Author Topic: Should my dad sell his ESPP?  (Read 11448 times)

frugalnacho

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Should my dad sell his ESPP?
« on: February 10, 2015, 08:38:32 AM »
I just got a little insight into my families finances.  My dad is 62 years old and has been working at waste management (garbage disposal company) driving a truck for about 10-12 years.  They are not very mustachian.  Anyway I just found out he has been participating in his ESPP the whole time.   His 401k balance is about $75k, and his balance in his ESPP is about $65k.  To me these numbers seem really low for his age, but they also seem way out of balance.  He holds a disproportionate amount of his overall portfolio in the company he works for which seems bad for so many reasons.  If the company tanks not only will he lose his job, but most of his portfolio.

It does appear that this has worked out well for him.  He got the stocks at a discount (not sure of the exact details) and the stock has performed nicely since he started buying it.  Here is a link to the holding compared to VTSAX:

http://finance.yahoo.com/echarts?s=WM+Interactive#{%22range%22%3A%22max%22%2C%22scale%22%3A%22linear%22%2C%22comparisons%22%3A{%22VTSAX%22%3A{%22color%22%3A%22%23cc0000%22%2C%22weight%22%3A1}}}

Should he sell his ESPP and transfer that into another account?

How does he go about doing this?

What implications are their going to be from liquidating that account? Capital gains? unrealized income from the ESPP discount?  Is an ESPP tax sheltered?

I have never dealt with ESPP before.


kaizen soze

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Re: Should my dad sell his ESPP?
« Reply #1 on: February 10, 2015, 09:53:32 AM »
I'm not a tax expert, but while I think he should sell the stock, he will want to be careful about the tax implications.  As I recall, if he bought at a discount, the delta between what he paid for the stock and what it was actually worth when he bought is taxable as regular income if sold within a certain period of time, and then becomes taxable as capital gains (at lower rate) if he's held onto the stock for a while.  These rules may have changed since I was in an ESPP (and I got unlucky and had to sell my ESPP shares at a loss).  Definitely warrants further research.

mm1970

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Re: Should my dad sell his ESPP?
« Reply #2 on: February 10, 2015, 09:55:59 AM »
It really depends on his ESPP.  At my old company, we had ESPP and it was linked to an E-trade account.  I think.

Anyway, I would always sell fairly quickly after getting the stock, then transfer it to something else, like an Index fund or mutual fund or...?  Your dad is nearing retirement, I'd go with a bond.

That company plan was a 15% discount, minimum.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #3 on: February 10, 2015, 09:57:59 AM »
Yea i'm hoping some mustachians can drop some knowledge on me to help him reap the most out this situation while paying the least amount in taxes.  I don't think him and my mom make more than 60k/yr in all, so i'm hoping there is some leeway for him to realize some capital gains tax free and get his money into a safer and more diversified asset.

geekette

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Re: Should my dad sell his ESPP?
« Reply #4 on: February 10, 2015, 10:15:48 AM »
I wouldn't sell it all at once, but here's some info about the tax implications.

Basically, the difference between the price he paid and the fair market value on that date is ordinary income, no matter when he sells.  The profit above that is taxed as ordinary income or long term capital gains, depending on how long he's held it.



nawhite

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Re: Should my dad sell his ESPP?
« Reply #5 on: February 10, 2015, 10:23:06 AM »
Apparently there are a lot of threads going on about ESPPs right now :-)

Fortunately the answer for taxes is really simple for your dad (though you should always double check with a tax professional) Any shares you have held for 2 years after the purchase date will be subject to long-term capital gains when you sell them. Less than 2 years after the purchase date and things get funny. Depending on what rules the ESPP follows, gains could get taxed as income or short-term capital gains. But in almost all cases I'm aware of, if you hold for at least 2 years, you can sell and only worry about long-term capital gains.

That being said he should ABSOLUTELY sell at least some of those ESPP holdings! Keeping 40% of your savings in your employer's stock is very financially dangerous and is what happened to all of those poor people who got screwed at Enron. I don't have a problem with keeping some of your savings in your company, maybe even as much as 10% of your NW, but the correlated risk is a dangerous thing.

I'm a big fan of "Sell your ESPP shares at the earliest point possible and just pay the income taxes on the additional value". With the standard rules for ESPPs that the IRS encourages, keeping your shares until they turn into long term capital gains is basically a leveraged bet that the company's share price won't go down by 2% two years from now. I don't feel strongly enough about any company to make that bet and I won't be holding the shares long term due to the correlated risk and thus I sell immediately. I can walk through the math if anyone is interested.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #6 on: February 10, 2015, 10:34:50 AM »
He currently has his ESPP allocation set to 10% of his earnings, and it's deducted right out of his check just like his 401k.  He has been there for around 10 years I think, and based on his salary and the amount of stock he has I would say he has probably been doing this the entire time.  So i'm sure most of the value is older than 2 years.

