My ESPP, sound like a good idea?

[RDamien]

Stock is offered at a base price of 37.41 which is a 15% discount off the stock as of May 30th.
Currently trading at 41.16.

They buy quarterly. I am 100% vested when they buy and they dont buy if it's below the offer price. Note this runs 18 months.

Last time around I contributed 15% of my salary and did very well. Base was 46.00 and sold for well over 60 most quarters, never below 55. Should I go for it again? I'm assuming we're near a bottom of the market but.. yeah. You know.

Anyway i'm in for another 15% but I can always change my contribution. Advice appreciated.

 

[CitricAcid]

What is the time frame by which you could sell? The tax implications of warrants are very important as well, because, correct me if I am wrong, it is treated almost like a bonus. Not taking advantage of this, however, is leaving money off the table similar to not taking advantage of an employer match 401k... if you really do not like maintaining too much of a position in one company (especially your own, *cough* Enron *cough*), you could sell it after a year and diversify it. Just my thoughts.

 

[RDamien]

I can sell right away and typically do. I'm told there are some tax benefits to waiting a year before selling but I dont know the details and I'm not sure if it's worth the added risk of waiting. Any guidance there would be great.

I agree though, in my mind it's free money. Just wanted some verification I suppose.

 

[CitricAcid]

Yeah, I am not entirely sure about the tax benefits of it, but I believe any gain will be taxed as taxable income (whatever your tax bracket is) and if you hold onto it longer than a year it is long term capital gains (0 or 15% depending on what your bracket is). You are right though, it may not be worth the added risk of holding onto it, especially if you do not want to overload on your company. I mean you have enough risk riding on the fact they are the source of most of your income

 

[Animorph]

This sounds a little different than the ESPP's I've used. The quarterly buy/don't buy is something I haven's seen.

However, the normal IRS ESPP treatment was another pain in the butt I'm glad to be rid of in ER. If you sell before a year it's all normal income, so that's not too bad. If you sell after a year but before 2 years (I think) has passed since the ESPP grant (start of the buy period) then you get some long term gains (I think from the market price when the shares were purchased) and the rest is income. After 2 years from the start and 1 year from the purchase long term gains are calculated from the starting market price instead of the purchase market price. So depending on what the price did from start to end and your expectations of what will happen in the next year or so it may be to your advantage to hold on to the shares for up to 2 years (probably 1.75 years after purchase in your case). Plus the normal income amount may or may not be included in your W2 amounts.

Check the IRS investments publication, which explicitly lays out the ESPP scenarios. It's too far past April for me to be certain about those numbers, and your plan sounds different than normal.

Selling right a way is safe (and easy for taxes), but if the stock went way up and you don't expect it to fall back down it may be nice to get the LTCG tax rate.

 

[Marquette]

My wife gets 15% off twice a year on her ESPP with no holding time. We do that. It buys at the lower of the start or end of the period and then we sell it the next day. On the other hand, I get 25% off but it buys once a year and then I need to hold it for a year... I don't know that I have that much faith in my employer so we pass on that one.

In your case, I don't see why I wouldn't do it.

 

[ziggy29]

Yeah, I am not entirely sure about the tax benefits of it, but I believe any gain will be taxed as taxable income (whatever your tax bracket is) and if you hold onto it longer than a year it is long term capital gains (0 or 15% depending on what your bracket is)

When you sell, the discount is always treated as ordinary income for tax purposes, and the gain (if any) above that is a regular capital gain, either short term or long term depending on holding period.

Let's say that you buy stock in an ESPP for $50 a share, and at the time the shares were purchased and placed in your account, the shares were worth $70. The discount -- $20 per share -- is treated as taxable ordinary income when you sell the stock, regardless of how long you held it. So if you sell 13 months later for $80, you'd pay tax on $20 ordinary income and $10 of LTCG (minus commission) per share. The tax on the "discount" is due when you sell, not when you received the shares.

