Today TaxMama hears from Rick in the Tax Quips Forum with set of questions. “I have a tax question about my company stock purchase plan. I elected to contribute ($5,000) to the plan last year and it runs from Oct 1, 2010 till Oct 1, 2011. The benefit of the plan is that I receive a 15% discount on the company stock price at either Oct 1, 2010 or Oct 1, 2011; whichever price is lower. The current stock price is $90.00 per share. The price on Oct 1, 2010 was $70.” He’s got several questions about this transaction.
Dear Rick,
No, I don’t believe this has been added to your payroll yet. It should get added to your wages when you exercise the option.
When you do cash it in, you will be paying for the stock. You will exercise the option. As you say, you have two choices – 1) Buy AND sell the stock on the same day, or 2) Buy the stock and hold it.
Either way, the difference between the current market price and your purchase price will get added to your wages right now. Withholding will be taken. You won’t pay taxes on $5,000. That money came out of your own wages, after tax. You will only pay taxes on the profits.
If you sell the stock on the same day, you won’t have any profits at all. In fact, you will have a small loss – the amount of any brokerage fees. Why? Because when the 15% profit is added to your wages, it’s as if you had paid that additional money to buy the stock. So your total basis (purchase price for tax purposes) will be your option price plus the amount added to your wages, which will equal 100% of the market price. The small loss will be short term, since you bought and sold on the same day.
However, if you exercise the option (just buy it) and leave the stock in your brokerage account, you can build a long-term capital gain. You must hold on to the stock for 1 year plus a day. So if you think the stock is going up in value, buy and hold.
The federal and state taxes on that 15% difference won’t be significant – perhaps $500 or less, assuming instant profits of under $1,500. You may want to check the numbers with your benefits department before making a final decision. Enjoy the windfall!
And remember, you can find answers to all kinds of questions about employee stock purchase plans and other tax issues, free. Where? Where else? At www.TaxMama.com.
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Lucie Replied:
it’s an ESPP. The company withholds an amount from his pay during the offering period (10/2010 – 10/2011). At the end of the offering period they buy the stock at either 85% of the market price at the beginning ($70) or the end ($90). The shares are purchased and deposited into his brokerage account. When he sells, the ordinary and capital gains are figured separately depending on the holding period, which is either 2 years from the beginning or 1 year from the end. In this case it’s the same. Intuit has 3-month offering periods, so the dates become more critical.
You perfectly described an NQSO, where the employee has the option to buy stock but doesn’t actually own (or pay) anything till it’s bought. In an ESPP, the money is taken out of his pay during the offering period, usually at a fixed dollar or percentage of pay rate.
Clearer?
TaxMama asked:
So, the gain is never added to wages?
The basis is purely his $5,000 contribution plus any broker fees?
And his holding period starts now (oct 1 2011) not when his offering period opened up?
Interesting.
Lucie Replies:
No, not exactly.
He’ll have a disqualifying gain if he sells before 10/2/2012 that will be added to wages and added to cost basis to figure capital gain/loss.
TaxMama asks:
Really?
But if the stock is placed with the brokerage,
how would the employer even know if he sold it before 10/2/12
TO add it to his wages?
Signed.
Easily confused.
Lucie Replies:
Yeah that’s a problem if the brokerage and the employer don’t have a relationship. Our company does but a lot don’t. in that case the burden is on the taxpayer to get it right. Sure.
Hi Lucie
Thanks for the feedback.
But I don’t think so.
He hasn’t bought the stock yet.
How can he have bought the stock if he hasn’t settled on a purchase price yet?
Please clarify.
Hugs
Eva
Well TaxMama,
You’re usually right but this time you are wrong! 🙂
You described a Nonqualified Stock Option Plan (NQSO), but Rick has an Employee Stock Purchase Plan (ESPP). The rules for ESPPs are different. Rick owns the stock outright as of October 1, 2011 with no tax implications until he sells. If he sells before October 2, 2012, he’ll have a disqualifying gain that will be added to his wages as ordinary income. This is separate from any capital gain or loss and is based on the difference between the market price when he bought the shares ($90) and the actual purchase price. If he holds the shares longer, he will have qualifying gain and capital gain or loss.
As to what he should do to get the most tax benefit, it seems to me he should hold the shares at least a year to avoid as much ordinary gain as possible, since capital gain tax rates are lower than ordinary tax rates.