Author Topic: espp question  (Read 4692 times)

notredame232

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espp question
« on: April 16, 2015, 02:26:34 PM »
I'm in a where my ESPP is at a 15% discount at the close of each quarter. Employees can contribute a max of $21.5k per year which equates to $25k in stock.

If I'm making $60k/yr, this represents about ~35% of my income that I am essentially deferring. If I can live without needing the $5,375/quarter, this is an easy $3500 (less taxes) per year right?

MDM

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Re: espp question
« Reply #1 on: April 16, 2015, 02:31:54 PM »
Sure is - good for you for realizing and taking advantage.

Also see http://forum.mrmoneymustache.com/investor-alley/should-i-get-stock-options-at-a-discount-or-save-that-money/ for similar discussion.  You may be able to (and should if you can) do both 401k and ESPP.

jnc

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Re: espp question
« Reply #2 on: April 16, 2015, 02:38:16 PM »
Yeah just make sure to stay disciplined and sell those shares as soon as you get them.

The other thing to check is that at some companies, the discount is 15% off either the price either at the beginning of the period or the end - whichever is the lowest. If that's the case, your return is even higher than 15%.

Financial.Velociraptor

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Re: espp question
« Reply #3 on: April 16, 2015, 02:57:47 PM »
I'm in a where my ESPP is at a 15% discount at the close of each quarter. Employees can contribute a max of $21.5k per year which equates to $25k in stock.

If I'm making $60k/yr, this represents about ~35% of my income that I am essentially deferring. If I can live without needing the $5,375/quarter, this is an easy $3500 (less taxes) per year right?

I had a similar deal before FIRE.  It was 15% below the lower of the beginning or ending price so usually  quite a lot better than 15%.  If you sold less than 3 years, the gain was ordinary income for US tax purposes.  I never understood that but took the free (less 28%) money anyway.  Mine was capped at 10k, so yours is very generous!

notredame232

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Re: espp question
« Reply #4 on: April 16, 2015, 03:50:23 PM »
Yeah just make sure to stay disciplined and sell those shares as soon as you get them.

The other thing to check is that at some companies, the discount is 15% off either the price either at the beginning of the period or the end - whichever is the lowest. If that's the case, your return is even higher than 15%.

it's definitely 15% from where the stock closes the quarter.
and I'm doing 401k as well, targeting $10k for the year.

any thoughts on eating the short term capital gains tax vs. waiting a year for lower taxes? my plan is to take the money and reinvest in vfinx or another similar fund.

seattlecyclone

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Re: espp question
« Reply #5 on: April 16, 2015, 04:15:18 PM »
In general, you should sell your ESPP shares right away. You get a huge return on your investment the instant the discounted shares land in your account. The amount you stand to earn by holding for 12-18 months afterwards to get the best tax treatment is comparatively small, and you have to weigh that potential gain against the risks inherent to holding too much of one particular stock.

clifp

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Re: espp question
« Reply #6 on: April 16, 2015, 04:49:25 PM »
In general, you should sell your ESPP shares right away. You get a huge return on your investment the instant the discounted shares land in your account. The amount you stand to earn by holding for 12-18 months afterwards to get the best tax treatment is comparatively small, and you have to weigh that potential gain against the risks inherent to holding too much of one particular stock.
I disagree.   In general I think it worth waiting the extra 18 months or so to get the lower tax rate.  Say you are the 28% marginal rate waiting an additional 18 months will give you an additional 13% tax saving which is about 9% year or roughly the same as the average stock market gains. It does depend on your individual risk tolerance and financial situation.

Let say you are making $100K a year and contribute 10% holding 2 years of stock is roughly $20K.  If you only have $20k in other saving than yes have $20K is too much. On the hand if you have $400K in saving than 20K is only 5% of you net worth and well worth holding.

