Should I contribute to this ESPP?

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boglengineer
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Joined: Thu Jun 02, 2011 5:45 pm

Should I contribute to this ESPP?

Post by boglengineer » Mon Jun 11, 2018 8:46 pm

I have my first opportunity at an ESPP and I’m trying to figure out whether I should participate it in or not so I have come here for advice as it’s not all that straightforward to me. It may all be standard terminology, but it is new to me. Here are the details. I can purchase up to $25k per year on a quarterly basis. They are purchased for a price equal to the lower of 85% of the market price of the shares at the beginning of the quarter or 85% of the market price at the end of the quarter.

The program states that it complies with Section 423 of the Internal Revenue Code that established a 2-year holding period. If I sell or transfer the shares, they report the ordinary income portion of the gain as additional compensation on W-2. The holding period is technically 2 years after the beginning of the purchase period (21 months after I actually purchase the shares).

If I sell the shares after the 2 year holding period, then I have to report ordinary income in the amount of the lesser of 15 percent of the 15 percent of the fair market value of the shares on the first day of the purchase period, or the excess, of the fair market value of the shares on the date of the sale over the purchase price. If the purchase price exceeds the fair market value on the date of the sale, no amount is reported as ordinary income. If the fair market value of the shares on the date of the sale exceeds the sum of the purchase price plus any amount recognized as ordinary income, then I must report the amount as a long-term capital gain. If the purchase price exceeds the fair market value on the date of the sale, the excess is long-term capital loss.

If I sell the shares before the end of the 2 year holding period, then I need to report the excess of the fair market value of the shares on the purchase date over the purchase price as ordinary income. If the fair market value of the shares on the date of the sale exceeds the fair market value on the purchase date, I must report the excess as capital gain. If the purchase price plus any amount recognized as ordinary income exceeds the fair market value on the date of the sale, the excess is long-term capital loss. These gains or losses may be short-term or long-term if sold less than or greater than 12 months from the purchase date.

However, it also says that the company requires employees to hold the shares for at least 1 year from the purchase date but then I can send them at any time.

So I guess my questions are is it worth waiting for 2 years before selling or should I just sell at 1 year? And is this plan even worth contributing to or is the mandatory 1 year waiting period not worth it? I am in the 24% tax bracket with 5.1% income tax. Thanks in advance for your help!

viz
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Re: Should I contribute to this ESPP?

Post by viz » Mon Jun 11, 2018 10:47 pm

I personally would not contribute if this was a plan for my company as the price of the stocks move up and down 15% almost every year so basically it is like investing in a single stock. Worse, your income is tied to the same underlying company. I would just take your contribution and invest it in a fund.

I am sure others would disagree and with everything stock related you could miss out on a big upside by not contributing.

HornedToad
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Re: Should I contribute to this ESPP?

Post by HornedToad » Mon Jun 11, 2018 11:32 pm

That's a pretty awesome ESPP. You should contribute the max. I'd be tempted to sell immediately instead of trying to wait 1-2 years for more favorable tax treatment.

See articles below

https://blog.wealthfront.com/good-espp-no-brainer/
https://www.mystockoptions.com/content/ ... -treatment

isidhu
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Re: Should I contribute to this ESPP?

Post by isidhu » Tue Jun 12, 2018 1:21 am

I have a similar plan, except the contribution amount is lower. I sell the shares as soon as they are in my account. I gain 15% in the process even if the shares are down and pay what ever taxes (24%). Even with the tax considered I am still taking about 10% on top of my invested amount. Pretty sweet deal.

I dont wait or hold this. Sell and direct the return to brokerage where my regular investments live.

boglengineer
Posts: 35
Joined: Thu Jun 02, 2011 5:45 pm

Re: Should I contribute to this ESPP?

Post by boglengineer » Tue Jun 12, 2018 4:29 am

HornedToad wrote:
Mon Jun 11, 2018 11:32 pm
That's a pretty awesome ESPP. You should contribute the max. I'd be tempted to sell immediately instead of trying to wait 1-2 years for more favorable tax treatment.

See articles below

https://blog.wealthfront.com/good-espp-no-brainer/
https://www.mystockoptions.com/content/ ... -treatment
Thanks for the links HornedToad. I think you’re right that it seems like a no-brainer. I think I still have to hold it for a year according to the plan but I will look into it further. But I’ll sell as soon as I can. I agree that the favorable tax treatment likely isn’t worth the added risk.

Valuethinker
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Re: Should I contribute to this ESPP?

Post by Valuethinker » Tue Jun 12, 2018 4:57 am

boglengineer wrote:
Tue Jun 12, 2018 4:29 am
HornedToad wrote:
Mon Jun 11, 2018 11:32 pm
That's a pretty awesome ESPP. You should contribute the max. I'd be tempted to sell immediately instead of trying to wait 1-2 years for more favorable tax treatment.

