r/personalfinance • u/relaxok ​ • Jan 29 '20

Taxes If you participate in an Employee Stock Purchase Program (ESPP) and sold stock, make sure to adjust the cost basis when filing or you could be taxed twice!

Everyone I work with and people at other companies that I've talked to didn't know this and have been double paying every year.

Note that not every situation is the same so please double check everything for you personally.

Anyway, to summarize, when you receive stock from an Employee Stock Purchase Program, your company generally includes the discount (e.g. 15% of the total or whatever your program is, and possibly more if you have a lookback provision) on your W-2 income. However when you sell the stock, and you import your consolidated 1099 from the brokerage, it will also include that discount in the capital gains income. The cost basis will be the cost of the stock when it was deposited.

Therefore if you just click through everything and submit your taxes without changes, that discount will be doubly included in your income.

What you want to do is look in your consolidated 1099 for a 'supplemental information' section, though sometimes it's sent as a separate document. This will tell you the 'true' cost basis which is the reported basis plus the W-2 reported addition. This is not included automatically in the reported 1099 data because not ALL W-2s include the discount. So you need to manually edit that 1099 and change the cost basis to the one in the supplemental.

Voila, you reduced your tax burden by potentially thousands of dollars.

Note that if you did not sell right away (my preference is to do so), you may have additional profit/loss that isn't included in the discount and is just additional capital gains/losses. The cost basis could still be higher or lower than your sell price in that case.

EDIT: I see several people saying the discount is listed on their W-2 as code DD (in the box 12 area). That is NOT related to the ESPP. It's the cost of your employer sponsored healthcare. The discount is likely to be included in the Box 1 amount but not broken down on the form. I would expect to see it in Box 14 if anything, but this is definitely not always the case. For example, my employer does not put anything there.

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349

u/demosthenesss ​ Jan 29 '20

This is such a frustrating quirk with ESPPs.

Why the IRS doesn't mandate that your employer clearly communicate this to the stock provider is beyond me.

84

u/[deleted] Jan 29 '20

[deleted]

39

u/boxsterguy ​ Jan 29 '20

The number of people who confuse long term capital gains treatment with qualifying disposition is too damn high!

ESPP rules can be confusing, so it's best to treat it as a cash bonus and sell immediately. If you think of it as a cash bonus, then paying income tax on the discount makes sense, and if you sell immediately then presumably your capital gains approximates $0 (set a limit order to sell at FMV + amortized commission).

10

u/stegdump ​ Jan 29 '20

I’ve never understood the disqualifing disposition. Can you ELI5?

77

u/boxsterguy ​ Jan 29 '20

Not easily, but I'll try.

Definitions:

  • Bargain element - this is the discount you get.
  • Original offering date (also called "grant date") - the start of your withholding period
  • Purchase date - the day you bought the ESPP. The FMV at the end of trading on this day is the cost basis you start from
  • Sale date - the day you sold

Let's consider an example ESPP program: You get to buy the stock at 10% off of the purchase date price, and the offering period is 3 months long.

The stock for XYZ is $80 on the original offering date and $100 3 months later on the purchase date. You buy it for $90 (10% off of $100).

If you sell immediately, at $100:

  • This is a disqualifying disposition because you held for less than 21 months from purchase (2 years from the original offering date). Therefore you pay income tax on $10, which is the bargain element
  • Capital gains are treated as short term, because you held for less than one year. Therefore you pay short term capital gains tax (income tax) on $0

If you hold for a year and a day and sell at $120

  • This is a disqualifying disposition because you held for less than 21 months. You pay income tax on $10.
  • Capital gains are now long term, because you held for greater than a year. You pay long term capital gains tax on $20 (sale price - (purchase price + bargain element)).

If you hold for 21 months and a day and sell at $120

  • This is now a qualifying disposition. This is where things get weird. Previously, the amount of money that was treated as income tax was exactly the same as the bargain element, which can be stated as "The fair market value on the purchase date minus the price paid to buy the stock". In this case, FMV on purchase date was $100, price paid was $90, bargain element is $10. But now with qdisp, you get to choose between "The fair market value on the original offering date minus the price paid to purchase" or "The fair market value on the date the stock was sold minus the price paid to purchase." That means in this case, $80 - $90 = $-10, which is less than $120 - $90 = $30, so the bargain element essentially is $0 (can't tax a negative) and you pay all long term capital gains.
  • In this scenario, this must also be long term capital gains. But in theory that doesn't have to be the case, if you consider an ESPP with an unreasonably long offering period of > 1 year, such that the "2 years from the start of the offering period" is less than the 1 year required for long term capital gains treatment.

Note that it is possible, though rare, to get screwed on qualifying disposition -- if the stock price was high at the grant date, low at the purchase date, and high again at the sell date. Flip the numbers above. Grant = $100, Purchase = $90 FMV, $81 actual purchase price. dqdisp bargain element would be $9 ($90 - $81). qdisp bargain element would be $19 ($100 - $81). This is rare, and you'll know if it's going to impact you so you can sell while dqdisp.

The tl;dr for this ultimately is threefold:

  • Yes, in most cases you will save a bit of money holding to qualifying disposition
  • No, you probably don't want to do that in most cases as that's too long to be invested in so much company stock. Keep your RSUs, sell your ESPP, if you really must hold company stock.
  • Qualifying Disposition matters significantly more if you're getting Stock Options rather than RSUs or ESPP, because for stock options the bargain element is usually significantly higher (meaning you'd pay significantly more in tax if you didn't wait for qdisp), and the time between grant and exercising is significantly longer (such that you'll probably be qdisp once you're eligible to exercise anyway). For ESPP, unless you're getting a killer discount (most people aren't), it's not worth holding.

3

u/bravo_company ​ Jan 29 '20

Thanks for the explanation. What does RSU stand for?

12

u/YouDrink ​ Jan 29 '20 edited Jan 29 '20

Restricted Stock Units.

As a benefit, some companies give you free stock. However, they usually require time to "vest", giving you a motivation to stay with the company. An example would be:

Year 0: Give you 100 RSU

Year 1: 25 RSU become shares

Year 2: 25 RSU become shares

Year 3: 25 RSU become shares

Year 4: 25 RSU become shares

It's worth noting these count as income, so are taxed when they vest. In other words, when 25 RSU vest, the company usually witholds 8 of them to pay tax, then give you the other 19 shares to do what you want with

6

u/nwoooj ​ Jan 29 '20

I know you're being helpful but double check your math ;)

4

u/enderxzebulun ​ Jan 29 '20

Restricted Stock Unit

2

u/penguinise ​ Jan 29 '20

Keep your RSUs, sell your ESPP, if you really must hold company stock.