The other important factor is how much capital gains there is to lock in.  If the stock was say 20% higher at the end of the period than the beginning than it make sense to hold to lock in the capital gains. On the other hand if it was flat or only a up a few percent than selling immediately for most people makes sense.

seattlecyclone

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Re: espp question
« Reply #7 on: April 16, 2015, 05:01:27 PM »
In general, you should sell your ESPP shares right away. You get a huge return on your investment the instant the discounted shares land in your account. The amount you stand to earn by holding for 12-18 months afterwards to get the best tax treatment is comparatively small, and you have to weigh that potential gain against the risks inherent to holding too much of one particular stock.
I disagree.   In general I think it worth waiting the extra 18 months or so to get the lower tax rate.  Say you are the 28% marginal rate waiting an additional 18 months will give you an additional 13% tax saving which is about 9% year or roughly the same as the average stock market gains. It does depend on your individual risk tolerance and financial situation.

Let say you are making $100K a year and contribute 10% holding 2 years of stock is roughly $20K.  If you only have $20k in other saving than yes have $20K is too much. On the hand if you have $400K in saving than 20K is only 5% of you net worth and well worth holding.

The other important factor is how much capital gains there is to lock in.  If the stock was say 20% higher at the end of the period than the beginning than it make sense to hold to lock in the capital gains. On the other hand if it was flat or only a up a few percent than selling immediately for most people makes sense.

I believe you may be mistaken about how these plans are taxed. Assuming the stock is sold for a set discount off of the price at the end of the offering period, that discount you received is taxed as regular income regardless of when you sell. Your basis is then set to the fair market value at that time. So if you sell right away, you pay essentially no capital gains taxes, and regular income tax on the discount. If you wait, the stock could go up or down. If it goes up, you'll pay long-term gains on the increase, sure, but you'll still be paying your regular marginal rate on the discount you received. So the question really is: do you have some reason to believe that your employer's stock will beat the market, and are you willing to bear that risk? If not, just sell right away and invest in an index fund.

GreenPen

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Re: espp question
« Reply #8 on: April 16, 2015, 05:03:15 PM »
In general, you should sell your ESPP shares right away. You get a huge return on your investment the instant the discounted shares land in your account. The amount you stand to earn by holding for 12-18 months afterwards to get the best tax treatment is comparatively small, and you have to weigh that potential gain against the risks inherent to holding too much of one particular stock.
I disagree.   In general I think it worth waiting the extra 18 months or so to get the lower tax rate.  Say you are the 28% marginal rate waiting an additional 18 months will give you an additional 13% tax saving which is about 9% year or roughly the same as the average stock market gains. It does depend on your individual risk tolerance and financial situation.

Let say you are making $100K a year and contribute 10% holding 2 years of stock is roughly $20K.  If you only have $20k in other saving than yes have $20K is too much. On the hand if you have $400K in saving than 20K is only 5% of you net worth and well worth holding.

The other important factor is how much capital gains there is to lock in.  If the stock was say 20% higher at the end of the period than the beginning than it make sense to hold to lock in the capital gains. On the other hand if it was flat or only a up a few percent than selling immediately for most people makes sense.

I think you are overstating the tax difference.

Waiting the extra 18 months or so will not lock in a lower rate on the 15% discount. The discount is going to be treated as ordinary income either way (unless the shares happened to drop in value between the purchase date and the date of sale). There is no way to get the 15% discount to be treated as long-term capital gains.

So I would say that the OP should sell right away to get the correct asset allocation. (On a side note: the OP originally talked about waiting "a year" to sell. It would probably take more than a year, since the shares would need to be held for two years from the grant date, or beginning of the offering period).