See articles below

https://blog.wealthfront.com/good-espp-no-brainer/
https://www.mystockoptions.com/content/ ... -treatment
Thanks for the links HornedToad. I think you’re right that it seems like a no-brainer. I think I still have to hold it for a year according to the plan but I will look into it further. But I’ll sell as soon as I can. I agree that the favorable tax treatment likely isn’t worth the added risk.
Once you are in the plan for 2 years do you not then have a deferred income scheme?

i.e. each year you sell the shares you bought 2 years before? Effectively a steady state -- except that your salary will rise over the time period, probably.

You are taking full equity risk for 2 years, but if you are doing this every year (sell 2 year old stock) does that matter?

It depends whether the tax arbitrage is worth it to you. Although you are taking 2 years of downside risk, you are also taking on 2 years of upside risk (shares could go up in price over that time).

JimmyD
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Re: Should I contribute to this ESPP?

Post by JimmyD » Tue Jun 12, 2018 7:17 am

I also recently went through this decision as I recently joined a new company with a very similar ESPP offering.

I ultimately decided that I am going to initially contribute a small amount (2% of my salary) and slowly increase it over time (maybe 2%/year) with the thought of eventually maxing it out (20% of salary) in time. This is obviously after maxing out all tax-advantaged accounts.

With that said, if my ESPP holdings ever start to creep up into a significant allocation of my overall portfolio, I'll most likely start selling and re-evaluate my contributions. I wouldn't be comfortable holding more than 5-10% of my portfolio in company stock.

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Cycle
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Re: Should I contribute to this ESPP?

Post by Cycle » Tue Jun 12, 2018 7:44 am

I have a similar plan. I buy like 10% of salary at a 15% discount. I have to hold the shares for 1 year. I then sell them as long term cap gains, whether they are up or down (no timing). There's a good chance I've been doing my taxes wrong the last ten years, but I'm doing the best I can with the little mental capacity at my disposal.

boglengineer
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Re: Should I contribute to this ESPP?

Post by boglengineer » Tue Jun 12, 2018 9:13 am

Thanks everyone for the feedback. I've decided to contribute the max ($6250 per quarter) and treat is as deferred compensation. I will probably sell at 1 year (which is the earliest I can) and take some of the difference in price as ordinary income rather than tie it up another year for slightly better tax treatment as capital gains. Regardless, it seems like in general it should work to my benefit out as long as the company stock doesn't continually go down during my tenure here.

new2bogle
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Re: Should I contribute to this ESPP?

Post by new2bogle » Tue Jun 12, 2018 9:30 am

Cycle wrote:
Tue Jun 12, 2018 7:44 am
I have a similar plan. I buy like 10% of salary at a 15% discount. I have to hold the shares for 1 year. I then sell them as long term cap gains, whether they are up or down (no timing). There's a good chance I've been doing my taxes wrong the last ten years, but I'm doing the best I can with the little mental capacity at my disposal.
You should google how to fill in your taxes for ESPP. Your company/ESPP administrator should provide you with a "blue" sheet that lists the actual cost basis of the ESPP stock. Putting this adjustment in greatly reduces your tax liability since it correctly adjusts the taxes already paid via ordinary income tax. If you're already doing this, then nevermind!

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Cycle
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Location: Minneapolis, USA

Re: Should I contribute to this ESPP?

Post by Cycle » Tue Jun 12, 2018 11:54 am

new2bogle wrote:
Tue Jun 12, 2018 9:30 am
Cycle wrote:
Tue Jun 12, 2018 7:44 am
I have a similar plan. I buy like 10% of salary at a 15% discount. I have to hold the shares for 1 year. I then sell them as long term cap gains, whether they are up or down (no timing). There's a good chance I've been doing my taxes wrong the last ten years, but I'm doing the best I can with the little mental capacity at my disposal.
You should google how to fill in your taxes for ESPP. Your company/ESPP administrator should provide you with a "blue" sheet that lists the actual cost basis of the ESPP stock. Putting this adjustment in greatly reduces your tax liability since it correctly adjusts the taxes already paid via ordinary income tax. If you're already doing this, then nevermind!
If it reduces my tax liability, I'll definitely look into it. The espp doesn't provide any how-to-guides, except the 20 page plan description book which doesn't have instructions per session for dealing with taxes. I've always just assumed the basis that shows up in fidelity is accurate. Haven't been audited yet, though that's probably bc I've been making unitentional donations to Uncle Sam.