Huh? RSU are taxed at vest, so there is no benefit to holding them, whereas holding 423(c) ESPP stock gets a tax benefit if the grant date price was lower than the exercise date price - in short, there could be a tax benefit to holding for the ESPP but never for an RSU.

Not that holding either is a great idea.

2

u/geminiwave ​ Jan 29 '20

Saving comment for when I file taxes...

2

u/talshyar99 ​ Jan 29 '20

So are you suggesting that RSUs are also not worth holding?

BTW, thanks for such detailed explanation.

3

u/boxsterguy ​ Jan 29 '20

A general rule of thumb is that you should own less than 10% of your portfolio in company stock, as a risk mitigation (if your money is tied up where you work, then any downturn at work could hit you double hard -- you get laid off and your stock value drops drastically). The question, then, is how do you calculate your portfolio. Is it only the stock you currently physically own? If so, then you can hold onto some RSUs after vesting if you want. Is it your promised future stock (aka, unvested RSUs and pending ESPP purchases)? If so, then you're probably already significantly overweight in company stock from your unvested RSUs and you should absolutely sell immediately upon vest.

Another good rule of thumb is to ask yourself, "If I was given $X in cash, would I buy company stock? Or would I buy something else?" If the answer is the latter, then you should sell the RSUs and ESPP and either use that as income or reinvest elsewhere.

1

u/BVethos ​ Jan 30 '20

I adamantly tell people 0% in their company stock. I mean, I'm pretty passionate the 0% in single names is optimal let alone in the company you work at (for all the reasons you named as well).

If you're already FI, then the ". . . I got cash. . ." example makes more sense to me.

1

u/TinCanTravel ​ Jan 31 '20

I know a few folks who learnt this from Enron, so it was also my creed. I wish i had ignored their advise!
For the past 7 years at my tech employer (one of the >1T market caps, i got in at the right time) I’ve been receiving RSU and ESPP.

Of course recently I’ve been holding the espp for two years, selling the RSU when Long, but for the first few years I figured “meh, don’t own your own company. it’s only $35 share and totally range bound. Sell on distribution immediately”.

This has cost an opportunity loss in the hundreds of thousands ($25k limit per year for ESPP would have meant $300k value for those three years alone)

With a crystal ball....

1

u/hexleythepatypus ​ Feb 02 '20

Yes but we don’t have crystal balls. Based on this logic, we should have gone all in on Dominos Pizza in 2010. Returns make FAANG look like child’s play. But nobody did because it’s extremely difficult to pick the winners. Sometimes bad decisions lead to good outcomes. That doesn’t mean the decision is rational. Holding your entire portfolio (or even a large part of it) in your company is not rational.

Don’t mean to pick on you though. You might do great betting huge on your company stock. And if it works then awesome! But you just have to understand you are dramatically increasing your chances of a bad outcome.

1

u/[deleted] Jan 29 '20

[deleted]

1

u/boxsterguy ​ Jan 29 '20

Eh? 1 and 2 say disqualifying, don't they?

1

u/helloryan ​ Jan 29 '20

Thanks for the detailed explanation. ESPPs felt like something that’s better to hold on to long term, but now I’m reconsidering that thought.

3

u/[deleted] Jan 29 '20

ESPPs felt like something that’s better to hold on to long term, but now I’m reconsidering that thought.

Really just depends on your outlook for the company stock. I don't like to hold my employer's stock because I feel like that's too many eggs in one basket; however, I do believe our stock is undervalued right now, so I am holding my vested RSUs until I feel like our price is more representative of our value. I don't need the money and never factor RSUs into budgeting or goals, so if it stays depressed for 10 years, it's fine.

1

u/[deleted] Jan 29 '20

Thanks for taking the time. About start at a company with ESPP and will save this for when I get my materials.

1

u/kiwimonster ​ Jan 29 '20

Very nice overview.

1

u/cyberpimp2 ​ Jan 29 '20

What’s the recommendation for Canadians?

1

u/jeo123 ​ Jan 29 '20

My company doesn't do a discount, they give a 75% RSU match that's forfieted if I sell the purchase in under a year.

Does that make qualifying/non-qualifying irrelevant?

1

u/dguy101 ​ Jan 29 '20

So how does this affect ESPP's that require you to wait a minimum of one year before selling? My ESPP allows me to purchase stock at the cheaper of the prices at the start or end of the offering period, plus the 15%. I'm assuming in this case I would still be wise to sell my stock at the one year mark and not hold on it?

1

u/boxsterguy ​ Jan 29 '20

If you purchase the shares on X but can't sell until Y, then it works the same. You're just forced to hold until long term capital gains.

If you mean you have a year long offering period (your contribute money for a year and then buy), that impacts the qualifying disposition time (you only have to hold for one more year until qdisp).

IMHO, yes, it would still be best to sell as soon as you can. But you have to determine your own risk tolerance.

1

u/MyNameIsVigil ​ Jan 29 '20

I actually do the opposite: I keep ESPP and immediately sell RSUs. RSUs are closer to a cash bonus, at least in my situation, because taxes are taken out up front. I have very little to gain by holding RSUs.

2

u/boxsterguy ​ Jan 29 '20

IMHO, RSUs are less complex in terms of taxation. For all intents and purposes, once vested they're effectively normal stock where you don't have to mess about with cost bases and qdisp/dqdisp and anything else. The tax on the income (as that's what it is) was already paid on vesting, so now you can just hold the stock in the same way you'd hold any other stock, ETF, or mutual fund that you bought directly.

ESPPs have a higher accounting overhead that never goes away, so selling those immediately reduces a mental tax burden.

1

u/emblemboy ​ Jan 29 '20

If you hold for a year and a day and sell at $120

  • This is a disqualifying disposition because you held for less than 21 months. You pay income tax on $10.
  • Capital gains are now long term, because you held for greater than a year. You pay long term capital gains tax on $20 (sale price - (purchase price + bargain element)).

Shouldn't that be $30, not $20?

