ESPP Shares - What to do?

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jh-1391
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ESPP Shares - What to do?

Post by jh-1391 »

My company offers a discounted stock purchase plan for employees - 15% discount for stocks - for a 6 month period, and the share price is based on the lesser of the two prices on the first and last day of the offering period. Now, from what I understand in regards to ESPP, the 15% discount will ALWAYS be taxed as ordinary income, but any gains must be held for a certain amount of time (for this plan, 18 months after the offering period ends and I'm able to sell them) to become long term capital gains. Is that pretty common/correct?

Now I know I've read on here before that most advocate selling these shares right away, locking in at least a 15% gain (possibly more if stock has gone up in the 6 months but thus incurring short-term capital gains on the difference between the first and last day share price), and using the proceeds in index funds/ETFs and spreading around risk. My question is: does anyone here disagree with this philosophy? It seems like most people at my work hold their shares and wait to hit long term capital gains. Now some of those people I don't really agree with their financial philosophy, but others I have a lot of respect for and generally agree with what they say/do.

I was thinking of this method: sell anywhere from 50-75% of the shares to lock in some gains, and holding the rest to get the benefit of long term gains. While I know it isn't smart to be heavily invested in your company's stock since you're already heavily invested via salary (hence selling the majority), I also have the benefit of knowing how the company is doing and, currently, I'm pretty confident that the share price/company performance will continue to grow.

What do y'all think? I probably couldn't start this plan of selling most and holding some for a year, since I'll need the cash this year for a large landscaping project, but is this plan of selling the majority and holding some just an awful idea? Should I hold it all and wait the 18 months for long term gains or sell it all? As a "FYI", I work in the energy industry, but I'm also confident that, excluding some major IRS/SEC scandal from top management, my company will continue to outperform its peers.
ieee488
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Re: ESPP Shares - What to do?

Post by ieee488 »

I did the ESPP purchase and immediate sell twice last year.

I would not risk $ to save on the difference between long-term capital gain and short-term capital.
You could end up losing all of your 15% discount easily.
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scone
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Re: ESPP Shares - What to do?

Post by scone »

We always sell immediately. IMO it's always all about risk management. The perceived health of the company is totally irrelevant-- you're just making a concentrated bet, and you likely won't be rewarded for it.
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dickenjb
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Re: ESPP Shares - What to do?

Post by dickenjb »

Don't let the tax tail wag the investment dog. Sell and reinvest the proceeds in VTSAX or other broadly diversified fund.
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mhc
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Re: ESPP Shares - What to do?

Post by mhc »

If you sell immediately there are virtually no capital gains tax to pay. Isn't no tax better than long term capital gains tax? I sell immediately so that I can properly diversify my investments.
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joppy
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Re: ESPP Shares - What to do?

Post by joppy »

Assuming you are allowed to buy up to 10% of your salary at 15% discount, every 6 months. So, if you hold until the end of the 18 month holding period, you will have received 4 lots of ESPP shares having invested about 20% of your salary.

If you have a solid 6-month to 1-year emergency fund, and have other investments, then it is okay to hold. If 20% of your salary is a large number compared to the rest of your liquid assets, then you should probably sell immediately.

Over time, you may do well to have a target or maximum percentage to your company in your asset allocation. For many people here on the Bogleheads that percentage is zero. Capping your allocation to 10% of your net worth is prudent, unless you are in a special situation (e.g. in a startup with illiquid stock).

Cheers,
Joppy
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siamond
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Re: ESPP Shares - What to do?

Post by siamond »

In my foolish days, I did more or less what you suggested. Selling ESPP 18 months later to get long-term capital gains. Thinking that I had a good handle of where the company stock was going (and I was one of the lead strategists for the company, so I truly had a clue). Well, I got burned several times before I got the point... Since then, I sold right away and re-invested in index funds. I would advise you do the same...
dimdum
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Re: ESPP Shares - What to do?

Post by dimdum »

I sell 50% immediately or as soon as I can for ESPP. Rest I sell in 25+25 lot. Mine is div paying, big company stock, so holding 50% has some benefit.
As others have said, don't let the tax tail wag the investment dog.
jda
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Re: ESPP Shares - What to do?

Post by jda »

Would you buy your company's share if there were no discount was given?

If the answer is no then why would you want to hold it for long term cap gain (if there is even one)?
If the answer is yes then you may want to consider hold it.