Does his "discounted" stock price get deferred until he sells the shares?  For example he buys $100 worth of stock for only $85, then holds onto it for 3 years.  Does that $15 difference get counted as income in the year he earns it and buys stock?  Or only when he sells that stock does it get counted as regular income?  And if he sells that $100 worth of stock for $110...does it count as $85 his money (his basis he bought for) plus $15 regular income (discount purchase from ESPP) and then $10 in capital gains?

neil

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Re: Should my dad sell his ESPP?
« Reply #7 on: February 10, 2015, 10:52:53 AM »
You can read up on ESPP tax implications.  Long term/short term gains are typical (1 year after your dad received the stock) but the cost basis depends on whether or not it was a qualifying distribution (2 years after grant).  There is always an ordinary income component even if the stock goes to $0, so you want to make sure you do the math right.

Rules now dictate all ESPP ordinary gains are reported on your W-2 if you are still working at the company that granted the shares.  So you want to make sure you don't get double taxed.  But if they don't report on the W-2, you will have to report the ordinary gain manually on line 1.  I haven't had to do that in some time, but it was necessary years ago.

You are just going to have to make a call whether the taxes are worth the risk.  WM is not a high risk hold but holding any individual equity is tremendous risk compared to any other kind of market risk and that is usually not compensated with higher returns.  (Look at a WM chart and what happened in 1999.  Unless that was a spinoff - but their wikipedia entry suggest an accounting scandal occurred in 1999.  I would bring this up as what can happen if you don't diversify.)

Based on the chart, it has been mostly flat until this recent bull run, so most of his ESPP lots will probably have significant long term gains.  I would guess $65K has at least $25K in long term gains and $10K of ordinary income.

$10K * .25 = $2.5K
$25K * .15 = $3.8K

So the question is basically whether $65K of WM vs $59K of something else.  I would vote for the $59K being somewhere else.  Trying to hold the gains to retirement serves as a proxy for tax-deferred growth, but 50% of your investment net worth in one stock (real estate equity returns 0% if you don't rent) is definitely out of bounds.

The good news if you sell all the stock in one year is you only have to do the hard work on your taxes once.  Going forward, I would suggest any new ESPP lots be sold immediately.  This will result in almost all gain being reported as ordinary income and would typically be directly reported on his W-2.  (You still need an entry on your Schedule D as with any stock sale, and there will usually be some nominal amount of capital gain/loss because the cost basis will likely not match the sale price exactly.  Many people where I work don't seem to know this.)  My company offers an automated option where shares are sold the next day when the market is open; you may want to ask if WM has a similar option.

The larger issue is if they can actually commit to keeping the money invested.  Unless they have other assets they have not told you about, the answer to that might be no.

neil

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Re: Should my dad sell his ESPP?
« Reply #8 on: February 10, 2015, 10:59:19 AM »
Calculator:

http://twtitw.firebus.com/node/270

However, qualifying/disqualifying is not the same as short term/long term.  There are actually 3 categories of tax situations.

I would not trust the calculator at face value but it seems to be correct.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #9 on: February 10, 2015, 11:14:14 AM »
This all seems complicated and a bit overwhelming to take in all at once.  I really have no idea how the accounting has taken place over the last...well my dad's entire life, so it's difficult for me to glance at the balance and back calculate what is long term vs short term, etc.  It's speculation on my part, I just want to get somewhat up to speed because it seems like a risky and undiversified holding for him.

In regards to the bolded part, if him and my mom gross about 60k/yr, and say they have an AGI of 50k/yr, couldn't he sell and realize $25k in long term capital gains which would all be taxed at 0% (assuming it doesn't nudge them into the 25% income bracket)?  Or if their AGI is higher than I think, couldn't he sell just enough to remain in the 15% bracket to get all those gains tax free, and then sell the remaining qualified stock in following years so he doesn't get dinged by selling all of it at once?  I don't really see a problem with him perpetually holding onto the most recent stock purchases for a year or 2 or whatever the cut off is either, so long as he can sell the previous 8 years worth and get into a more diversified fund.

You can read up on ESPP tax implications.  Long term/short term gains are typical (1 year after your dad received the stock) but the cost basis depends on whether or not it was a qualifying distribution (2 years after grant).  There is always an ordinary income component even if the stock goes to $0, so you want to make sure you do the math right.

Rules now dictate all ESPP ordinary gains are reported on your W-2 if you are still working at the company that granted the shares.  So you want to make sure you don't get double taxed.  But if they don't report on the W-2, you will have to report the ordinary gain manually on line 1.  I haven't had to do that in some time, but it was necessary years ago.

You are just going to have to make a call whether the taxes are worth the risk.  WM is not a high risk hold but holding any individual equity is tremendous risk compared to any other kind of market risk and that is usually not compensated with higher returns.  (Look at a WM chart and what happened in 1999.  Unless that was a spinoff - but their wikipedia entry suggest an accounting scandal occurred in 1999.  I would bring this up as what can happen if you don't diversify.)

Based on the chart, it has been mostly flat until this recent bull run, so most of his ESPP lots will probably have significant long term gains.  I would guess $65K has at least $25K in long term gains and $10K of ordinary income.

