ESPP and income tax in a FIRE situation

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GuySmiley
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Joined: Fri Aug 10, 2018 6:02 am

ESPP and income tax in a FIRE situation

Post by GuySmiley » Mon Feb 11, 2019 5:39 pm

I'm aware of the Boglehead philosophy to sell shares purchased in an ESPP at the soonest possible time to diversify risk. Without regard to whether or not it is a good idea to hold those shares long-term, I was wondering about this:

In my plan (all plans?) the difference between the purchase price and market price is not counted as taxable income until the shares are sold. If I were to keep those shares, retire early, then sell in small doses over the coming years without having another job, would the income taxes associated with selling the ESPP shares count as earned income in that year and therefore allow Roth IRA contributions?

FireAway
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Re: ESPP and income tax in a FIRE situation

Post by FireAway » Mon Feb 11, 2019 6:08 pm

No, selling stock gets you a capital gain (short or long term), not earned income, and doesn't get you the ability to contribute to IRA.
When I received ESPP shares, I got them at a discount to market price. That discount DID count as income, and was taxed as such in the year I received the shares. But later when I sold the shares, that income was all CG.
Depending on your situation, it may still make some sense to hold onto the stock. Holding it for 1 years (after receipt) will get you long term cap gains treatment, and depending on your AGI, could even help you to avoid taxes on the gain altogether.

Topic Author
GuySmiley
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Re: ESPP and income tax in a FIRE situation

Post by GuySmiley » Mon Feb 11, 2019 6:34 pm

My Form 3922 says "no income is recognized when you exercise an option under an employee stock purchase plan". It refers me to Pub 525, which I guess I'll have to read next.

FireAway
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Re: ESPP and income tax in a FIRE situation

Post by FireAway » Mon Feb 11, 2019 7:02 pm

Well, you've lost me. Exercising an option is not the same as selling shares; and in general exercising an option WILL result in income (if exercising means "buying below FMV"). I'm not sure whether you're talking about options, or shares, or selling shares purchased earlier as an option exercise.

ALso, my apologies, I missed the part where you said you were talking about the difference between purchase price and FMV. In my case, that was counted as income when I received the shares, not when I sold them.

Topic Author
GuySmiley
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Re: ESPP and income tax in a FIRE situation

Post by GuySmiley » Mon Feb 11, 2019 9:13 pm

Let's try this: my hypothetical scenario is exactly as documented here in example 10:
https://www.irs.gov/publications/p525#e ... 1000229228

"In the year of sale, you must report as wages the difference between the option price ($20) and the value at the time the option was granted ($22)."

Back to my original question, would this qualify as income to which is eligible for Roth IRA contribution purposes?

megabad
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Re: ESPP and income tax in a FIRE situation

Post by megabad » Mon Feb 11, 2019 9:38 pm

Does employer include on W2? Would employer continue issuing W2 if amount in excess of filing limit? If the answer to both of these is yes, my opinion is yes, W2 income counts as taxable compensation for the purposes of Roth IRA contributions so you could contribute.

This would necessitate good record keeping on your part of course. I can assure you that no one other than me has the cost basis for my ESPP purchases from years ago. This goes back to my "keep records forever" philosophy (at least anything related to taxes).

FireAway
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Re: ESPP and income tax in a FIRE situation

Post by FireAway » Mon Feb 11, 2019 11:50 pm

So obviously I'm not an expert here, and this is different from my situation, but I would say that if the IRS says you need to report it as wage income then it counts as wage income for IRA contributions.

IRS Pub 590-A is the document which should cover this, and I can't see where they carve out any disqualification for "wages resulting from ESPP". Wages are wages, and are IRA eligible.

Topic Author
GuySmiley
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Re: ESPP and income tax in a FIRE situation

Post by GuySmiley » Tue Feb 12, 2019 9:23 am

Thanks guys. I'm not sure about the W2 since it's future. TBD if I ever test this out but it's one more knob to turn, should I choose to do so. I could see a scenario where selling shares from taxable and having incidental income along the way could be useful if retired early.

privateer79
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Re: ESPP and income tax in a FIRE situation

Post by privateer79 » Sat Feb 16, 2019 11:38 pm

strangely enough I had thought about this a few years ago (using ESPP "earned income" to justify IRA contributions). Just this year I got a "mysterious" W-2 from an employer from 3 years ago....turns out sure enough, I sold some ESPP shares that resulted in a W-2...

so it was a bit of a "DOH" moment due to my current tax bracket, but at least I confirmed there's a good chance of trying this Manuver between retirement and RMD's in a few years.

cheers.

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