The bottom line is don't let the tax tail wag the investment dog.
ccieemeritus
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Re: ESPP Shares - What to do?

Post by ccieemeritus »

I am an imperfect Boglehead.

Part of my investment philosophy is to minimize taxes by buying and holding until retirement (the only
exception being when I bought and eventually paid off my house by selling ESPP). Once I retire my tax rate will be
lower thanks to lower income and (possibly) relocating out of CA. I'm close to my number so holding
until retirement is not that long term. I'm at peak earning levels in CA so my tax rate is substantial.
People call that "tail wagging the dog". I call it avoiding 35% CA cap gain taxes.

I love index funds because I can buy them, set dividends to reinvest, and forget them. No worries
about picking individual stocks, whether my kick-ass mutual fund manager retired, or turnover resulting
in significant capital gain distributions. Low expense ratios rule!

My main non-boglehead item is ESPP. I've historically held on to my ESPP shares to make all gains long term.
When the ESPP first vested it was a small enough amount of money (about 1% of my net worth) that the fact
that it wasn't an index fund didn't worry me. In my case I got lucky and my company stock went up.
Now I have years of ESPP accumulated.

So here I am. I'm an ESPP winner. I live below my means and save save save. I'm close to the number.
But a significant percentage of my net worth is in one stock in a taxable account. So I'm stressed.

If you hold on to your ESPP you will be a saver. You might be a winner. You might be a loser. But you will be stressed.
Nukeboilermaker
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Re: ESPP Shares - What to do?uarter

Post by Nukeboilermaker »

darrellr wrote:I am an imperfect Boglehead.

Part of my investment philosophy is to minimize taxes by buying and holding until retirement (the only
exception being when I bought and eventually paid off my house by selling ESPP). Once I retire my tax rate will be
lower thanks to lower income and (possibly) relocating out of CA. I'm close to my number so holding
until retirement is not that long term. I'm at peak earning levels in CA so my tax rate is substantial.
People call that "tail wagging the dog". I call it avoiding 35% CA cap gain taxes.

I love index funds because I can buy them, set dividends to reinvest, and forget them. No worries
about picking individual stocks, whether my kick-ass mutual fund manager retired, or turnover resulting
in significant capital gain distributions. Low expense ratios rule!

My main non-boglehead item is ESPP. I've historically held on to my ESPP shares to make all gains long term.
When the ESPP first vested it was a small enough amount of money (about 1% of my net worth) that the fact
that it wasn't an index fund didn't worry me. In my case I got lucky and my company stock went up.
Now I have years of ESPP accumulated.

So here I am. I'm an ESPP winner. I live below my means and save save save. I'm close to the number.
But a significant percentage of my net worth is in one stock in a taxable account. So I'm stressed.

If you hold on to your ESPP you will be a saver. You might be a winner. You might be a loser. But you will be stressed.
I too am imperfect, this is one area I'm biting my lip and risking a little. My company is a large utility with a solid dividend. I have about 2/3 of my equivalent efund value in my ESPP and still max out all other tax advantaged retirement funds. My efund earned about $100 in interest last year, in contrast my ESPP earned 1k in qualified dividend after just two years of share purchasing.

My company took a beating since 2008 (I started buying towards the bottom) and I feel like its a reasonable risk given the 3 to 5% dividend. However, I don't know where the stock value will go but we all need electricity made, sold, and delivered and my company does just that and again that solid quarterly dividend adds up in a hurry especially with a DRIP (note this is a fairly un bogleheadish thing to do but I'm young and have a high risk tolerance)
jda
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Re: ESPP Shares - What to do?

Post by jda »

darrellr wrote:I am an imperfect Boglehead.

Part of my investment philosophy is to minimize taxes by buying and holding until retirement (the only
exception being when I bought and eventually paid off my house by selling ESPP). Once I retire my tax rate will be
lower thanks to lower income and (possibly) relocating out of CA. I'm close to my number so holding
until retirement is not that long term. I'm at peak earning levels in CA so my tax rate is substantial.
People call that "tail wagging the dog". I call it avoiding 35% CA cap gain taxes.

I love index funds because I can buy them, set dividends to reinvest, and forget them. No worries
about picking individual stocks, whether my kick-ass mutual fund manager retired, or turnover resulting
in significant capital gain distributions. Low expense ratios rule!