$10K * .25 = $2.5K
$25K * .15 = $3.8K

So the question is basically whether $65K of WM vs $59K of something else.  I would vote for the $59K being somewhere else.  Trying to hold the gains to retirement serves as a proxy for tax-deferred growth, but 50% of your investment net worth in one stock (real estate equity returns 0% if you don't rent) is definitely out of bounds.

The good news if you sell all the stock in one year is you only have to do the hard work on your taxes once.  Going forward, I would suggest any new ESPP lots be sold immediately.  This will result in almost all gain being reported as ordinary income and would typically be directly reported on his W-2.  (You still need an entry on your Schedule D as with any stock sale, and there will usually be some nominal amount of capital gain/loss because the cost basis will likely not match the sale price exactly.  Many people where I work don't seem to know this.)  My company offers an automated option where shares are sold the next day when the market is open; you may want to ask if WM has a similar option.

The larger issue is if they can actually commit to keeping the money invested.  Unless they have other assets they have not told you about, the answer to that might be no.

seattlecyclone

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Re: Should my dad sell his ESPP?
« Reply #10 on: February 10, 2015, 11:20:48 AM »
If the shares were offered at a discount, the income won't be all capital gains. There will be a "regular/wage income" component to it as well, regardless of how long your parents have held the shares. See this post and Publication 525 for more info. Don't feel bad if the rules make your head hurt. It's not just you, they really are needlessly complicated.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #11 on: February 10, 2015, 11:22:01 AM »
He also has no real estate equity.  His house is foreclosed on and gone.  Him and my mom are actually living in my house and reimbursing me for the mortgage payment.  He claims they have IRAs, but it's only a few thousand.   He says they contributed one year only, and it was years ago and doesn't have the details of it.   So his entire retirement nest egg is about $140k right now, plus maybe a few grand in IRAs.  He has a significant amount (maybe $60-80k) worth of student loan debt that he cosigned for with my dead beat sister, so that can't be discharged.  They are not in very good shape financially.  I fully expect that at some point in the near future he will no longer be able to physically work and will be forcibly retired.  Then they will be living in my house and not paying me anything because they don't have money.  Wish I could just tell them tough luck and kick them out, but it's my mom and dad, so they will probably just end up living in my house and a disproportionate amount of my stash will be in real estate not earning me any money.  So i'm trying to interject myself into their finances and retirement planning to help them get the most of it.  I think their current retirement plan is to not think about it and keep working until they physically can't. 

MDM

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Re: Should my dad sell his ESPP?
« Reply #12 on: February 10, 2015, 11:42:14 AM »
As mm1970 said, "It really depends on his ESPP."

And as nawhite said, "Apparently there are a lot of threads going on about ESPPs right now :-)."

E.g., see http://forum.mrmoneymustache.com/investor-alley/employer-stock-options/.  Just saying "ESPP" is not descriptive enough.  You (or your dad) will have to discover the specifics of WM's plan.

It does seem you are on the right track regarding selling the shares while the long term capital gain will be taxed at 0%. 

neil

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Re: Should my dad sell his ESPP?
« Reply #13 on: February 10, 2015, 12:22:39 PM »
I agree it is overwhelming.  I was trying to provide an idea of what the overall situation might be.  But if you have some chance to sell without incurring much in taxes, that is better than the scenario I provided.

Selling will still incur some tax increase because ordinary gain portion will not receive the favorable 0% rate.  But on qualifying lots it should be a very small portion of the gain.  Anything 2012 and older will definitely be qualifying dispositions.

The broker holding the ESPP probably provides a summary of gains but not ordinary/capital gain split.  For AGI purposes total gain is really the only important number.  You can worry about the split during tax time.  Selling ESPP will not result in any withholding.

I wouldn't rush, but one thing you could do is sell enough now that would get you around $70K AGI at tax time (provide some buffer for raise/bonus) and get it diversified immediately.  You'll have to make a decision about the remainder.  If you are dead set on trying to keep the cap gains tax rate 0%, you will probably need to provide buffer in your AGI so you can sell up to $75K AGI on 12/2015 and sell the rest on 1/2016.  But generally it is not a good idea to make investment decisions solely based on your tax situation.  WM stock will be far more volatile than any amount of tax bill you are trying to minimize.

If you have the time (and perhaps access to 2014 tax software to run a "simulation" more easily) you can spend the time to figure out each ESPP lot manually and see what the tax difference is between selling all vs selling enough to stay under the 0% cap gain bracket.  If you set up a spreadsheet, the scenarios for qualifying dispositions (2012 and older) will be very easy to do.  For simulation purposes you can manually increase box 1 of his w-2 for ordinary income and make a single entry in schedule D for capital gains.