As long as there are no penalties for selling shares right away -- effectively locking in the discount (minus sales commission) taxable as ordinary income -- there's really no appreciable risk or downside (unless the company goes Enron the same day you bought the discounted shares).

 

[RDamien]

As long as there are no penalties for selling shares right away -- effectively locking in the discount (minus sales commission) taxable as ordinary income -- there's really no appreciable risk or downside (unless the company goes Enron the same day you bought the discounted shares).

Well thats the one caveat with mine. The discount is not locked in. The buy rate is set, in this case 37.41 per share for 18 months. So if this quarter it's selling for 50.00 on buy day then I get a nice big discount if I sell immediately. Next quarter if it's selling for 38.00, they still buy at 37.41 and I dont get much at all. If it's selling for below 37.41 I just get my money back.

So it's really no risk, but not a guaranteed 15% either. If buy day was today it'd only be about 10%. Not that I'll complain about 10% no risk.

 

[ProspectiveBum]

My only caveat would be around holding the stock for any length of time (particularly at those prices). My wife and I both worked for a company that offered an ESPP, similar terms to yours, except that we always got at least a 15% discount over the market price (it was 15% off the price at the beginning of the quarter, or on the buy date, whichever was lower). The few times that we had a nice bounce in the share price during the quarter, we got a very nice discount on the purchase price. We held our shares long enough for the company to have some difficulties, and we were severely underwater for a while. We held on until the shares crept back up to a break-even price and sold 'em all. Three months later the share price was 8 times what we sold for.

If I had it to do over again, I'd sell immediately and save myself the headaches.

 

[RDamien]

Yeah I'm still hanging on to 100 shares from the last round that were bought at 46.00. Stock's at 42.00 now. I could have sold and actually did sell 200+ shares at about 68.00 but got greedy on the last batch and now i'm stuck waiting or taking a small loss.

 

[ziggy29]

Well thats the one caveat with mine. The discount is not locked in. The buy rate is set, in this case 37.41 per share for 18 months. So if this quarter it's selling for 50.00 on buy day then I get a nice big discount if I sell immediately. Next quarter if it's selling for 38.00, they still buy at 37.41 and I dont get much at all. If it's selling for below 37.41 I just get my money back.

So it's really no risk, but not a guaranteed 15% either. If buy day was today it'd only be about 10%. Not that I'll complain about 10% no risk.

Ah. Our plan is 15% off of the lower of the price per share at the start of the six month window and the price at the end of it. So with ours, there's basically a sure 15% discount at the time, and probably more. Still, to avoid an Enron situation you may want to sell immediately to lock in the profit.

 

[RDamien]

Yeah your plan would be better, I wish we had that. I guess in theory if we are at the bottom of the market it could turn into a good thing depending on how the company does. A year from now 37 bucks could be a very nice discount, possibly.

I definitely wont hang on to any more than 5000.00 worth of stock at any one time. No Enron risk for me.

 

[rayvt]

Actually, the discount is 15%, which makes the return 17.6%. You buy $1 worth of stock for 85 cents.

I always took this deal and sold the stock immediately. I considered it to be a bonus equal to 2.6% of my salary. (17.6% on 15%) And I paid ordinary income tax on it, just like any other cash bonus.

 

[Spanky]

Anyway i'm in for another 15% but I can always change my contribution. Advice appreciated.

Why not? That's free money.

 

[Finance Dave]

A couple thoughts:

1) Keep an eye on the election. Likely both McCain and Obama will raise cap gains taxes, although not right away. Be sure to sell prior to the increase, but after one year to get the better treatment.

2) Keep good records (Excel spreadsheet showing buy price, # of shares, $ amount, etc.) for every transaction. You'll need it come tax time after the year of sale.

Otherwise, it's a good deal so long as it's a relatively small amount of your total portfolio (less than 5% IMO). Good luck.

P.S. I did the ESPP at my company for 2 years at 12%. It tripled in value, + I bought the stock at 10% discount to the market. I bought a car with the proceeds, and pocketed about $20,000 for retirement in addition.

