Compensation income from an ESPP is added to your reported earnings but is not added to your paycheck (because the value is in your brokerage account or the stock itself). For reporting purposes, the broker reports the transaction and the income on a Form 1099-B.
Your compensation income from ESPP shares in a qualifying disposition is the lesser of two amounts.
The first is the discount allowed on your purchase, determined as of the “grant date,” which is normally the first day of the offering period. (Your company should inform you if a different grant date is used.)
Note that this is not necessarily the actual discount you received on the shares. It’s the discount determined as if you bought the shares on the grant date, even though you didn’t buy the shares that day and couldn’t have done so even if you wanted.
Beginning with the 2010 tax year, you should find the numbers needed to calculate this amount on Form 3922 supplied by your employer. It’s the difference between the fair market value of the stock on the grant date and the purchase price determined as of the grant date (not the actual purchase price).
The second number, which comes into play only if smaller than the first one, is essentially your profit from the shares. More precisely, it’s the difference between the fair market value of the stock when you disposed of it and the actual amount you paid for the shares.
The smaller of these two numbers (the discount or the profit) is the amount of compensation income you have as a result of the disposition.
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