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Re: Should my dad sell his ESPP?
« Reply #14 on: February 10, 2015, 12:31:43 PM »
My first step would be to stop contributing to the ESPP and shift the contributions over to his 401(k).  You might also check and see what (if any) is happening to the dividends.  They could be set to reinvest.  If so, you could redirect them into an IRA.   

nawhite

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Re: Should my dad sell his ESPP?
« Reply #15 on: February 10, 2015, 01:06:28 PM »
My first step would be to stop contributing to the ESPP and shift the contributions over to his 401(k).  You might also check and see what (if any) is happening to the dividends.  They could be set to reinvest.  If so, you could redirect them into an IRA.

No, don't stop contributing to the ESPP! The same way that 401k matches are free money, ESPPs have free money. Generally its not as good as a 401k match but with many plans it works out to: if you don't touch $100 of your own money for 6 months they give you an extra $17 of income and then you can take your $117 and do what you want with it. Its free money. Definitely keep doing it, just sell the shares immediately.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #16 on: February 10, 2015, 01:14:42 PM »
My first step would be to stop contributing to the ESPP and shift the contributions over to his 401(k).  You might also check and see what (if any) is happening to the dividends.  They could be set to reinvest.  If so, you could redirect them into an IRA.

Isn't he going to be leaving free money on the table if they are selling it at a 15% discount to him?  Seems silly for him to not take advantage of that as long as he is employed there.  Where else can he get an instant 18% return on his money? (if he buys a $100 stock at $85, he essentially just gained 18% of his investment immediately)

I don't know what his dividends are doing, but I assume they are being reinvested since he doesn't have a bunch of dividend checks laying around.  I will have to ask him to know for sure though, but that's what I suspect.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #17 on: February 10, 2015, 01:16:51 PM »
My first step would be to stop contributing to the ESPP and shift the contributions over to his 401(k).  You might also check and see what (if any) is happening to the dividends.  They could be set to reinvest.  If so, you could redirect them into an IRA.

No, don't stop contributing to the ESPP! The same way that 401k matches are free money, ESPPs have free money. Generally its not as good as a 401k match but with many plans it works out to: if you don't touch $100 of your own money for 6 months they give you an extra $17 of income and then you can take your $117 and do what you want with it. Its free money. Definitely keep doing it, just sell the shares immediately.

You beat me to the "free money" point.

I don't even see it as a problem for him to keep dumping 10% of his income into the stock and perpetually holding the most recent 2 years worth of stock as long as he purges everything older than that moves it into vanguard or something.  Then he can keep taking advantage of the ESPP, but not hold a disproportionate amount of his net worth in the company at any given time.

seattlecyclone

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Re: Should my dad sell his ESPP?
« Reply #18 on: February 10, 2015, 01:22:25 PM »
In general there's little reason to hold the stock for two years. The tax benefits to doing so are minimal, typically nowhere near enough to make up for the risk of owning your employer's stock.

nawhite

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Re: Should my dad sell his ESPP?
« Reply #19 on: February 10, 2015, 01:40:55 PM »
In general there's little reason to hold the stock for two years. The tax benefits to doing so are minimal, typically nowhere near enough to make up for the risk of owning your employer's stock.

This is my opinion too. If the stock goes down 2% after the two years, you loose all of your 17-18% because it is a leveraged bet.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #20 on: February 10, 2015, 01:57:30 PM »
In general there's little reason to hold the stock for two years. The tax benefits to doing so are minimal, typically nowhere near enough to make up for the risk of owning your employer's stock.

This is my opinion too. If the stock goes down 2% after the two years, you loose all of your 17-18% because it is a leveraged bet.

How does he lose all of it?  If he pays $85 for $100 stock, and it drops 2%, won't he still be able to sell it for $98?

Also how is it leveraged? He is getting a discount buying the stock, but he isn't borrowing money to buy it.  If he buys it, and it drops 15%, isn't he essentially back to where he started?  He paid $85 for a $100 stock, then it dropped 15% to $85, then he sold it.  The only consequence is that when he sells it he now has to claim that $15 discount as ordinary income and pay taxes on that, which in the 15% income bracket costs him an additional $2.25 in taxes (plus he would owe some state income tax for michigan).  It seems like his stock could realistically drop 10-12% from his purchase date to his sale date and he would still come out ahead, unless I am completely misunderstanding how this works.

seattlecyclone

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Re: Should my dad sell his ESPP?
« Reply #21 on: February 10, 2015, 02:35:03 PM »
In general there's little reason to hold the stock for two years. The tax benefits to doing so are minimal, typically nowhere near enough to make up for the risk of owning your employer's stock.

This is my opinion too. If the stock goes down 2% after the two years, you loose all of your 17-18% because it is a leveraged bet.

How does he lose all of it?  If he pays $85 for $100 stock, and it drops 2%, won't he still be able to sell it for $98?

Also how is it leveraged? He is getting a discount buying the stock, but he isn't borrowing money to buy it.  If he buys it, and it drops 15%, isn't he essentially back to where he started?  He paid $85 for a $100 stock, then it dropped 15% to $85, then he sold it.  The only consequence is that when he sells it he now has to claim that $15 discount as ordinary income and pay taxes on that, which in the 15% income bracket costs him an additional $2.25 in taxes (plus he would owe some state income tax for michigan).  It seems like his stock could realistically drop 10-12% from his purchase date to his sale date and he would still come out ahead, unless I am completely misunderstanding how this works.