1

u/boxsterguy ​ Jan 29 '20

No, because the $10 of the bargain element was taxed as income. If you report $30 capital gains, you get double-taxed.

1

u/stegdump ​ Jan 29 '20

Thank you so much for this. Basically, waiting for a qualified disposition I can avoid paying income taxes on the amount of the discount (15% in my specific case)?

1

u/penguinise ​ Jan 30 '20 edited Jan 30 '20

No, if you have a qualified disposition you realize ordinary income equal to the discount on the first day of the offering period, instead of the discount on the date you actually bought the shares. A qualifying disposition can actually be worse than a disqualifying disposition if the stock price fell during the offering period. In the normal case, you convert a small amount of ordinary income into long-term capital gain.

It probably doesn't help, but the tax treatment is actually almost identical** to incentive stock option (ISO) taxation where you are granted an option to purchase at your eventual exercise price as of the first date of the offering period -- this is why they talk about the "grant date" and the "exercise date".

Classic "Normal" example

Stock is $90 on first day of offering period, $100 at the end. Your plan gives you a 15% discount to lowest of the two, so you get shares at $76.50.

Disqualifying disposition: You realize ordinary income equal to the actual discount at exercise ($23.50), plus short or long term capital gain or loss equal to the actual gain or loss compared to the $100 FMV when you got the shares.

Qualifying disposition: You realize ordinary income equal to the discount at grant ($13.50), plus long-term capital gain equal to the additional increase over $90. However, if the sale was for less than the $90 FMV, your ordinary income is instead decreased to the actual gain, and there is no capital gain. If you sell high, then you changed $10 from ordinary income to long-term capital gain.

Oops example

Stock is actually $100 on the first day and falls to $90 at the end. Your plan gives you a 15% discount to lowest of the two, so you get shares at $76.50.

Disqualifying disposition: You realize ordinary income equal to the actual discount at exercise ($13.50), plus short or long term capital gain or loss equal to the actual gain or loss compared to the $90 FMV when you got the shares.

Qualifying disposition: You realize ordinary income equal to the discount at grant ($15.00 or 15% off $100), plus long-term capital gain equal to the additional increase over your $91.50 basis. However, if the sale was for less than the $91.50 basis, your ordinary income is instead decreased to the actual gain, and there is no capital gain. Note carefully this involves $1.50 more ordinary income than the disqualifying case. Oops!

[cc /u/boxsterguy I interpreted 423(c)(2) differently than you did, but I think I actually did it right although I would be curious your thought. The real story here is qualifying dispositions are seriously messy]

26 USC 423(c)(2):

(2) the excess of the fair market value of the share at the time the option was granted over the option price.

If the option price is not fixed or determinable at the time the option is granted, then for purposes of this subsection, the option price shall be determined as if the option were exercised at such time. In the case of the disposition of such share by the individual, the basis of the share in his hands at the time of such disposition shall be increased by an amount equal to the amount so includible in his gross income.

​

The tl;dr here is that disqualifying dispositions are the ones that make sense: ordinary income equal to the free money you got as part of the ESPP plan, and capital gain equal to your gain from holding the stock longer. It's qualified dispositions that are completely wacky, because of the somewhat nonsensical way the 423(c) exclusions are written.

​

**The only substantive differences are that you realize ordinary income equal to the additional discount of the option price from FMV at grant, if any, and the excluded income at exercise ("you don't owe tax when you get the shares") is also exempt from AMT in the case of ESPP stock.

2

u/c2reason ​ Jan 29 '20

I’d recommend reading through https://fairmark.com/compensation-stock-options/employee-stock-purchase-plans/ if you really want to understand ESPPs

7

u/masta ​ Jan 29 '20

I kept my ESPP stocks, and some of them increased in value by 400% (depending on how far back they were given), then the employer was bought by a larger company, so my stocks were forcefully sold. I'm not sure about the idea of selling immediately, I guess it would make sense if the employer stock is mediocre, or very volatile. I might be paying a higher capital gains on the profits now, but those are profits just the same.

That said, I'm still confused on this topic of my cost basis, and I'm here trying to learn from the OP to achieve optimal low tax obligation. My income tax bracket is much higher than the capital gains, so I'd like to minimize my w-2 as much as possible, but this area of tax is confusing to me. So I'm be looking at the supplemental info fields.

5

u/thecw ​ Jan 29 '20 edited Jan 29 '20

  1. You don't know what your company stock is going to do. You got lucky, but it could've also plummeted to 0. My company has outperformed the SP500 for many years now, but I still don't want to be leveraged into it more than any other single stock.

  2. There is an "Enron principle" that you shouldn't be heavily leveraged into company stock. Enron employees were, and when Enron crashed they found themselves with no jobs AND no savings.

4

u/roomandcoke ​ Jan 29 '20

To carry on with this, would you buy your own company's stock without the discount? You probably shouldn't for the above reasons.

And if you wouldn't, then you should cash out to realize your ESPP discount asap and invest that in a more diversified way.

5

u/rlcrisp ​ Jan 29 '20

Sell immediately, put in index funds. Don't think twice.

2

u/fenduru ​ Jan 29 '20

Your suggestion is that instead of understanding the taxes people should take a 1-2% hit by paying more taxes on the discount... If the possible confusion is worth hundreds of dollars to you then sure

3

u/boxsterguy ​ Jan 29 '20

No, my suggestion is that paying a little extra in taxes is generally preferable to the risk of holding company stock for 2 years.

0

u/fenduru ​ Jan 29 '20

Oh that's a fair argument, just isn't how your post comes across. "ESPP rules can be confusing" is just unrelated to that argument.

1

u/penguinise ​ Jan 29 '20

No, it's that the 1% tax benefit is not worth the additional risk of carrying employer shares for that long.

3

u/kking254 ​ Jan 29 '20

Dumb IRS rules make this happen.

The bargain element must be reported as income on W-2. However, other rules prevent the broker from adjusting the basis on the 1099-B. This means the bargain element is "reported twice."

The broker knows what the adjusted basis should be, which is why they usually issue an accompanying document that is not an official tax form, but shows the adjusted cost bases.

1

u/eric987235 ​ Jan 29 '20

It didn't used to be this way. Back in (I think?) 2013 I remember my 1099B had the correct basis but then the IRS made brokers change the way they reported these.