My main non-boglehead item is ESPP. I've historically held on to my ESPP shares to make all gains long term.
When the ESPP first vested it was a small enough amount of money (about 1% of my net worth) that the fact
that it wasn't an index fund didn't worry me. In my case I got lucky and my company stock went up.
Now I have years of ESPP accumulated.

So here I am. I'm an ESPP winner. I live below my means and save save save. I'm close to the number.
But a significant percentage of my net worth is in one stock in a taxable account. So I'm stressed.

If you hold on to your ESPP you will be a saver. You might be a winner. You might be a loser. But you will be stressed.
You are paying the 35% tax on the 15% guaranteed gain no matter what and if you believe your stock is a winner (aka better than market return) then by all means hold it until your retirement. However, if you truly believe it's a winner then why not buying your company's stock in ROTH IRA? That way you won't have to pay tax on the cap gain, ever.
ccieemeritus
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Re: ESPP Shares - What to do?

Post by ccieemeritus »

However, if you truly believe it's a winner then why not buying your company's stock in ROTH IRA?
I know it's been a winner in the past. Tomorrow? Who knows. The 15% guaranteed return entices me to max out ESPP, which I don't sell to defer and minimize taxes. But my risk in this one stock is high enough that I won't voluntarily buy another share without a 15% bribe. Roth is 100% index fund but is small. 401k is large and mostly index.
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jh-1391
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Re: ESPP Shares - What to do?

Post by jh-1391 »

Thank you all so much for the replies. Pretty much all of it I agree with (if not 100% then at least half). I think for now, until I get established, I will be selling all immediately. I have bought company stock without the discount but have since sold it to fully fund my Roth. I have maxed out the purchase at 10% of my salary so, after just working for 9 months, it's still a big percentage of my net worth, around 15%, so I'll be selling all shares once I am able for at least the next 2 years.

To answer the question of how one would have capital gains if selling immediately, I believe this is a scenario where that can happen: say company share price is $50 on Jan 1st. At the end of the offering period it has gone up to $75. My ESPP purchase price is based on a 15% discount on the lesser of those two prices, so the 15% discount is taxed at normal income, and the $25/share increase is taxes at short term capital gains. I could be wrong, but that's how I understand it. Technically it's all just regular income, but the designation of the two increases in value would be different.

Thank you for all of the opinions!
flybynite
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Re: ESPP Shares - What to do?

Post by flybynite »

Great conclusion, just want to add an extra 2.6% to your reasons to sell immediately. 15% discount is ~17.6% gain, of course as many have pointed out this is only close to guaranteed (in most plans there is some transfer time delay beyond next day opening) if you sell immediately. There will always be someone who made money keeping an ESPP who will try to dissuade you to get the additional tax benefit, but even if your company doesn't implode like Enron or Lehman in the holding period, you may find the variance over the holding period of your companies stock is in many cases on the same order or higher than the discount. This has been true of every MegaCorp I've worked for. Why add risk to an almost perfect opportunity for a high return?
ieee488
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Re: ESPP Shares - What to do?

Post by ieee488 »

jh-1391 wrote: To answer the question of how one would have capital gains if selling immediately, I believe this is a scenario where that can happen: say company share price is $50 on Jan 1st. At the end of the offering period it has gone up to $75. My ESPP purchase price is based on a 15% discount on the lesser of those two prices, so the 15% discount is taxed at normal income, and the $25/share increase is taxes at short term capital gains. I could be wrong, but that's how I understand it. Technically it's all just regular income, but the designation of the two increases in value would be different.

Thank you for all of the opinions!
When you sell it immediately figuring out the taxes are a bit of a pain. At least it was to me since I was new to it.
I Googled and found an E-trade document that explained what I had to do.
The discount in the scenario that you mention above [$75 market price - $42.50 ] x # of shares is taxed at normal income and shows up on your W-2.
$42.50 purchase price = $50 - $7.50 where 15% of $50 = $7.50
If you buy 100 shares, you will have $3,250 reported on your W-2.
You need to track that carefully. It was on one of my paystubs.
You will need it for filling out your Form 8949.

If the stock goes up $1 by the time you sell. The short term capital gain is $100 Edit: if you buy 100 shares.
Last edited by ieee488 on Sat Apr 19, 2014 2:32 pm, edited 3 times in total.
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Topic Author
jh-1391
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Re: ESPP Shares - What to do?