The ordinary income component doesn't magically disappear after two years.

I don't know how your father's ESPP works exactly. I'll give an example using how my wife's ESPP works, which seems to be a relatively common structure for these plans.

The program is structured into six-month offering periods. During the offering period, money is collected from paychecks and saved in a pot to buy shares at the end of the period. The price that is paid for the shares is 85% of the price at the beginning or end of the offering period, whichever is lower.

If she doesn't meet the holding period, her basis is equal to the FMV the date she purchased the shares. Any further discount is regular income reported on the W-2.
If she does meet the holding period, her basis is equal to the FMV on the date the option was granted (i.e. the lower price of the beginning or end of the holding period). Any further discount is regular income reported on the W-2.

Suppose the stock was worth $20 at the beginning of the offering period and $25 at the end of the offering period. She would pay $17 for the shares.

If she sold immediately for $25, her basis would be $25 (the FMV on the purchase date), meaning $0 of capital gains income and $8 of regular wage income.
If she met the holding period and sold two years later for $25, her basis would be $20 (the FMV at the beginning of the offering period), meaning $5 of capital gains income and $3 of regular wage income.

So by waiting two years, she gets a lower tax rate on $5/share of income (saving perhaps 75˘/share in taxes in the 15% bracket). If you want to hold on to $25 worth of stock for two years to save 75˘ on taxes, go ahead, but it seems a bit of a risky thing to do with 10% of your salary.

Suppose instead that the stock was worth $25 at the beginning of the offering period and went down to $20 at the end of the offering period. She would still pay $17 for the shares, but meeting the holding period doesn't change her basis at all, so there's zero tax advantage to waiting.

The more the stock went up between the beginning and end of the offering period, the more potential tax advantage there is to waiting. Unless it went up a lot during this time, I don't think the risk is worth it.

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Re: Should my dad sell his ESPP?
« Reply #22 on: February 10, 2015, 02:36:00 PM »
My first step would be to stop contributing to the ESPP and shift the contributions over to his 401(k).  You might also check and see what (if any) is happening to the dividends.  They could be set to reinvest.  If so, you could redirect them into an IRA.

Isn't he going to be leaving free money on the table if they are selling it at a 15% discount to him?  Seems silly for him to not take advantage of that as long as he is employed there.  Where else can he get an instant 18% return on his money? (if he buys a $100 stock at $85, he essentially just gained 18% of his investment immediately)

I don't know what his dividends are doing, but I assume they are being reinvested since he doesn't have a bunch of dividend checks laying around.  I will have to ask him to know for sure though, but that's what I suspect.

What is his current tax bracket (including state)?  What rate do you expect his 401(k) withdrawals to be taxed in retirement?  What is the difference?
« Last Edit: February 10, 2015, 02:40:50 PM by So Close »

MDM

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Re: Should my dad sell his ESPP?
« Reply #23 on: February 10, 2015, 02:51:58 PM »
I don't know how your father's ESPP works exactly. I'll give an example using how my wife's ESPP works, which seems to be a relatively common structure for these plans.

The program is structured into six-month offering periods. During the offering period, money is collected from paychecks and saved in a pot to buy shares at the end of the period. The price that is paid for the shares is 85% of the price at the beginning or end of the offering period, whichever is lower.

It appears WM's plan is identical to what seattlecyclone describes, so there is good reason to believe the rest of his analysis is applicable.  From a WM SEC filing:
Quote
16.    Stock-Based Compensation

Employee Stock Purchase Plan

We have an Employee Stock Purchase Plan (“ESPP”) under which employees that have been employed for at least 30 days may purchase shares of our common stock at a discount. The plan provides for two offering periods for purchases: January through June and July through December. At the end of each offering period, employees are able to purchase shares of our common stock at a price equal to 85% of the lesser of the market value of the stock on the first and last day of such offering period. The purchases are made at the end of an offering period with funds accumulated through payroll deductions over the course of the offering period, and the number of shares that may be purchased is limited by IRS regulations.

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Re: Should my dad sell his ESPP?
« Reply #24 on: February 10, 2015, 03:46:05 PM »
In general there's little reason to hold the stock for two years. The tax benefits to doing so are minimal, typically nowhere near enough to make up for the risk of owning your employer's stock.

This is my opinion too. If the stock goes down 2% after the two years, you loose all of your 17-18% because it is a leveraged bet.

How does he lose all of it?  If he pays $85 for $100 stock, and it drops 2%, won't he still be able to sell it for $98?

Also how is it leveraged? He is getting a discount buying the stock, but he isn't borrowing money to buy it.  If he buys it, and it drops 15%, isn't he essentially back to where he started?  He paid $85 for a $100 stock, then it dropped 15% to $85, then he sold it.  The only consequence is that when he sells it he now has to claim that $15 discount as ordinary income and pay taxes on that, which in the 15% income bracket costs him an additional $2.25 in taxes (plus he would owe some state income tax for michigan).  It seems like his stock could realistically drop 10-12% from his purchase date to his sale date and he would still come out ahead, unless I am completely misunderstanding how this works.