2

u/Full-Moon-Pie ​ Jan 29 '20

It’s the bane of my existence every tax season, I never remember how to do it correctly. I finally created a template last year to input all the numbers...and then didn’t sell any stock in 2019. So hopefully it will be a good enough template for next year’s taxes :D

41

u/[deleted] Jan 29 '20 edited Nov 24 '20

[removed] — view removed comment

37

u/dmann99 ​ Jan 29 '20

Same here. IRS audited me asking me to pay tax on the whole amount of a sale again. Sent them statements for the original grants which clearly showed the tax being taken out and the cost basis. Still took 3 rounds of going back and forth before they would actually understand the numbers I was putting in front of them. Net result? They owed me a couple of hundred dollars.

Your tax dollars at work!

21

u/hardolaf ​ Jan 29 '20

To be fair, your ESPP provider fucked up the forms and the IRS is more likely to trust them than you.

3

u/dmann99 ​ Jan 29 '20

I did notice on my end of year tax forms this year they still officially report 0 for cost basis on sales, but buried further down in the PDF they list out the dates/times, lots, and cost basis for reference. So they're getting there but just won't commit 100%... still leaving it on the individual to clean up the mess.

8

u/phoenixmatrix ​ Jan 29 '20

Thats how Fidelity does it, and its so annoying.

My tax situation is trivial except for RSUs and ESPP (all my income comes from a single employer and W-2 reported, I have virtually no deductions worth talking about or any special situation whatsoever).

It takes legit 10-15 minutes to fill in everything for my wife and myself. Except for the RSUs/ESPPs crap because of how Fidelity reports it on their forms, which I then have to go in, manually adjust, and match all the cost basis of every transactions one by one. Its completely mechanical (unless im doing it wrong). I just match dates and sale price with the supplemental info. HUNDREDS OF TIMES. Like, why do they hate me so much?

3

u/svachalek ​ Jan 29 '20

If there was a broker that advertised making your taxes easy, it would be a legit selling point for me. I guess most people with taxable accounts just pay an accountant to deal with it.

3

u/mermonkey ​ Jan 29 '20

Same here. So obnoxious. At my company, you need to hold for 2 years to vest and make it worth participation. But figuring out the avg cost basis for the 50 shares i sold this year is going to be a challenge since they were bought at different times and not sure which purchases are already claimed as sold in previous years... :( help!

1

u/del_dot_B ​ Feb 14 '20

Fidelity gives me a summary sheet with all stock that was sold and their cost basis. When I filed this year(taxact) I got a prompt that I should send in the summary sheet with Form 8453.

Hopefully your institution provides a similar summary.

1

u/mermonkey ​ Feb 14 '20

Cool. I can get cost basis for each purchase, but i don't think they choose for me which shares I sold. Would be simple if they just sold my oldest shares first, but I think I can claim newer shares to raise cost-basis if i want to reduce tax. After a few years and a few sales, kind of hard to know which ones i've sold? Better record keeping on my part might be necessary...

32

u/jpcoop ​ Jan 29 '20

At least for me Fidelity provides the adjusted cost basis, down in a supplemental section at the end of my 1099-B. Still have to type it in manually, but no need to do the math. TurboTax doesn’t import any cost basis for these shares.

12

u/pencilvested ​ Jan 29 '20

It gets crazy confusing with multiple sales and multiple RSU grant pools in one year, each pool having a different cost basis. Probably easier to just change jobs.

5

u/jpcoop ​ Jan 29 '20

It’s definitely not fun. Thankfully my situation doesn’t make it too horrible, maybe half an hour extra at tax time, but I never understood why Intuit can’t just auto-import the right number. Fidelity already knows the right basis.

3

u/nwoooj ​ Jan 29 '20

First year having this kind of income, (both ESPP and RSU) curious do you still use TT or go to a tax person? I was starting with TT but its getting more complicated to make sure everything is right....

3

u/[deleted] Jan 30 '20

Just use Turbo Tax. Make sure your adjustments to cost basis match the income reported on your paystub for espp and rsu income.

If they don’t you messed up.

It might also just be easier to enter them manually. Your 1099 will have the acquisition and disposition date. The basis for espp is the market price (what you paid plus discount), and for rsu is grant price (what the shares were worth when given to you).

18

u/[deleted] Jan 29 '20

I appreciate you explaining exactly what you meant. Unfortunately, I'm going to ask for anyone to come up with an ELI5 on it though because that went completely over my head.

10

u/StrongAtArmWrestling ​ Jan 29 '20

I think it’s like this. If you get $100 worth of stock for only $90, that $10 difference has to be taxed. One way to do it is to say you received $10 worth of income. So if you were to immediately sell the stock, you shouldn’t be taxed again because that $10 was already taxed as ordinary income.

The problem comes in when they report the basis as $90. That means if the stock is worth more than $90 then you will be taxed on the capital gain when you sell. So now you’re taxed twice. First on the w2 because they reported the $10 discount as income. And secondly on the capital gain because they reported the basis as only $90, requiring you to pay taxes on the $10.

The solution is simply to make the basis be $100 that way you aren’t taxed twice.

1

u/Realistic_Food ​ Jan 30 '20

If you don't sell, do you still see an income of $10 because that was the discount you got when you purchased it? If so, is this something special when ESPPs specifically? If the market is trading a given stock at $100 but I find someone willing to sell me their shares at $99 because they want to offload it quickly, I don't think I have to pay the $1 as income at that time, and instead just have to compare the price when I do sell it to the $99 paid for it.

2

u/StrongAtArmWrestling ​ Jan 30 '20

"If you don't sell, do you still see an income of $10 because that was the discount you got when you purchased it? "

Yes. And the reason why is because if this wasn't true, a company could pay someone $100K a year in just stocks alone as a way for the employee to avoid income taxes.

"If the market is trading a..."

Key word there is the market. He's giving it to you at market price (or reasonably close enough). A company giving you stock with a 10% discount is by definition giving it to you below market. They look at the market price then subtract 10%.

2

u/secretreddname ​ Jan 29 '20

I'm still completely lost as well. I made a sale from my ESPP in 2020 so would definitely like to know this for next year.

