If you work for a publicly-traded company, you may have access to an Employee Stock Purchase Plan (ESPP). This allows you to buy company stock typically at a discount of 10% – 15% providing employees a great incentive. These plans are popular for good reason and a great way to build wealth. Below are five things you should know when using a stock purchase plan.
1. Details on How ESPP Work
To participate in ESPP, deductions are taken from the employee’s paycheck and used to purchase the stock. Often the stock is purchased at a discount creating an immediate benefit for the employees (i.e.; ABC stock trades at $100 per share the employee purchases the stock at $85 given a 15% discount). There typically are limits on how much an individual can purchase by the company but the IRS limit is $25,000 per year.
2. Understanding Tax Implications
There are only tax implications when you decide to sell the stock in the ESPP. To qualify for the lowest tax rate (capital gains tax rate) the sale must meet the qualifications of being a qualifying disposition. To qualify the shares must be held two years from offering date and one year from the purchase date before being sold. If this criterion is not met, then the transaction is considered a disqualifying disposition and taxed at higher income tax rates.
3. Have an exit strategy
Like any good investment, it is important to have a plan as to when and how you will exit the position. Too often people forget about their ESPP and just lets it accumulate over time. While this is good for wealth accumulation, these accounts can create a concentrated position where their company stock represents a large position of their overall net worth. It is important to have a plan over time to reduce exposure to company stock (especially as you continue to contribute to the plan). The plan can be a sale strategy to reduce concentration risk, using it to fund goals like a home purchase or college education or to gift to charity and family.
4. Gifting Rules
Perhaps your exit strategy is to gift some company stock to a family member or charity. The ESPP is an excellent vehicle to use for gifting strategies to reduce taxes tax liability and concentration risk. Be aware though that the rules are different when gifting ESPP stock. Typically, if you gift stock you can deduct for full stock value on your taxes. With ESPP stock the discount component is added to your taxable income (the 10% -15% discount portion from original purchase). Also, make sure to gift stock that meets the qualifying distribution to avoid reductions in the gift.
5. Keep Good Records
As you can see there is a lot of information to track and keep a record of. Unfortunately, companies do not always keep accurate records. Until the stock is sold or gifted it is in your best interest to keep records to help make sure your tax preparer uses the most accurate information.
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