Death and Taxes

December 11, 2008 1:39 PM

[Tax/Stock Filter:] Employee Stock Purchase Plan advice especially in re: taxation

I am an employee at a medium-large company that offers an Employee Stock Purchase Plan. We can contribute up to 15% of income to purchasing company stock at 85% of its fair market value on either the first day of the offering period or the last day (offering period = 6 months).

I am obviously taking advantage of this free money come January 1 (I started work at this company last year) but want some advice in regard to the taxation consequences of an ESPP. I would like to sell most of the stock as soon as possible after the offering period so as to stay diversified, but is there any way of avoiding a huge tax hit for selling after owning for such a short time?

If I'm not mistaken, the 15% discount will always be counted as income, no matter when I sell the stock, correct? Is it advisable for me to hold the stock for a year+ to avoid short-term capital gains? And if so, is it a year from the beginning of the offering period, or a year from when I become fully vested?

I am also interested in hearing some creative options if such exist, such as rolling the stock over into an IRA or 401k that would mitigate my tax hit. Or any general advice from someone who has thought/researched this matter significantly. Thanks!

posted by jckll to work & money (5 comments total)

If I'm not mistaken, the 15% discount will always be counted as income, no matter when I sell the stock, correct?

Yes.

Is it advisable for me to hold the stock for a year+ to avoid short-term capital gains?

That is entirely up to you. I've never held, figuring that I've already got my salary tied up in the company -- holding its stock would be doubling down.

And if so, is it a year from the beginning of the offering period, or a year from when I become fully vested?

Interesting question. I don't know.

In general however, I know that just paying the taxes and being done with it has always been a much better strategy for me than trying to get creative.
posted by tkolar at 1:47 PM on December 11, 2008

And if so, is it a year from the beginning of the offering period, or a year from when I become fully vested?

Interesting question. I don't know.

Quick chat with an HR rep: it's a year from the purchase date, which is the last day of the offering period regardless of which price is used.
posted by tkolar at 1:51 PM on December 11, 2008

Ok, IANAL, IANYL, this is not legal advice, Sec. 523 stuff, yadda yadda yadda.

Employee Stock Purchase Plans (ESPPs) are treated under IRC Sec. 421-425, specifically 421 and 423. Check those out if you can't sleep tonight, you'll be dozing like a baby in no time flat. Anyway, from what I can tell, the long and short of it is that you won't have to include the transfer of the stock as income (Sec. 421) as long as you comply with the holding requirements of Sec. 423(a). Specifically, in order to qualify for the benefit, you can't sell or otherwise dispose of the stock within 1 year of the purchase of the stock, or within 2 years of the granting of the option to purchase the stock. You also have to remain an employee of the company granting the option for the period beginning on the date of the granting of the purchase option and ending on the day 3 months before the exercise of the option (the actual purchase of the stock).

Since the option purchase price of the stock under your ESPP is 85% of the stock's fair market value, you are also subject to the "special rule" off Sec. 423(c). Basically, if you transfer the stock in compliance with the holding period requirements in Sec. 423(a), you'll have to include a portion of the amount in ordinary income, as compensation (and not as capital gains). The amounts are two ratios provided in that Code section, and you get to pick the lesser of the two.


The wikipedia article on ESPPs linked to this TurboTax article on the taxation of sales under ESPPs, it kind of sums up the Code sections and gives a few examples of qualifying and nonqualifying dispositions.

If you sell or transfer the stock, and don't qualify for the benefit (most likely by selling or transferring it before the statutory holding period in Sec. 423(a)), as near as I can tell from reading Sec. 421(b), the gain is going to be treated as ordinary income, and you're going to tax on it at the regular rates. I assume it will just be treated as additional compensation.

Honestly, I would suggest talking to an accountant or tax lawyer who has experience dealing with taxation of ESPPs about it. The funny thing about the Code is that for every benefit, there's usually a limitation, and all kinds of IRS practice and advice that isn't contained in the Code. Someone who has experience in that area will know what to look for, what the pitfalls are, and where you can legally cut corners. I took a quick look at it, but get someone qualified to figure it out. Anyway, I think I bombed my income tax final on Tuesday, so take my above analysis with a grain of salt.
posted by diggerroo at 2:49 PM on December 11, 2008

Crap, I forgot to link the second paragraph.

Sec. 421-425. Sec. 421. Sec 423.
posted by diggerroo at 2:52 PM on December 11, 2008

If anyone's still around...

I was just reading an article about Bernie Madoff's options strategy. While I have no interest in emulating him at all, this part of the article intrigued me:

Essentially, collars limit both the potential losses and gains for an investor who has bought a particular stock. An investor will buy a stock (let’s say at $50 a share), and buy an out-of-the-money put option (let’s say $35 a share), and sell an out-of-the-money call option ($65, let’s say). In this scenario, an investor collects a premium for selling the calls, which helps offset the price of buying the put options.

If the stock in question drops below $35, the investor has the right to sell the stock at $35, limiting the losses. But if the stock rises above $65, more than likely the purchaser of the calls is going to exercise his option — forcing the holder of the shares at $50 to sell at $65. “Typically investors choose strike prices that are at a wide enough gap to limit that possibility,” says David Gompert, senior market analyst at TradeMonster.

Mr. Gompert says that sometimes a collar strategy is employed for tax reasons, as it allows investors to lock in gains on a particular equity position without selling the position outright and being forced to pay the taxes.

Is this not exactly what I'm looking for? I'm no finance guy but this seems doable with just about any brokerage, and without much hassle, no?
posted by jckll at 11:21 AM on December 16, 2008