ESPP Question

[COlady]

My husband purchases stock through his employer's ESPP at a 15% discount. He purchases up the IRS max every year because there is no holding period so the risk is low. For the past 7 years he has always had gains so we've never ran into a loss situation. Except he got a little greedy one quarter in 2015 and decided to hold into 2016. The stock plummeted and he decided to cut his losses...but we'll take it...we've had great gains (hard not to with a 15% discount) over the past 7 years.

I'm a tax accountant so I understand the ins and outs of how ESPPs are taxed in general. What I'm wondering is, if at the time of sale in 2016 (when the taxable event is triggered), what is payroll going to do about this loss? So as an example: FMV of $10, Discounted purchase price of $8.50, sold for $6.50. He has a realized loss in this example of $2.00 per share. Will his payroll department consider this an ordinary loss of $2.00 and reduce his taxable wages by $2.00? Will they do nothing wage wise and then we'll just net the $2.00 STCL against other STCG from other ESPP sales?

[MDM]

This can depend on the specific type of ESPP. 

If the $1.50/share he realized when purchasing the shares was already counted as income, then his basis is $10/share.

Was the $1.50/share included as income in the 2015 W-2?

[COlady]

I confirmed that there is no tax affect at time of purchase, only at the time of sale. I'm going to see if I can see what they did by reviewing my husband's paystubs. Any guesses???

[COlady]

So to answer your questions specifically, no the discount was not included in his wages at time of purchase.

[MDM]

So to answer your questions specifically, no the discount was not included in his wages at time of purchase.

Ok, then it appears he has a "qualified section 423 Plan" (see http://personal.fidelity.com/products/stockoptions/faqpurchase.shtml).

Check the timing of the sale to determine whether the sale will be a "disqualifying disposition" or not, as that can affect things.  See http://www.fairmark.com/execcomp/espp/dispositions.htm for some background.

[COlady]

It's definitely a disqualifying disposition - he held the share for less than one year.

[MDM]

It's definitely a disqualifying disposition - he held the share for less than one year.

In that case, it seems the following from the Fairmark article applies:

Example: You decide to contribute $10,000 during an offering period and that turns out to be a good choice: the stock price rises dramatically, and because of a lookback provision you're able to buy $25,000 worth of stock, giving you a $15,000 benefit. You hold onto the stock only to see the price fall just as dramatically, leaving you with shares worth just $8,000.

In this situation, a disqualifying sale will require you to report $15,000 of compensation income. You'll also have a $17,000 capital loss on the sale, but because of the capital loss limitation you can deduct only $3,000. Overall, you have an out-of-pocket loss of $2,000 but you had to pay tax on $12,000 of phantom income ($15,000 of compensation income minus $3,000 of capital loss). By contrast, if you hold the shares long enough to avoid a disqualifying disposition, you would report no compensation income in this situation, just a capital loss of $2,000.

But that's based on a cursory read - you'll probably want to be more thorough as it is your money.