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William Perez

Selling Shares from Employee Stock Purchase Plans: A Taxing Calculation

By January 26, 2007

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Today's tax question comes from Melissa in New York. She asks:

"I used to work for [a big software company] and participated in the company's employee stock purchase plan. I've since left the company and was thinking of selling some of my stock, but I'm concerned about the taxes. I've heard that you have to hold the stock for a certain period of time before you sell to get a better tax rate. Is that true?"

 

Good for you, Melissa, for participating in your employer's stock purchase plan, or ESPP. This is a great way to get started in investing, and provides great tax benefits as well.


Companies can offer different types of plans to encourage employees to invest in the company's stock. ESPPs are one type of plan. Through an ESPP, employees can invest in the company's stock at a discount. When you sell stock bought through an ESPP, your proceeds are divided into three categories, each with their own tax implications. Here's the break down.

 


  • Return of capital: the amount you paid for the shares, which is non-taxable since you already paid tax when you earned the money.

  • Compensation income: the difference between the amount you paid for the shares and the market value of those shares on the purchase date. This represents the income you earned on the ESPP discount, and is taxed at regular tax rates.

  • Capital gain: the difference between your ESPP cost basis and your proceeds from the sale. This represents the income you earned by holding on to the stock. Capital gains are taxed at capital gains tax rates as low as 5% or 15%.

 

How you split the profits between compensation income and capital gain depends on whether your sale is a "qualifying" or "disqualifying" disposition. Usually, qualifying dispositions will shift more of your profits into capital gains. But "usually" here is a code-word for tax complexity. You will need to crunch a lot of numbers to figure this out.

Fortunately, most ESPP administrators will help you calculate your gains and let you know what amount to report as ordinary income and what amount to report as capital gains. When you sell your ESPP shares, you will get Form 1099-B to report your gross proceeds from the sale and Form W-2 to report the amount of ordinary income you earned. Since you have left the company, you might not receive a W-2 for the ordinary income.

Now, here's an additional word of caution. I have seen plan administrators calculate these amounts incorrectly. I don't see mistakes in this area frequently, but I have seen it often enough that I always run my own calculations. You'll need to keep excellent records to document your calculations. Dig out your original plan documents, all statements from your ESPP administrator, and sit down with these step-by-step instructions provided by Fairmark.com:

 

 


Do you have a tax question? Visit the Ask a Tax Question page. Disagree with my answers? Post your comments in the Tax Forum.

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Comments
January 14, 2011 at 9:10 am
(1) TBUrke says:

So what about the answer to her question? You never answered if there is any tax incentive to hold onto the stock for a certain period of time.

February 3, 2011 at 9:07 pm
(2) Dr. Drake says:

The answer’s yes, in general. If you hold onto the shares long enough for it to be a qualified disposition, any capital gains from selling them will be taxed at the lower rate he mentioned.

February 26, 2011 at 5:58 pm
(3) Tim Rucker says:

This is all so silly. The massive amount of human energy wasted by Americans doing all their little income tax calculations is more depressing than war. Some economist out there must have put a dollar value on it by now. It must rival the defense budget.

July 30, 2011 at 12:51 pm
(4) JC says:

My plan manager has a trade calculator that asks me what % I would like to withhold. How do I decide?

December 13, 2011 at 1:17 am
(5) Former Employee says:

Do these rules also stand for a former employee?

December 13, 2011 at 1:38 am
(6) William Perez says:

Yes these rules apply to former employees. Some companies will issue a W-2 for the amount of ESPP shares that is compensation income, but many companies will not. The broker managing the ESPP plan should provide you with a report that shows how much of the ESPP is compensation income.

March 1, 2012 at 3:59 pm
(7) SEAN says:

I was an employee of a publically traded company who participated in their ESPP up until the day they were bought out by a private organization. Therefore my shares were all bought back by the private company, my current employer. My question is do I have to recognize a short-term gain on the shares that I recently purchased when I was forced to make an involuntary sale? Or do I get to treat them all as long-term cap gains?

Thanks,
Sean

August 2, 2012 at 4:14 pm
(8) Tom Kiddle says:

Ok, so before I pull out my short term tax gains I need to deposit the long term stock sells. Then if I make the 15% dividend on the 85% capital gain I might (and the key word is might here ) have to pay a higher tax bracket. What about short selling the gains and reinvesting the stock back into a capital liquidation fund? It seems to me there isn’t enough accountants out there to crunch enough numbers to even begin to fathom the reality of inverted major/minor losses. Believe Tim Rucker said it best, “This is all so silly” when in fact its the seriousness of the situation which will prevail the real truth of it all!

August 9, 2012 at 1:33 pm
(9) Angie Tass says:

I worked for Woolworths years ago and was given shares by Woolworths.
I have no sold these shares due to debt do i pay tax on what i sold them for

August 9, 2012 at 1:35 pm
(10) Angie says:

I worked for Woolworths years ago and they gave me some shares i have since sold them as i was in bad debt do i pay tax for the sold shares?

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