The plan says some of the favorable tax benefits are lost if sold before 24 months. A DQD (disqualifing dispostion) will show up on the W2 if sold before 24 months, though I'm not sure what that means.
Last edited by Cycle on Tue Jun 12, 2018 12:43 pm, edited 1 time in total.

emlowe
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Re: Should I contribute to this ESPP?

Post by emlowe » Tue Jun 12, 2018 12:40 pm

So that I understand:

1) The purchase is quarterly at a 15% discount of the LOWER of the price at the start of the quarter or the end
2) You must hold for a year after purchase

The problem I see here is the holding period. After 1 year, you can sell, but this is still a disqualifying disposition - so the discount is W2 income regardless of whether you lose actual money. Your loss would be a capital gain loss which you may be able to claim, but your W2 income is increased.

An Example:

Start Date: Stock is $10
End/Purchase Date: Stock is $20

You purchase stock at $8.50. Your W2 income per share is $11.5. Your basis is now $20

(BTW, if you can sell immediately, this is a good deal of course, as you basically get at least 15% but sometimes you can make more)

1 year later - the stock is back to $10 and you sell at $10. Technically you made $1.50 per share, however, you have W2 income of $11.5 and a STCL of $10 - so you may end up paying more tax than the $1.50 per share you actually made because you may not be able to fully use the cap loss.

You should double check your holding period again to make sure. I'm not sure I would participate if I had to hold for 1 year from purchase.

Good description for disqualifying: http://fairmark.com/execcomp/espp/disqual.htm

-Earle

boglengineer
Posts: 35
Joined: Thu Jun 02, 2011 5:45 pm

Re: Should I contribute to this ESPP?

Post by boglengineer » Tue Jun 12, 2018 1:37 pm

emlowe wrote:
Tue Jun 12, 2018 12:40 pm
So that I understand:

1) The purchase is quarterly at a 15% discount of the LOWER of the price at the start of the quarter or the end
2) You must hold for a year after purchase

The problem I see here is the holding period. After 1 year, you can sell, but this is still a disqualifying disposition - so the discount is W2 income regardless of whether you lose actual money. Your loss would be a capital gain loss which you may be able to claim, but your W2 income is increased.

An Example:

Start Date: Stock is $10
End/Purchase Date: Stock is $20

You purchase stock at $8.50. Your W2 income per share is $11.5. Your basis is now $20

(BTW, if you can sell immediately, this is a good deal of course, as you basically get at least 15% but sometimes you can make more)

1 year later - the stock is back to $10 and you sell at $10. Technically you made $1.50 per share, however, you have W2 income of $11.5 and a STCL of $10 - so you may end up paying more tax than the $1.50 per share you actually made because you may not be able to fully use the cap loss.

You should double check your holding period again to make sure. I'm not sure I would participate if I had to hold for 1 year from purchase.

Good description for disqualifying: http://fairmark.com/execcomp/espp/disqual.htm

-Earle
Earle,

Thanks for your input. I did check the holding period and it is 1 year. And you definitely outlined a scenario where I could lose money. However, if I continued to invest in this program quarterly and sold the shares as soon as I could, I think the risk is limited as I'd be both buying and selling on the dips and highs. I think the 15% discount plus the lookback gives an advantage that outweighs the 1 year holding cons. At any given time, I'd have at most $25K in stock and over time (as long as the share price doesn't decrease 15% every quarter the entire time I work here), my expected return should be pretty reasonable.

emlowe
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Re: Should I contribute to this ESPP?

Post by emlowe » Tue Jun 12, 2018 1:51 pm

Yes, the look back feature can be very lucrative - I once was at a company where the ESPP effectively had a 12 month lookback. I made considerable money from that ESPP plan.

It sounds like you have a plan that you can stick to that limits your investment in your company to something that works for you.

-Earle

mervinj7
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Re: Should I contribute to this ESPP?

Post by mervinj7 » Tue Jun 12, 2018 5:32 pm

viz wrote:
Mon Jun 11, 2018 10:47 pm
I personally would not contribute if this was a plan for my company as the price of the stocks move up and down 15% almost every year so basically it is like investing in a single stock. Worse, your income is tied to the same underlying company. I would just take your contribution and invest it in a fund.

I am sure others would disagree and with everything stock related you could miss out on a big upside by not contributing.
He can sell the stock and immediately realize a 15% return. He doesn't have it to hold it for one year unless he wants to reduce his taxable gains. That's what many of us on this forum do. Others, sell off their stocks at exactly one year so they never hold more than 1 years worth of equity purchases.

There's absolutely no reason somebody shouldn't max out an ESPP as good as this one.

emlowe
Posts: 89
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Re: Should I contribute to this ESPP?

Post by emlowe » Tue Jun 12, 2018 5:45 pm

He must hold for one year per his plan - he cannot sell immediately.