The ordinary income component doesn't magically disappear after two years.

I don't know how your father's ESPP works exactly. I'll give an example using how my wife's ESPP works, which seems to be a relatively common structure for these plans.

The program is structured into six-month offering periods. During the offering period, money is collected from paychecks and saved in a pot to buy shares at the end of the period. The price that is paid for the shares is 85% of the price at the beginning or end of the offering period, whichever is lower.

If she doesn't meet the holding period, her basis is equal to the FMV the date she purchased the shares. Any further discount is regular income reported on the W-2.
If she does meet the holding period, her basis is equal to the FMV on the date the option was granted (i.e. the lower price of the beginning or end of the holding period). Any further discount is regular income reported on the W-2.

Suppose the stock was worth $20 at the beginning of the offering period and $25 at the end of the offering period. She would pay $17 for the shares.

If she sold immediately for $25, her basis would be $25 (the FMV on the purchase date), meaning $0 of capital gains income and $8 of regular wage income.
If she met the holding period and sold two years later for $25, her basis would be $20 (the FMV at the beginning of the offering period), meaning $5 of capital gains income and $3 of regular wage income.

So by waiting two years, she gets a lower tax rate on $5/share of income (saving perhaps 75˘/share in taxes in the 15% bracket). If you want to hold on to $25 worth of stock for two years to save 75˘ on taxes, go ahead, but it seems a bit of a risky thing to do with 10% of your salary.

Suppose instead that the stock was worth $25 at the beginning of the offering period and went down to $20 at the end of the offering period. She would still pay $17 for the shares, but meeting the holding period doesn't change her basis at all, so there's zero tax advantage to waiting.

The more the stock went up between the beginning and end of the offering period, the more potential tax advantage there is to waiting. Unless it went up a lot during this time, I don't think the risk is worth it.

Ok I think I understand.  Isn't that 75 cents in "savings" on the $25 (but really $17) all gravy though? And with an initial purchase price of $17, 75 cents would be a 4.4% return (over a 2 year period though, so 2.2% annualized).  2.2%/yr seems like a nice bonus on top of the actual market returns of the stock.

I agree though that it still doesn't seem quite worth the risk to hold that much in a single company.

seattlecyclone

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Re: Should my dad sell his ESPP?
« Reply #25 on: February 10, 2015, 05:05:45 PM »
The tax benefit is a slight additive to the actual market returns of the stock, true. I would calculate it based on the current value rather than the amount invested, because you can sell for $25 either now or later in my example. If you sell now in the 15% bracket, you get to keep $25 - ($8 * 15%) = $23.80. If you sell in two years and are still in the 15% bracket, you get to keep $25 - ($3 * 15%) = $24.55. That's less than a 3.2% return over two years (around 1.5% annualized).

My example was a pretty extreme one in which the stock increased in value by 25% during the six-month offering period. If this number goes down to a more average amount (say 5%), the potential tax benefit decreases proportionally to a fraction of a percent annually.

By holding the stock, you are making a bet that the stock won't underperform VTSAX (or whatever else you might invest in instead) by more than the percentage tax benefit you would realize by holding the stock. How confident are you that this will be the case? I wouldn't risk it if it were my parents' retirement (and my own possible need to subsidize their retirement) on the line.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #26 on: February 10, 2015, 06:10:38 PM »
The tax benefit is a slight additive to the actual market returns of the stock, true. I would calculate it based on the current value rather than the amount invested, because you can sell for $25 either now or later in my example. If you sell now in the 15% bracket, you get to keep $25 - ($8 * 15%) = $23.80. If you sell in two years and are still in the 15% bracket, you get to keep $25 - ($3 * 15%) = $24.55. That's less than a 3.2% return over two years (around 1.5% annualized).

My example was a pretty extreme one in which the stock increased in value by 25% during the six-month offering period. If this number goes down to a more average amount (say 5%), the potential tax benefit decreases proportionally to a fraction of a percent annually.

By holding the stock, you are making a bet that the stock won't underperform VTSAX (or whatever else you might invest in instead) by more than the percentage tax benefit you would realize by holding the stock. How confident are you that this will be the case? I wouldn't risk it if it were my parents' retirement (and my own possible need to subsidize their retirement) on the line.

Yea I think I understand the math behind it all.
Not at all confident.  I agree with you.




I have been thinking more about this all day.  I think he should probably liquidate the entire account, move most of it (45k) to a balanced fund at vanguard, and use the remaining 20k to fund his normal expenses this year, and supercharge his 401k and IRA contributions this year to get himself down to zero tax liability.  Then use the proceeds from his vanguard account to do the same thing until his account is depleted.  He should be able to use enough tax deferred space to completely negate the effects of liquidating the espp.  This way he could save thousands on income taxes over the next few years.  Make sense?

seattlecyclone

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Re: Should my dad sell his ESPP?
« Reply #27 on: February 10, 2015, 06:18:42 PM »
That sounds like a very reasonable plan. Good luck!