Post by jh-1391 »

I'll probably never hold 100% of the ESPP shares even I decide to eventually hold a portion, but it wasn't just a few people at the company who held shares for 18 months. Almost everyone I discussed it with at work did and it honestly shocked me, since most of the people I work with seem to be more of a diversified risk-type. This also isn't the only stock exposure in my compensation from my company since I also have Stock Appreciation Options and Restricted Stock so I have plenty of individual company stock money tied up.

Right now ESPP is a decent way to force myself to save an additional 10% of my salary than I already am, so I guess that's how I need to look at it - an extension of my EF that I need to cash out of a risky investment once I can.
tamudude
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Re: ESPP Shares - What to do?

Post by tamudude »

ieee488 wrote:
jh-1391 wrote: To answer the question of how one would have capital gains if selling immediately, I believe this is a scenario where that can happen: say company share price is $50 on Jan 1st. At the end of the offering period it has gone up to $75. My ESPP purchase price is based on a 15% discount on the lesser of those two prices, so the 15% discount is taxed at normal income, and the $25/share increase is taxes at short term capital gains. I could be wrong, but that's how I understand it. Technically it's all just regular income, but the designation of the two increases in value would be different.

Thank you for all of the opinions!
When you sell it immediately figuring out the taxes are a bit of a pain. At least it was to me since I was new to it.
I Googled and found an E-trade document that explained what I had to do.
The discount in the scenario that you mention above [$75 market price - $42.50 ] x # of shares is taxed at normal income and shows up on your W-2.
$42.50 purchase price = $50 - $7.50 where 15% of $50 = $7.50
If you buy 100 shares, you will have $3,250 reported on your W-2.
You need to track that carefully. It was on one of my paystubs.
You will need it for filling out your Form 8949.

If the stock goes up $1 by the time you sell. So, the short term capital gain is $100.
Look at your ESPP documents carefully and you might notice a term called disposition. There are two scenarios when it comes to disposition;
1. Disqualifying disposition - if ESPP shares are sold less than 24 months after the offering start date (which is also 18 months from purchase date) you HAVE to calculate income tax based on the higher of the two share prices (start date vs purchase date). In your example above that would mean income is calculated as $75-$42.50. This will MOST PROBABLY be reported as income on your W2 with clarifications in box 14. Basis for your capital gains will be $75. Anything above is capital gains and can be either short term or long term.
2. Qualifying disposition - if ESPP shares are sold more than 24 months after the offering start date (which is also 18 months from purchase date) you get to calculate income based on the lower of the two share prices (start date vs purchase date). In your example above that would mean income is calculated as $50-$42.50. This will MOST PROBABLY NOT be reported as income on your W2 and you have to correct for it in your tax returns. Basis for your capital gains will be $50. Anything above is capital gains and will be long term.
This is how the plan is setup at my company so your mileage may vary. The best thing to happen recently is that we now buy every three months. That makes it easier to make such decisions.
So as you see, there are tax consequences especially when the spread between the start date and the purchase date is significantly higher. You make the judgement as to how to play your cards. You are still coming out ahead no matter what unless things are really going downhill at your place of work.
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archbish99
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Re: ESPP Shares - What to do?

Post by archbish99 »

If you sell immediately, you'll have relatively little that gets taxed as a short-term gain, and the portion that's ordinary income will always be ordinary income. You could as easily reinvest in index funds and get long-term gains there in 12 months.
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jh-1391
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Re: ESPP Shares - What to do?

Post by jh-1391 »

1. Disqualifying disposition - if ESPP shares are sold less than 24 months after the offering start date (which is also 18 months from purchase date) you HAVE to calculate income tax based on the higher of the two share prices (start date vs purchase date). In your example above that would mean income is calculated as $75-$42.50. This will MOST PROBABLY be reported as income on your W2 with clarifications in box 14. Basis for your capital gains will be $75. Anything above is capital gains and can be either short term or long term.
That's basically what I was trying to say, though it probably is not technically correct. Just in my head since short term capital gains = taxed at same rate as regular income, I just separated them out so that the 15% discount = regular income no matter what, and the change in price from purchase price = short term gains = regular income if sold within 18 months, and change in purchase price = long term gain if sold after 18 months.

Thank you all for all of your help/comments. This is a great resource, especially for new investors!
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