According to OP

-Earle

Nate79
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Re: Should I contribute to this ESPP?

Post by Nate79 » Tue Jun 12, 2018 5:54 pm

mervinj7 wrote:
Tue Jun 12, 2018 5:32 pm
viz wrote:
Mon Jun 11, 2018 10:47 pm
I personally would not contribute if this was a plan for my company as the price of the stocks move up and down 15% almost every year so basically it is like investing in a single stock. Worse, your income is tied to the same underlying company. I would just take your contribution and invest it in a fund.

I am sure others would disagree and with everything stock related you could miss out on a big upside by not contributing.
He can sell the stock and immediately realize a 15% return. He doesn't have it to hold it for one year unless he wants to reduce his taxable gains. That's what many of us on this forum do. Others, sell off their stocks at exactly one year so they never hold more than 1 years worth of equity purchases.

There's absolutely no reason somebody shouldn't max out an ESPP as good as this one.
The OP says they have a 1 year holding period requirement:
However, it also says that the company requires employees to hold the shares for at least 1 year from the purchase date but then I can send them at any time.
I would not participate in a 1 year holding period ESPP.

mervinj7
Posts: 484
Joined: Thu Mar 27, 2014 3:10 pm

Re: Should I contribute to this ESPP?

Post by mervinj7 » Tue Jun 12, 2018 6:01 pm

emlowe wrote:
Tue Jun 12, 2018 5:45 pm
He must hold for one year per his plan - he cannot sell immediately.

According to OP

-Earle
Got it. In that case, I would hold for one year and sell off the previous year's investments as each new batch comes in. That way, he's never risking more than $25k of equity.

anoop
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Re: Should I contribute to this ESPP?

Post by anoop » Tue Jun 12, 2018 6:19 pm

boglengineer wrote:
Tue Jun 12, 2018 9:13 am
Thanks everyone for the feedback. I've decided to contribute the max ($6250 per quarter) and treat is as deferred compensation. I will probably sell at 1 year (which is the earliest I can) and take some of the difference in price as ordinary income rather than tie it up another year for slightly better tax treatment as capital gains. Regardless, it seems like in general it should work to my benefit out as long as the company stock doesn't continually go down during my tenure here.
This is not deferred compensation, because you have already been taxed on the $6250 contribution.

The only red flag in this is the 1 year holding period. If you could sell immediately it would be a no-brainer. Since you cannot, it would be up to you to analyze the company's prospects and decide if the risk of holding for one year after purchase is worth the potential reward of 15+% discount at purchase.

When I was younger I would have done it. Now that I'm older and experienced the loss of some serious money on Nortel ESPP, I would be less inclined to do it unless the company was actually doing well with respect to debt, earnings, etc. For example, I would not be comfortable doing it with AMZN (very high P/E), but I would be comfortable doing it with AAPL (more realistic P/E).

viz
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Re: Should I contribute to this ESPP?

Post by viz » Tue Jun 12, 2018 8:55 pm

mervinj7 wrote:
Tue Jun 12, 2018 6:01 pm
emlowe wrote:
Tue Jun 12, 2018 5:45 pm
He must hold for one year per his plan - he cannot sell immediately.

According to OP

-Earle
Got it. In that case, I would hold for one year and sell off the previous year's investments as each new batch comes in. That way, he's never risking more than $25k of equity.
Yes, it is something you can do. I just would be more comfortable putting the money in equity market fund. The 15% discount is w2 income so you would pay taxes on that which makes the premium less. Full disclosure: I participate in my company's espp but I can sell it immediately so I am guaranteed 15% - taxes. Thanks

isidhu
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Re: Should I contribute to this ESPP?

Post by isidhu » Wed Jun 13, 2018 12:42 am

Another way to look at it, you are basically investing in the company stock for 9 months. so treat it as such, a short term investment you can buy at a .85% market value. Now think if this investment is something you would make and if the amount of money you are tying into this is something you are comfortable with considering your overall portfolio.

Maybe lesser contribution with less risk is more comfortable. Just something to think about.

boglengineer
Posts: 35
Joined: Thu Jun 02, 2011 5:45 pm

Re: Should I contribute to this ESPP?

Post by boglengineer » Wed Jun 13, 2018 7:51 am

Hi All,

OP here. I think all of the comments have been spot on. I definitely have to hold the shares for 1 year. There is risk associated with that holding period. However, in the grand scheme of things, as some have mentioned, by buying and selling after 1 year and continuing the process, I will never have more than $25k equity in the company and the "expected" return is still positive. FWIW, $25k is less than 5% of our portfolio so it won't make or break us. It just seems likely to be a good deal.

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