What happens to shares in an employee stock purchase plan if sold before the holding period?

In an employee stock purchase plan (ESPP), if shares are sold before the required holding period, the shares are subject to ordinary income tax. This is because when an employee sells their shares before meeting the holding period requirements, the favorable tax treatment associated with qualified dispositions is lost.

In a qualified disposition, employees would typically benefit from capital gains treatment on the gain above the purchase price, which is usually more favorable than ordinary income tax rates. However, an early sale turns any gain into ordinary income, which is taxed at higher rates, making it less advantageous for the employee. Thus, the correct choice reflects the tax consequences associated with selling shares prematurely in an ESPP.