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #28 on: January 26, 2016, 04:12:18 PM »
Well my dad has been dragging his feet and not giving me full access to his finances.  I understand he doesn't want to relinquish control and admit he doesn't know what he is doing, but in the mean time he is literally doing nothing, except continuing to make bad financial decisions.  I have been harping on it for almost a year now, that this is what he needs to do, and every time he just keeps making more excuses and putting it on the back burner.  I really made a strong push to gain access so he could sell some of the ESPP and fund his IRA, and lower his tax bill for 2015 but that never came to fruition.  I finally got him to go along with me though, so we just liquidated all his shares in the old ESPP (sometime in 2015 WM switched brokerage firms for the ESPP). 

I set up an IRA account for him and my mom at vanguard.  He has a $68k check coming in the mail soon.  First plan of action is immediately drop $13 in his IRA, and $13k in my moms.  This should really help with their 2015 taxes, and hopefully their 2016 taxes.  I am planning to increase his 401k contributions for this year, and use a portion of the money to fund living expenses so we can lower their 2016 tax bill ($24k in 401k, and $13 in their IRAs should help reduce taxable income significantly).  The rest I am planning to square up some small issues they are having now (fix up the cars, etc), and dump the rest into a vanguard brokerage account.

The ESPP sale did not withhold any taxes though, so he is just getting a $68k check.  Should he make an estimated tax payment to the IRS to avoid penalty at the end of the year? Or should I just have him increase his withholding through his normal paycheck to make up for that?  I don't know how it's all going to shake out come tax season a year from now, but I imagine this is going to increase their tax bill even if I am able to get him to dump $39k into tax deferred accounts like I described above.

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Re: Should my dad sell his ESPP?
« Reply #29 on: January 26, 2016, 04:55:11 PM »
The ESPP sale did not withhold any taxes though, so he is just getting a $68k check.  Should he make an estimated tax payment to the IRS to avoid penalty at the end of the year? Or should I just have him increase his withholding through his normal paycheck to make up for that?
Either way works.  In general I like the withholding because you have to do that anyway and get to spread the payment over the rest of the year, but the effort to pay estimated tax isn't much different than changing W-4s.

Quote
I don't know how it's all going to shake out come tax season a year from now, but I imagine this is going to increase their tax bill even if I am able to get him to dump $39k into tax deferred accounts like I described above.
After finishing their 2015 tax return, they (you?) should do another one using 2016 estimated numbers.  Yes, there may be slight changes to brackets, deductions, exemptions, etc., but those changes should be minimal in comparison to the changes you describe.  See http://forum.mrmoneymustache.com/taxes/best-way-to-calculate-w-4-exemptions-for-2016/ for a similar discussion.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #30 on: January 26, 2016, 06:20:57 PM »
The ESPP sale did not withhold any taxes though, so he is just getting a $68k check.  Should he make an estimated tax payment to the IRS to avoid penalty at the end of the year? Or should I just have him increase his withholding through his normal paycheck to make up for that?
Either way works.  In general I like the withholding because you have to do that anyway and get to spread the payment over the rest of the year, but the effort to pay estimated tax isn't much different than changing W-4s.

Quote
I don't know how it's all going to shake out come tax season a year from now, but I imagine this is going to increase their tax bill even if I am able to get him to dump $39k into tax deferred accounts like I described above.
After finishing their 2015 tax return, they (you?) should do another one using 2016 estimated numbers.  Yes, there may be slight changes to brackets, deductions, exemptions, etc., but those changes should be minimal in comparison to the changes you describe.  See http://forum.mrmoneymustache.com/taxes/best-way-to-calculate-w-4-exemptions-for-2016/ for a similar discussion.

I have no idea what % of the $68k is going to be counted as regular income he already paid taxes on, regular untaxed income, and capital gains.  I have been almost completely in the dark other than knowing the total.  The website gave me an estimate of "gains", but I have no idea how it's going to be counted until he gets the forms.  They have never let me do their taxes, despite me trying to insert myself and offering to do it for free.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #31 on: April 14, 2017, 08:56:40 AM »
Bumping this ancient thread with an update...


My father never supercharged his 401k contributions despite me nagging him all of 2016.  Finally in october I gave up, as he had largely missed the opportunity.  Took forever to get their information to file taxes for this year also; they just got the stuff to me a couple of weeks ago so it's been a scramble to try and get their taxes finished before the due date.