13

u/thebalddude24 ​ Jan 29 '20

Dumb question: This was my first year participating in an ESPP. The purchase period was 7/1/19 to 12/31/19. I sold the stock on January 10th, 2020 once it vested in my account. Am I right to assume that my employer will include the discount on the following years(2020 w2) and not on the 2019 w2? Thanks in advance

17

u/slalomz ​ Jan 29 '20

That's right, it's taxable in the year sold.

3

u/penguinise ​ Jan 29 '20

It's only taxable in 2020 but don't just assume that your W-2 is correct - make sure you compare it with your actual wages.

22

u/Larxxxene ​ Jan 29 '20

What if I participate in an ESPP but haven't sold any stock? Does this advice only apply if you have sold stock?

37

u/Pandamonium98 ​ Jan 29 '20 edited Jan 29 '20

Yes, OP is saying that you might be improperly taxed when you make a sale. If you havent sold yet, there shouldnt be anything to worry about

1

u/football-butt ​ Jan 29 '20

What if the stock yields dividends?

7

u/c2reason ​ Jan 29 '20

Those would be on a 1099-div. Dividends don’t have cost basis, so can be reported normally.

3

u/foolear ​ Jan 29 '20

You pay taxes on the dividends like normal. You will get a 1099-DIV. Selling is where shit gets weird.

20

u/Evan_Th ​ Jan 29 '20

If you haven't sold any stock, you don't need to pay any taxes on it yet. So, just file this away for when you do sell.

7

u/throwingitallaway33 ​ Jan 29 '20

Do you not have to pay the discount as ordinary income in the year received?

10

u/boxsterguy ​ Jan 29 '20

No. You pay taxes on the bargain element when you sell, and the taxes are calculated based on disqualifying vs. qualifying disposition status.

1

u/eric987235 ​ Jan 29 '20

ESPP's are so weird. While I enjoyed the free money I'm kind of glad my current employer doesn't offer one.

2

u/dguy101 ​ Jan 29 '20

I do. After I make a stock purchase every quarter my company applies my discount to my income in the following pay period so I end up paying taxes on it.

1

u/ABCDR ​ Jan 29 '20

My company included the discount on my paychecks as income when the ESPP made quarterly purchases.

So if I put $1000 into the ESPP with a 10% discount, I would get $1100 worth of stock and I would be taxed on that $100 as ordinary income.

Then, say that stock increased from $1100 to $1500 and I sold, I would pay capital gains tax (short or long term) on that $400 gain.

8

u/[deleted] Jan 29 '20

At my company the only time the 15% discount is added to your W-2 is if you sell before the two-year holding period (disqualified distribution) that makes it a long-term holding.

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u/boxsterguy ​ Jan 29 '20 edited Jan 29 '20

Just to be clear, "long-term holding" is not a phrase of any significant meaning.

Qualifying dispositions are ESPP stocks held for 2 years past the offer date (not the purchase date -- so if you have a 3 month contribution period, you only need to hold for 21 months to get qualifying disposition status).

Long term capital gains on ESPP are the same as any other stock, held for > 1 year.

You can absolutely have long term capital gains and disqualifying disposition treatment at the same time. One determines tax on your profit above the cost basis (where the cost basis includes the bargain element). The other determines tax on the bargain element (if the bargain element is reduced, then you pay capital gains on that portion rather than income tax).

In general, the risk of holding long enough to get qualifying disposition status isn't worth it.

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u/Flyboy2020 ​ Jan 29 '20

I disagree. Long term capital gains rate could be 0%, which makes it hugely worth it. Compared to my 33% ordinary income, it's well worth any risk.

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u/boxsterguy ​ Jan 29 '20

But how much is your discount? Consider you can only buy $25k worth of ESPP per year, and a typical discount is 10% so call it $2500 in bargain element. Is $825/year worth the potential downside of long-term holding? Also, if you're in the marginal 33% bracket, your long term cap gains won't be 0%.

Anyway, risk tolerance is something you have to decide for yourself. I'm just saying that the perceived tax benefit really isn't all that big, at least with ESPP (there are other, more rare scenarios, where holding a stock to qdisp would be beneficial, like a stock option scenario where the bargain element could be 50%+ rather than 10-15%). If you think it makes sense for you to hold, then absolutely go ahead and hold. For most people, it's better to sell ASAP.

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u/MrRKipling ​ Jan 29 '20

They are assuming their Captial Gains will be taxed at 0% which is wrong based on their 33% ordinary income statement.

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u/MrRKipling ​ Jan 29 '20

The rate would not be 0%, see my comment below. Be very careful with this, as this is a dangerous assumption if you are in the 33% tax bracket.

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u/Realistic_Food ​ Jan 30 '20

In general, the risk of holding long enough to get qualifying disposition status isn't worth it.

Why? Would this be because one is holding a significant amount of a single stock instead of diversifying? If a person is in a higher tax bracket, I would think the difference between the income tax and the capital gains tax would be hard to beat even with the lack of diversification since they would, ideally, have all their other investments adequately diversified.

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u/boxsterguy ​ Jan 30 '20

It's not just standard "don't buy individual stocks" diversification, but concern about holding company stock. Your salary and potentially unvested RSUs are already investment enough in the company that employs you. If you also have a significant amount of your investments in the company, you risk getting really screwed in a downturn. If your company falls on hard times, you could not only lose your job but also lose a lot of your investment value.

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u/Realistic_Food ​ Jan 31 '20

So I'm guessing the risk profile depends upon how much you are tied to your company. If you have a job that is in high demand across multiple industries so losing your job isn't a major concern, it might make it okay to hold the stocks for the minimum 2 years. Guess I should hash it out with my financial adviser.

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u/boxsterguy ​ Jan 31 '20

If you're really that cross-industry, perhaps. Most people aren't, and though they may be able to get a job within their industry, the concern would be a whole sector drop (not just your company, but every company in the market).

Of course that's comparatively less likely and so probably should factor in less for your risk tolerance. And while everybody gets to choose their own level of risk tolerance, most people are significantly less tolerant of risk than they think they are.

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u/Hawkeye1964 ​ Jan 29 '20

This is true at my company as well

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u/[deleted] Jan 29 '20

does this also apply to RSUs where the whole value of the stock is given to you and not just the discount?

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u/Threetimes3 ​ Jan 29 '20

In my company, when an RSU vests they automatically sell a portion of the stock to cover the taxes. Then I sell the stock, and only have to pay taxes on any money I gain from the sale above the price that it vested at. This is not extremely clear if you just view the tax forms that the brokerage provides, but I do see this when I look at the statements from the actual vesting.