 

[RDamien]

P.S. I did the ESPP at my company for 2 years at 12%. It tripled in value, + I bought the stock at 10% discount to the market. I bought a car with the proceeds, and pocketed about $20,000 for retirement in addition.

It trippled in the 2 years? That's great, congrats. I still think I'll sell most of it immediately but now that has me thinking...

 

[rayvt]

Best to stop thinking about it. ;-)

Before I retired from Motorola in 2006, I kept track of the results for holding onto the discounted ESPP shares. We got a 15% discount to the lowest of the starting or ending price, every six months.
In the last 10 years, MOT has gone from 17 up to 60, down to 8, up to 25 and down to 8.

I always sold mine immediately for the built-in 17% profit. People who kept theirs are still underwater. I always thought it was better to sell immediately and pay tax at ordinary income rate than to hold it for a year as risk taking a loss at long-term capgain rate.

 

[RDamien]

Yeah I'm probably just getting greedy. The few I held are now 4 bucks under what I bought them for. Still, if were close to the bottom of the market, and I'm getting 15% off....

Oh the humanity!

 

[Finance Dave]

It trippled in the 2 years? That's great, congrats. I still think I'll sell most of it immediately but now that has me thinking...

Yes, it tripled. I sold between the doubling and tripling, so I lost out on a bit. Not complaining though.

 

[CitricAcid]

Yes, it tripled. I sold between the doubling and tripling, so I lost out on a bit. Not complaining though.

Can't get too mad at locking in profits when you look at the collapse of Enron...

 

[clifp]

Folks ESPP are almost always fantastic deals. Although ESPP do vary by company. My ex-companies was a 15% on the lowest price at the start or end of a 6 month period (the same as Marquette's wife) which is a better than RDamiens. But even RDamiens is a good benefit.

Lets run through some number suppose the stock is $40 less $15% = $34
If you make $68K and contribute 10% for the ESPP that means you've contributed $3400 per 6 month period for 100 share@$40 meaning you've made a minimum $600 profit. But you've contributed the $3400 over a 6 month period, so the return on your last paycheck is fantastic. When we ran the numbers the IRR was equivalent to a 90% return a year for ESPP with purchases every 6 months. And that is worse case if the stock goes up it is better than that.

I'd also recommend keeping the stock for the 2 year period in order to take advantage of the favorable capital gain rate. If you hold the stock for 2 years from the start of the grant date everything including the 15% discount is treated as capital gains. (See Fairmark) Although others disagree.

My strategy at Intel was to keep 2 years of ESPP and then sell them to take advantage of the capital treatment. If you are contributing 10% of your salary you are holding 20% of your salary in company stock. If your net work is 2x or great than your salary this isn't a huge risk.

In fact if you work for a Megacorp it is possible to buy an 18 month put (leap) for roughly 10% the price of stock, this allows you to lock in your profit while holding the stock long enough to get favorable tax treatment.
Buying a long term put would probably be best in a situation like RDamiens.

 

[Finance Dave]

Folks ESPP are almost always fantastic deals. Although ESPP do vary by company. My ex-companies was a 15% on the lowest price at the start or end of a 6 month period (the same as Marquette's wife) which is a better than RDamiens. But even RDamiens is a good benefit.

Lets run through some number suppose the stock is $40 less $15% = $34
If you make $68K and contribute 10% for the ESPP that means you've contributed $3400 per 6 month period for 100 share@$40 meaning you've made a minimum $600 profit. But you've contributed the $3400 over a 6 month period, so the return on your last paycheck is fantastic. When we ran the numbers the IRR was equivalent to a 90% return a year for ESPP with purchases every 6 months. And that is worse case if the stock goes up it is better than that.

I'd also recommend keeping the stock for the 2 year period in order to take advantage of the favorable capital gain rate. If you hold the stock for 2 years from the start of the grant date everything including the 15% discount is treated as capital gains. (See Fairmark) Although others disagree.

