $38.25
- Contribution: $20,000
- Shares purchased: 500 ($50 × 500 = $25,000 limit)
Even though the employee contributed less than $25,000, they hit the limit under IRS rules and receive a refund for the difference. This highlights why real-time tracking and proactive communication are critical.
Common Misconceptions
“It’s based on what I actually contribute.”
False. The calculation uses the grant date FMV, not the amount deducted or the discounted price.
“Extra contributions roll forward.”
They do not. Excess contributions must be refunded once the offering ends.
“Exceeding the limit isn’t a big deal.”
It is. Violations can disqualify the plan, create tax issues, and require complex remediation.
What Companies Can Do
Shorten Offering Periods
Using six-month offerings minimizes overlap and simplifies tracking.
Set a Conservative Contribution Cap
For example, limit contributions to $21,250 for plans with a 15% discount. This reduces the chance of exceeding the IRS limit.
Automate Limit Monitoring
Modern stock plan platforms can track participation and flag potential violations early. However, employees typically cannot see this data in real time, so education remains essential.
Communicate Clearly
Provide participants with simple examples and FAQs during enrollment. Notify employees before purchase dates if they are close to the limit.
Offer Modeling Tools
ESPP calculators or modeling tools help employees see how contribution levels, stock prices, and discounts interact, creating transparency and engagement.
Is the Limit Inflation-Adjusted?
No. The $25,000 cap has remained unchanged since the 1960s. Without inflation indexing, its real value has eroded significantly, especially in high-growth industries where stock prices rise quickly.
Looking Ahead
While the $25,000 ESPP limit is unlikely to change in the near term, companies can still create compelling, compliant, and equitable plans. By understanding the nuances of Section 423, anticipating scenarios like falling share prices, and emphasizing clear communication, employers can strengthen both compliance and employee trust.
Final Takeaway
Companies that proactively manage the $25K limit through plan design, technology, and participant education can reduce compliance risk and improve the overall employee experience.
Infinite Equity helps organizations navigate the complexities of Section 423 plans with precision and purpose. From plan design and financial modeling to participant communication and global alignment, our experts help you offer ESPPs that are both compliant and compelling.
Contact Infinite Equity to review your ESPP framework and uncover opportunities for smarter, more inclusive employee ownership.