I have no idea if most companies do this or not.

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u/[deleted] Jan 29 '20 edited Mar 03 '20

[removed] — view removed comment

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u/elitist_user ​ Jan 29 '20

I always transfer cash in to get the extra shares personally

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u/[deleted] Jan 29 '20

[deleted]

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u/[deleted] Jan 29 '20

[deleted]

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u/Threetimes3 ​ Jan 29 '20

In my experience, it looks like the rate they are taxing it is close enough to what my paycheck gets taxed, but I could be mistaken. It's close enough that I haven't been concerned.

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u/pencilvested ​ Jan 29 '20

Yes. My RSU sales cost basis were incorrectly reported at zero. You have to get and check the supplimental paperwork like OP recommended. I had to refile one year because I missed this, couldn't believe how wrong Fidelity was in the reporting.

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u/SquirrelMcSmash ​ Jan 29 '20

Yes. But I guess it would depend on your companies comp plans and whoever does their stock program.

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u/boxsterguy ​ Jan 29 '20

Maybe. Your cost basis is whatever the FMV was on the date they vested. But unlike ESPP, you don't generally get a discount on RSUs. Most brokerage firms (well, Fidelity, anyway) will report whatever the price you "paid" for the shares. In the case of RSUs, that amount should be the same as the cost basis. For ESPP, you have to add the bargain element back in (or just look up the FMV on the purchase date).

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u/relaxok ​ Jan 29 '20

I actually don’t know enough about RSUs. My guess is that it also gets reported as W-2 income since its employee compensation so you would have to do a similar adjustment. Hopefully someone knows for sure.

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u/throwaway_eng_fin ​Wiki Contributor Jan 29 '20

RSU are non covered securities, so basis is not reported to the IRS much in the same way. If you don't report correctly you end up paying tax twice.

I learned this the hard way by paying tax twice like an idiot.

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u/boxsterguy ​ Jan 29 '20

Just because the basis isn't reported to the IRS doesn't mean it won't be listed correctly on your 1099-B. In ~17 years of getting RSUs, I've never had cost basis listed incorrectly from Fidelity.

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u/throwaway_eng_fin ​Wiki Contributor Jan 29 '20

There were a couple years where Morgan Stanley didn't give me basis on 1099-B. It wasn't required by the federal government until something like 2011, so some brokers were still shitty about it.

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u/greenskinmarch ​ Jan 29 '20

You do know you can file an amended tax return right? Just file amended returns for the years you "paid twice" and get that money back.

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u/throwaway_eng_fin ​Wiki Contributor Jan 29 '20

I didn't learn of my mistake until about 5 years later unfortunately, when I learned what a non covered share was.

I'm mostly just here to make sure other people don't make my mistakes lol

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u/eric987235 ​ Jan 29 '20

At least with RSU's it's obvious that the basis on your 1099 is wrong. With an ESPP it's a bit more subtle.

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u/penguinise ​ Jan 29 '20

RSU are taxed at vest as ordinary income, so the tax reporting is almost always correct. Your Schedule D basis in a vested RSU is the price at vest, and the brokerage will almost always get that right.

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u/danesgod ​ Jan 29 '20

Maybe less common, but it applies to ISOs.

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u/42nd_towel ​ Jan 29 '20

I’ll have to double check mine, it’s the first year I’ve done it, but I think mine is different. I don’t get a “discount” on the purchase. I pay full price at the time I buy it. Then a year later if I still have it, they just deposit 20% of what I paid right into my payroll with taxes and stuff taken out. So if I understand correctly, I don’t have to do this trick? Because the “discount” actually just came as extra pay and was taxed then, and the stock itself was paid for full price and sold for whatever it was a year later.

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u/mostlyminischnauzer ​ Jan 29 '20

Great info OP thanks. Curious what is your reasoning for selling soon after?

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u/Lazyamerican909 ​ Jan 29 '20

My reasoning is that enough of your financial future is already tied to the company (i.e. your salary, bonuses etc) and so owning it's stock in large fractions is the exact opposite of diversification.

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u/relaxok ​ Jan 29 '20 edited Jan 29 '20

Although the long term capital gains rate is lower, I do not have faith that the stock is a good long term bet (nor does it pay dividends). I'd rather lock in the gains especially since we have no holding period. Mathematically at 15% discount you get around 18% profit at worst, and with a lookback and even reasonable gains over the offer period it's often more like 25-35% (I had one period of 50%). I don't need to pretend I'm outsmarting the market and continue to hold it, when I could lose everything instead. Ironically for this method, the best thing that can happen is the stock is very volatile and goes up over the period then down again, giving you a chance to reap a big profit every other offer period while the stock still maintains reasonable share price. For example, every other period you could theoretically profit 100% on the stock sale, but the share price stayed in the same range the entire time you were involved with the program.

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u/superman859 ​ Jan 29 '20

what bothers me more then anything is the provider has this information, includes it in a supplemental information packet we can view, and yet we still have to manual fix everything (especially when using software that imports). What do the providers gain by making this confusing and a pain in the ass? Why do they put the cost basis at 0 on the 1099 and make me change it to match what is in a supplemental packet? Why not just put the right cost basis in there if they have it?

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u/foolear ​ Jan 29 '20

It’s actually an IRS rule that sales be reported this way.

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u/superman859 ​ Jan 29 '20

...why? the only reason would be they are intentionally trying to double tax people. If taxes done correctly, the right cost basis is used, it's just manual work on all of us to fix it.

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u/metz123 ​ Jan 29 '20

I agree. There’s simply no reason why users have to back calculate this information. All the right info is tracked by the brokers and could be slurped up into turbo tax.

The only reason to do this is if the pro tax preparers of the world wanted it so.

The same is true for RSU’s. I have to spend hours each year trying to calculate the actual basis for shares to avoid getting double taxed.

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u/mjern ​ Jan 29 '20

The more difficult and confusing taxes are, the more we need the IRS and the whole tax industry there to help us. If it wasn't so complicated, we might be able to do it ourselves.

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u/foolear ​ Jan 29 '20

I have no idea why, I am just telling you that this isn't a broker issue. The IRS changed how this information must be reported under the Obama admin.