I entered all his data into turbotax (It was automatically imported into turbotax by providing turbotax with the login credentials), and the tax bill is significantly lower than I anticipated.  He got a check for around $68k after the sale.  Looking at schedule D on his tax forms he has:
                     
                                                  Proceeds    Cost Basis   Gain
1b short term gains:                    $4,766       $3,920       $846
8b long term (reported to IRS)      $29,251     $18,476     $10,775
9 long term (not reported to IRS)  $33,892     $17,823     $16,069


When I math it all out, all the gains from his sale are being counted as capital gains and none are being counted as "w2 income".  I was fully expecting a break down like this, but I was expecting one of those long term capital gains lines to be counted as regular, taxable, W2 income.  This gives them a very high AGI and makes them miss out on some credits (like tax savers credit), but the actual tax owed is very low because it looks like it's counting all those gains as long term capital gains, which means they are paying no tax on it.  When I calculate out the tax owed by hand (line 44 on 1040) I am getting very close to what turbotax is getting, but only when I count all the gains as long term capital gains. 

I guess I should be happy that their tax bill is significantly lower than I was anticipating, but something about it feels like it is wrong.  Did they make an error on his 1099-B?  Did I make an error understanding something? I imported the data directly from the website (and have since double checked it was all imported correctly and matched the pdf copy I have) so there shouldn't be any errors on my part.   I'd hate to have this come back on them later when the IRS is like "whoa buddy your tax rate on that $16k is actually 15%, not 0% for long term capital gains! cough up another $2,400!".  I fully expect them to turn it on me and be like "wtf frugalnacho you fucked up our taxes!"


Another question: The state of michigan apparently doesn't do favorable tax rates for capital gains and just wants to tax them on all income, so their state tax is very high and they owe almost $900.  They don't owe an underpayment penalty, but turbotax is telling me they need to send in estimated tax payments quarterly for 2017.  This was a one time event, and all their income in 2017 will be through W2 wages which will have state taxes withheld at the time of earning.  Do they still need to send in quarterly prepayments when we know their liability for 2017 is going to be less than their w2 withholding? 

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Re: Should my dad sell his ESPP?
« Reply #32 on: April 14, 2017, 12:10:48 PM »
I guess I should be happy that their tax bill is significantly lower than I was anticipating, but something about it feels like it is wrong.  Did they make an error on his 1099-B?  Did I make an error understanding something? I imported the data directly from the website (and have since double checked it was all imported correctly and matched the pdf copy I have) so there shouldn't be any errors on my part.   I'd hate to have this come back on them later when the IRS is like "whoa buddy your tax rate on that $16k is actually 15%, not 0% for long term capital gains! cough up another $2,400!".  I fully expect them to turn it on me and be like "wtf frugalnacho you fucked up our taxes!"
Can't say for sure w/o looking at it directly, but this result is consistent with what you have described previously.  In other words, it looks ok.

Quote
Do they still need to send in quarterly prepayments when we know their liability for 2017 is going to be less than their w2 withholding?
No.

frugalnacho

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Re: Should my dad sell his ESPP?
« Reply #33 on: April 14, 2017, 12:40:52 PM »
I guess I should be happy that their tax bill is significantly lower than I was anticipating, but something about it feels like it is wrong.  Did they make an error on his 1099-B?  Did I make an error understanding something? I imported the data directly from the website (and have since double checked it was all imported correctly and matched the pdf copy I have) so there shouldn't be any errors on my part.   I'd hate to have this come back on them later when the IRS is like "whoa buddy your tax rate on that $16k is actually 15%, not 0% for long term capital gains! cough up another $2,400!".  I fully expect them to turn it on me and be like "wtf frugalnacho you fucked up our taxes!"
Can't say for sure w/o looking at it directly, but this result is consistent with what you have described previously.  In other words, it looks ok.

Hmmm.  I think it seems inconsistent. It was my understanding that the discounted portion of the stock would be counted as regular income*, but not until the year he sold it. 

*ie buy $100 worth of stock for only $85, then when you sell it for $100 you realize $15 worth of regular income.  If you sell for $115 then you realize $15 worth of regular income and $15 in capital gains. 

It appears none of the discount he received is counted as regular income though, it's all just capital gains.  The discount didn't count as income in the year he bought it, and it's not counted as regular income in the year he sold it either. 

MDM

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Re: Should my dad sell his ESPP?
« Reply #34 on: April 14, 2017, 01:00:18 PM »
Hmmm.  I think it seems inconsistent. It was my understanding that the discounted portion of the stock would be counted as regular income*, but not until the year he sold it. 

*ie buy $100 worth of stock for only $85, then when you sell it for $100 you realize $15 worth of regular income.  If you sell for $115 then you realize $15 worth of regular income and $15 in capital gains. 

It appears none of the discount he received is counted as regular income though, it's all just capital gains.  The discount didn't count as income in the year he bought it, and it's not counted as regular income in the year he sold it either.
Depends on the particulars of the ESPP.  Seattlecyclone described one treatment in a previous post.  At Megacorp where I worked, there was immediate ordinary income on the difference between market and offer price on the day purchased.  The correct basis, used whenever the ESPP shares were sold, was then the market price from the purchase day.

But see Your 1099-B form for an ESPP sale will probably be wrong.  The problem described in that thread is an incorrect basis that is unfavorable to the taxpayer.  It seems here you have a 1099-B with a favorable basis.  Unless you know differently, it is not unreasonable to assume the basis is correct, in addition to being favorable.