ESPP stock and taxes

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any experts on this topic here? I'm confused why some advisors recommend holding stock for 2 yrs before purchase. I thought 1 yr is sufficient since that would put be in the long-term taxes bracket

Thanks

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If you purchase ESPP shares at a discount, then the sum of the discount is considered income if you sell within the first two years. The basis of the shares is the un-discounted price. If you hold for more than two years, then the basis becomes the discounted price. As an example, suppose you buy $1000 ESPP stock for $900. Let's say you sell for $1200. If you sell prior to two years, then you will pay income tax rates on the $100 discount and capital gains on the $200 gain. If you sell after two years, then you pay capital gains tax on the whole $300. Since it's long term, you typically less in taxes.

Not true. The difference between fair market value and the price you paid is always taxed as ordinary income rates.

So what if you buy stock at NO discount? (I know, I buy stock from my employer at no discount. Just figured It's be nice to have.) Do you still need to hold it for 2 years or is just 1 year sufficient for capital gains??

raceman73 said:   So what if you buy stock at NO discount? (I know, I buy stock from my employer at no discount. Just figured It's be nice to have.) Do you still need to hold it for 2 years or is just 1 year sufficient for capital gains??
  huh ? why would you do that ? unless your employer waives off the brokerage fee.

The tax treatment of ESPP shares is complicated, and depends on a number of factors. The time that you hold the shares determines whether you have a qualifying disposition or a disqualifying disposition. Each of these is treated completely differently according to their own rules.
To be a qualifying disposition, you need to hold the shares for at least 1 year from the date of purchase and 2 years from the "grant date". Maybe that's why some mention 2 years.
Anyways, read some resources on the internet. I find that the Fairmark.com website has some good articles about qualifying versus disqualifying dispositions.

My own recommendation, if you employer doesn't offer a "lookback discount", then just sell the shares as soon as you get them. Don't hold on to them.
If you have a "lookback discount", and that discount is working in your favor, then you should hold on to the shares long enough to be a qualifying disposition.

TJtv said:   The difference between fair market value and the price you paid is always taxed as ordinary income rates.
  
Where are you getting your info? It depends on grant and sell dates and how long that's been. Yes, you can pay the lower capital gains rate if you do it right.

As far as I can tell, it mostly only matters if the stock price decreases because if you sell within the 2 year period the entire discount counts as ordinary income.

Assuming you get a 20% discount and the stock price is $50 when you are buying (purchase price =$50-20%=$40)
Months after purchase Sell Price Short Term Capital Gains Long Term Capital Gains Ordinary Income
6 $45 -$5 $0 $10
18 $45 $0 -$0 $10
30 $45 $0 $5 $5
6 $55 $5 $0 $10
18 $55 $0 $5 $10
30 $55 $0 $5 $10


A long time ago, in a galaxy far away, I participated in a ESPP. At first it was nice buying stock in the company. Then it got tedious. My company decided to spin our our division, and then the company split in half, and then one half of the split company was bought out by an internet company that shall not be named. Oh, and my ESPP account was set up to re-invest dividends in more stock.

For a while, I owned stock in three different companies, and had to carry the cost basis for each lot into each of the three different companies. With the dividend reinvestments, I think I have 30 or so lots.

Eventually, the company I work for got taken private, so all the stock was cashed out. Figuring out taxes was a treat. And this was before brokerages were supposed to track cost basis for you. Figuring out taxes when the internet company bought one of the two split companies was a treat.

My company is public again, and there's an ESPP. I've chosen NOT to participate. First, I get to listen to my co-workers whine about how the stock drops every time they get their next ESPP lump, pretty much offsetting the 15% discount, short term. Second, I already work for the company and get my salary checks from them. I don't want to be doubly-beholden financially to a company that might decide to lay me and half my co-workers off because some senior VP spent too much traveling.

micha8s said:   Second, I already work for the company and get my salary checks from them. I don't want to be doubly-beholden financially to a company that might decide to lay me and half my co-workers off because some senior VP spent too much traveling.
  
This. So very this.

to piggyback on the thread, how do i know if the difference between fair market value and the price i paid is included in w2?

Here is my attempt to explain it:

  • Selling ESPP shares always results in some compensation income and some capital gains (or loss) income.  
  • In most (but not all) cases you get slightly better tax treatment for a "qualifying disposition" because you get to treat more of the gains as capital gains vs income
  • Specifically, for a disqualifying disposition your compensation income is always the difference between the fair market value on the purchase date and your purchase price (no matter what the stock price does after you buy it), and the rest is capital gains (either short term or long term depending on if you held the shares for 1 year).  If the stock price goes down between when you bought and when you sold, your compensation goes up by an amount that you never actually saw, and you are limited in how much you can offset this gain with the capital loss in a year.  That could potentially make it so you are paying taxes on phantom income that you can't offset until later years as you roll over your disallowed capital losses. 
  • A qualifying disposition, your compensation income in the sale is the lesser of: the difference between amount you sold the stock vs the for paid for it (including discount), or the discount that you got compared to the grant date.  This can be significantly less than the compensation income that you show for a disqualifying disposition, and the rest will always be long term capital gains.
  • A qualifying disposition is when you hold the shares for at least 2 years from the grant date (not the purchase date!), and 1 year from the purchase date.


So lets say we have the following:

  • Grant date price: $100
  • Exercise (purchase) date price: $110
  • Discounted purchase price: $85
  • Shares purchased: 100
  • Sale price: $115

Here are the 3 options for how it would treated for your taxes depending on how long you held the shares (not including commissions):
Type of sale Compensation Income Capital Gains Short Term/Long Term
Disqualifying Disposition < 1 year $2500 ($110-85) $500 Short Term
Disqualifying Disposition > 1 year $2500 ($110-85) $500 Long Term
Qualifying Disposition $1500 ($100-85) $1500 Long Term

The qualifying disposition is clearly the best here when the stock goes up after the exercise.  Another:

  • Grant date price: $100
  • Exercise (purchase) date price: $110
  • Discounted purchase price: $85
  • Shares purchased: 100
  • Sale price: $90

Type of sale Compensation Income Capital Loss Short Term/Long Term
Disqualifying Disposition < 1 year $2500 ($110-85) $(2000) N/A
Disqualifying Disposition > 1 year $2500 ($110-85) $(2000) N/A
Qualifying Disposition $500 ($90-85) $0 N/A

Assuming you don't hit the capital loss limits, its a wash here and they all result in the same tax liability.

SummerSoFar said:   
micha8s said:   Second, I already work for the company and get my salary checks from them. I don't want to be doubly-beholden financially to a company that might decide to lay me and half my co-workers off because some senior VP spent too much traveling.
  
This. So very this.

While I agree that holding a lot of company stock long term is unwise because you are putting too many eggs in one basket, I find it very hard to believe that micha8s' employers stock goes down 15% the day after every exercise date eliminating the entire discount.  As long as there are no minimum holding periods for the plan and you can sell as soon as the shares are deposited in your account, it is in your best interest to participate if the realized gain is better than you are getting in other low-risk vehicles.  And yes, I think it is low risk to bet that the stock wont go down by more than 15% before you can sell.



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