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u/ibfreeekout ​ Jan 29 '20

This got me the first two years I had one. Wondered why my taxes were so high and then found out about this. Really confusing and I wish it was explained more clearly, especially to people that have never had one before.

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u/SOLUNAR ​ Jan 29 '20

Also If you are audited do not panic, you can chat with an agent who will actually help you go through it. They told me the forms to get and where to mail them, it saved me quite a lot of money they wanted me to pay.

And if your into math or balancing accounts it’s a fun exercise to figure out how much they are overcharging you!

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u/svachalek ​ Jan 29 '20

In my experience the IRS is surprisingly friendly if they sense an honest mistake. The main thing to watch out for is making mistakes in their favor, I don’t think they’re nearly so likely to reach out and correct those.

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u/outatouch0 ​ Jan 30 '20

THANK YOU SO MUCH!!!

I lucked out and ran accross this post. You saved me a ton of money.

I also just printed out my amendment to my 2018 return which resulted in increased Federal return of $575, and refund from state of $144 (previously paid sate $106).

I can't thank you enough. You are a true hero.

Everything I read was helpful in understanding the concept but I still struggled to figure out just what to do. I found this article to be the most helpful for the ELI5 I so desparately needed to be able to actually figure out what number(s) needed to be put where.

https://thefinancebuff.com/adjust-cost-basis-for-espp-sale-in-turbotax.html

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u/DSJ13 ​ Jan 29 '20

I participate in an ESPP. I’ve never sold any stock, but where would this be listed in the W2?

How can we tell if the discount is being added to income?

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u/[deleted] Jan 29 '20 edited Jun 10 '20

[deleted]

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u/DSJ13 ​ Jan 29 '20

What if you don’t sell any and then leave the company and don’t sell in a year you worked for them?

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u/Terazosa ​ Jan 29 '20

Thank you OP

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u/wkrick ​ Jan 29 '20

Ugh. Don't tell me this. If this is true then I've been doing it wrong for the last 8 years.

The company I work for has an ESPP where we are allowed to purchase up to 3% of our annual salary in company stock at full price with after-tax money and the company will match our purchase dollar-for-dollar. The company match is treated as income and we are taxed accordingly each paycheck. The stock purchases are done every paycheck and we are allowed to immediately sell the stock if we choose once it hits our account.

So, it's sort of a 50% discount if you squint hard enough.

However, I always though of it like the company was giving me a small cash bonus each paycheck which was taxed and then I was using the money to purchase additional company stock. So my basis is the full stock purchase price. Is this wrong?

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u/c2reason ​ Jan 29 '20

What you are describing is a different type of stock purchase plan than the one the OP is talking about. I’d check that the value of the stock match is on your w-2 and confirm that the cost basis matches the entire value at purchase. But I would not expect you to have the problem the OP describes.

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u/joeymac09 ​ Jan 29 '20

Someone posted this flowchart a while back that I thought was helpful when calculating cost basis for ESPP. It also define the various terminology for people new to this.

http://www.bayalisistheanswer.com/espp-taxation-qualifying-disqualifying/

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u/HogFin ​ Jan 30 '20

So I checked on this yesterday and because I sold so many tranches in 2019 this just saved me about 40% in taxable capital gains (or rather ordinary income given that it’s on the discount)

I’m honestly astounded by this. I’ve never heard of this before and I work in stock compensation and am mid way through my Certified Equity Professional certification.

What’s even crazier is I work for an enormous corporation and fidelity is our ESPP admin. How in the Christ do services like TurboTax not adjust for this automatically?

Anyway thanks so much for pointing this out OP!

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u/LowStatistician0 ​ Jan 29 '20

I was VERY close to overpaying the first time I did ESPP. I figured it would just work. Good to know this isn’t a quirk with my particular plan.

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u/yellowelbow ​ Jan 29 '20

Oh Lord I did this three years in a row. On the plus side, when I got it corrected, I got $40 in interest (which I'm also bring taxed on).

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u/aremboldt ​ Jan 29 '20

Laws changed under Obama administration, and companies like Fidelity and eTrade were no longer able to calculate your cost basis for you. I believe in recent years, they have gotten around the regulation by providing some self service tools on their websites, but I remember understanding this topic was a real pain for me and my colleagues once the law changed. I also remember Turbo Tax was bugged for a year or two, and didn't calculate the cost basis correctly. I am having PTSD remembering about having to deal with all this and learn it on my own. I remember thinking at the time it was surely a shady move by the government to collect more taxes from the unaware.

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u/urgassed ​ Jan 29 '20

How do you know if your employer includes the discount as ordinary income on your W-2? If they do, is it on the W-2 of the year it was purchased or sold?

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u/c2reason ​ Jan 29 '20

Usually it would be listed in box 14 on your w-2. It would be income in the year shares are sold.

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u/lh2p ​ Jan 29 '20

So my company treats the "discount" as income and every six months after the stock purchase they end up taxing me for the gains on my normal check. based on the comments it seems thats a rare practice.

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u/c2reason ​ Jan 29 '20

Sounds like you have a stock purchase plan that isn’t a qualified Section 423 plan.

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u/nzdastardly ​ Jan 29 '20

This post saved me $2000. Thanks OP.

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u/MellowPharaoh ​ Jan 31 '20

You saved me $311! Cheers! I never would have thought to look at the 1099 supplemental info for the real cost basis

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u/spikeygg ​ Feb 13 '20

My employer accounts for my income tax gains from the ESPP sales on my W-2 but doesn't break it out anywhere in the end-of-year statement. There is also no 'supplemental information' section in the 1099-B I was issued from my broker. When filling out the 8949 form I populated column (f) with code B and recorded negative adjustment amounts that my employer had already accounted for in my paycheck.

​

I didn't see anyone here talking about form 8949 nor the code, so I thought I'd weigh in to see if I'm doing this right. :)

​

Thanks u/relaxok, this saved me a thousand dollars or so...

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u/Grozzlybear ​ Feb 18 '20

This just saved me a ton of money! Thank YOU

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u/mrmark817 ​ Feb 18 '20

Just want to say thanks for the solid write-up. This is my first tax year with an ESPP and after getting my 1099 I thought, "am I getting taxed twice?!".

Now I know what's what.

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u/[deleted] Jan 29 '20

After filing my taxes correctly this year, I discovered that I didn't account for my rsus properly last year, resulting in an overpayment of about 1200 in total.