KungfuRabbit

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Re: espp question
« Reply #9 on: April 16, 2015, 06:45:29 PM »

[/quote]

I believe you may be mistaken about how these plans are taxed. Assuming the stock is sold for a set discount off of the price at the end of the offering period, that discount you received is taxed as regular income regardless of when you sell. Your basis is then set to the fair market value at that time. So if you sell right away, you pay essentially no capital gains taxes, and regular income tax on the discount. If you wait, the stock could go up or down. If it goes up, you'll pay long-term gains on the increase, sure, but you'll still be paying your regular marginal rate on the discount you received. So the question really is: do you have some reason to believe that your employer's stock will beat the market, and are you willing to bear that risk? If not, just sell right away and invest in an index fund.
[/quote]

Thats not true for my ESPP.  We get a 15% discount when we purchase.  if we sell in less than 2 years that 15% discount is treated as income, if we sell in more than 2 years it is treated as capital gains. 

Either way.  Max it out man, just make sure to diversify as soon as you can.

clifp

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Re: espp question
« Reply #10 on: April 16, 2015, 06:51:16 PM »


I believe you may be mistaken about how these plans are taxed. Assuming the stock is sold for a set discount off of the price at the end of the offering period, that discount you received is taxed as regular income regardless of when you sell. Your basis is then set to the fair market value at that time. So if you sell right away, you pay essentially no capital gains taxes, and regular income tax on the discount. If you wait, the stock could go up or down. If it goes up, you'll pay long-term gains on the increase, sure, but you'll still be paying your regular marginal rate on the discount you received. So the question really is: do you have some reason to believe that your employer's stock will beat the market, and are you willing to bear that risk? If not, just sell right away and invest in an index fund.
[/quote]

Thats not true for my ESPP.  We get a 15% discount when we purchase.  if we sell in less than 2 years that 15% discount is treated as income, if we sell in more than 2 years it is treated as capital gains. 

Either way.  Max it out man, just make sure to diversify as soon as you can.
[/quote]

Yup that is the way it worked when I was doing them. The laws may have changed in the last 15 years, and the 2 year starts at beginning of the period so it is generally 18 months after the shares are purchased.

seattlecyclone

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Re: espp question
« Reply #11 on: April 16, 2015, 07:05:36 PM »
This IRS document explains taxation of ESPP shares. The OP mentioned that the discount is always applied at the end of the period (i.e. there is no "lookback" feature to their plan). I'll quote a relevant portion of the documentation below:

Quote
Option granted at a discount.   If, at the time the option was granted, the option price per share was less than 100% (but not less than 85%) of the fair market value of the share, and you dispose of the share after meeting the holding period requirement, or you die while owning the share, you must include in your income as compensation, the lesser of:

  • The excess of the fair market value of the share at the time the option was granted over the option price, or
  • The excess of the fair market value of the share at the time of the disposition or death over the amount paid for the share under the option.

For this purpose, if the option price was not fixed or determinable at the time the option was granted, the option price is figured as if the option had been exercised at the time it was granted.

   Any excess gain is capital gain. If you have a loss from the sale, it is a capital loss, and you do not have any ordinary income.

So if you meet the holding period requirements (two years), you have taxable compensation income, at your regular rate, equal to the original discount (assuming the stock went up since you bought it). Any amount the stock increased since then will be a long-term capital gain. If the stock went down, the ordinary compensation income amount will be lower or potentially nonexistent.

What if you sell within two years and fail to meet the holding period?

Quote
If you do not satisfy the holding period requirement, your ordinary income is the amount by which the stock's fair market value when you exercised the option exceeded the option price. This ordinary income is not limited to your gain from the sale of the stock. Increase your basis in the stock by the amount of this ordinary income. The difference between your increased basis and the selling price of the stock is a capital gain or loss.

If you don't meet the holding period, the discount on the stock counts as ordinary compensation income, same as if you do meet the holding period. Any change in value between the purchase and sale counts as a short-term capital gain or loss. If you sell right away, any capital gains or losses should be minimal.

notredame232

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Re: espp question
« Reply #12 on: April 16, 2015, 07:25:54 PM »
definitely going to sell. just wanted to make sure I wasn't missing anything critical. thanks for all the input!