My strategy at Intel was to keep 2 years of ESPP and then sell them to take advantage of the capital treatment. If you are contributing 10% of your salary you are holding 20% of your salary in company stock. If your net work is 2x or great than your salary this isn't a huge risk.

In fact if you work for a Megacorp it is possible to buy an 18 month put (leap) for roughly 10% the price of stock, this allows you to lock in your profit while holding the stock long enough to get favorable tax treatment.
Buying a long term put would probably be best in a situation like RDamiens.

This is the first I've heard that the favorable cap gains tax rate is only after TWO years...I've always used ONE year. Do you know something I don't?

My company's ESPP allows me to buy at only 10% below market...not 15%...but still good. However, there are selling costs (nominal) to consider also.

Lastly, keep in mind that the stock price can go down...which you don't mention. My company's stock is currently at an all-time high...and I own zero stock in my company at the moment. Could it go higher? Sure. Could it go lower...yup. One never knows.

Dave

 

[clifp]

This is the first I've heard that the favorable cap gains tax rate is only after TWO years...I've always used ONE year. Do you know something I don't?

My company's ESPP allows me to buy at only 10% below market...not 15%...but still good. However, there are selling costs (nominal) to consider also.

Lastly, keep in mind that the stock price can go down...which you don't mention. My company's stock is currently at an all-time high...and I own zero stock in my company at the moment. Could it go higher? Sure. Could it go lower...yup. One never knows.

Dave

I am not a tax expert but the folks at Fairmark generally are.

Disqualifying dispositions
The amount of compensation income you report depends on whether your disposition is a disqualifying disposition. In general, this is any disposition (sale or gift) unless both of the following are true:

• It is more than a year after the purchase of the shares, and
• It is more than two years after the beginning of the offering period.

Many of these plans have an offering period of less than a year. In that case, holding the shares a year and a day won't be long enough to avoid a disqualifying disposition.

• Example: Your company's ESPP has a six-month offering period. You buy shares and, 13 months later, you sell them. This is a disqualifying disposition, even though you held the shares more than a year, because you didn't hold the shares until more than two years after the beginning of the offering period. To avoid a disqualifying disposition in this situation, you would have to hold the shares more than 18 months.

Of course you are right that there is a risk in holding an individual stock especially if your pay check is also tied to the company's fortunes.

Still in the example I gave lets say the stock goes from $40 to $60. If you sell you owe taxes on the difference between 100@ $60=$6,000 and the $3400 you paid. If you live in a high tax state your combined state and federal maybe in the mid 30% and possibly higher. Waiting 18 months can bring that rate down to ~20%. This will save you 15%*3400= $510 or roughly $5 a share. Assuming the stock remains at $60 and you sell after 18 months and pay 20% on your $3400 gain leaving you $5320.

If you sell immediately you owe the government 35%x$3400 = $1,190 in taxes leaving you $4810 to invest in something else. Lets say you are smart and/or lucky and buy an ETF/Fund that goes up 25% in the next 18 months, making it worth $6010. After paying your 20% fed+state cap gains on $1200 you are left with $5760 after tax, or $440 more than the company sock. On the other hand unless the fund and your company are unrelated assets (e.g. Small cap stock and gold) it is likely that if the fund went up 25% your company stock is up also. In fact if the company stock went by only 10% you are now better off having held the company stock.

Rather than automatically selling your ESPP. I think it is worth constructing a simple spreadsheet to determine your break even point. In general the greater the appreciation during the subscription period and the higher your tax bracket the move you save by holding on for 18 months to gain a better tax treatment.

All that being said there are plenty of valid reasons to sell immediately if you have doubts about the companies future, or more than 10-20% of your net worth is tied up in company stock.

 

[Finance Dave]

I am not a tax expert but the folks at Fairmark generally are.

Thanks for the quote clifp....they mention a situation which doesn't apply at my company. They say "many" plans have short offering periods...I would have no knowledge of this other than my company.