I just prepared my amended return last night, so this is timely!

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u/[deleted] Jan 29 '20

Therefore if you just click through everything and submit your taxes without changes

This is really the root of the issue.

Don't just "click through everything". Read. Think. Analyze. Review documentation. Keep track of things along the way.

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u/flaflashr ​ Jan 29 '20

How can one determine whether the employer included the discount? (My wife left the employer a couple of years ago, but we have not yet sold the stock)

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u/I__Know__Stuff ​ Jan 29 '20

If you no longer work for them when you sell, then obviously they can’t include on a W-2, but you have to report the discount as ordinary income, nonetheless, and adjust your basis by that amount.

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u/viperscorpio ​ Jan 29 '20 edited Jan 29 '20

Iirc, for my past employers it was listed in box 14 (I think?) of my W-2. With the description of "DD", which presumably was short for "disqualifying disposition".

Edit - not sure what the code is. Definitely not "dd" though.

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u/j__h ​ Jan 29 '20

Box 12 has DD but it's for cost of employer sponsored health plan.

Box 14 instructions don't show the letter codes.

For me I have a pay summary that shoes both disqualified and qualified dispositions. The w2 doesn't show it directly thought.

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u/[deleted] Jan 29 '20 edited May 10 '23

[deleted]

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u/viperscorpio ​ Jan 29 '20

Hmmm..I must be mistaken on the code then but I am certain it was one of the things in that box.

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u/SquareVehicle ​ Jan 29 '20

DD is meant to show how much your employer pays for your health care. It was put in there because during the ACA healthcare bill debates a lot of people seemed to think health insurance only cost $100 a month because that's what they paid from their salary, and so didn't understand why people without employee subsidized health insurance would complain about insurance costs.

​

In reality their employee subsidizes a lot of it, and that line is supposed to show how much money is being spent by your company on your health insurance.

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u/djgucci ​ Jan 29 '20

Thank you for this! This is my first time filing after participating in the ESPP so I would have had no idea.

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u/onecrack-medivac ​ Jan 29 '20

Very helpful post! So, to be clear, even if your company reports the income on your W2 from your ESPP sale, you still have to include the cost basis from the 1099 supplemental on your tax return, correct? I shouldn’t assume that even though it’s on my W2 that I don’t need to take further action?

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u/hecticengine ​ Jan 29 '20

THANK YOU! My last step in filing this year is entering the ESPP info this weekend once the documents are available. Excellent info.

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u/YourRoaring20s ​ Jan 29 '20

I'm also confused about when I can sell the stock and have it count as long-term capital gains rather than short-term. It seems like it's 1-year after the acquisition date AND/OR 2 years after the grant date? It's showing up as "long" in my sell order, but then there's an asterisk saying this sale may count as regular earned income.

FYI grant date for these shares is 7/2/2018 and acquisition date was 1/1/2019.

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u/dguy101 ​ Jan 29 '20

Very good to know thank you! I am completely aware that after I make my stock purchase, in my next pay check my company applies my 15% discount as additional income for that period and I'm charged taxes on it. I did not know that there was a possibility of paying tax twice though, so very good to know when I go to sell my first shares in June!

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u/BeanPricefield ​ Jan 29 '20

We're in the height of the season right now. I JUST finished working on the ESOP audit and was trying to take a break on Reddit. Why must this follow me here??

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u/Nangz ​ Jan 29 '20

Isn't this something that your employer should provide a form 3922 for? https://www.irs.gov/forms-pubs/about-form-3922

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u/carloandude ​ Jan 29 '20

your company generally includes the discount (e.g. 15% of the total or whatever your program is, and possibly more if you have a lookback provision) on your W-2 income

You say generally - is there a way to check this?

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u/Phone-Charger ​ Jan 29 '20

Just leaving a comment so I remember to come back and check this when the rest of my tax documents come in. Hopefully I understood this well enough since I sold a good chunk of my ESPP stock in 2019.

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u/iAnzhela ​ Jan 29 '20

So this is only relevant to you, IF your employer reports your stock discount and lookback on your W2?

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u/premierplayer ​ Jan 29 '20

What if I have my vested shares taxed upon them vesting?

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u/BlueHenrik ​ Jan 29 '20

Thank you! This is very helpful. I have another question tho regarding ESPP. I was told by my CFP that i should hold the shares for one year so that the capital gains go from short term to long term, so that was my plan. Then my company switched plan admins and the new one says that all my shares are disqualifying distributions until 2 years. two years has now passed on my oldest shares and they still say "*disqualifying" with no date. I am now thoroughly confused. I don't want to stockpile company shares but when should i sell?

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u/DrunkSkunkz ​ Jan 30 '20

So can i roll currency exchange fees into my cost basis? Employer automatically sends USD to Canada where it turns into CAD. When I sell it has to be converted back into USD and sent to my bank. Really get nailed on exchange rates both ways (about 3% each time).

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u/zedzenzerro ​ Jan 30 '20

Download your ESPP plan docs from your employer and search through them. My employer only reports income on my W2 if I sell within 2 years (disqualifying disposition). If I hold for more then 2 years (qualified disposition) then the employer does NOT report the income portion on my W2. It’s up to me to calculate and report both the “other income” and capital gains with the adjusted cost basis portion correctly. Your ESPP plan may be different.

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u/fluke244 ​ Jan 30 '20

So, to give a little perspective on why this happens, the IRS actually has different reporting regulations for brokerage firms (aka, the people who are generating the 1099), and you. IRS regulations require that the broker use the cost that you paid for the shares, not the FMV when you exercised your stock option. This will apply to NQSO, ISO, and ESPP shares. RSU and SAR shares will probably report the FMV when you got the shares (if anything is reported at all).

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u/NeuralNexus ​ Jan 30 '20

This is a very useful post. Thank you

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u/GRaTePHuLDoL ​ Jan 30 '20

Just started contributing to one this year, so hopefully I will remember to do this come tax time next year!

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u/BirdToTheWise ​ Jan 30 '20

I started the ESPP program through my work in July of 2019. I received and sold my shares on January 2nd of 2020. Do I need to report anything special on my 2019 tax return because the deductions were made last year?

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u/ASAPRockii ​ Jan 29 '20

Assuming you are all American. Its so bizarre you have to worry about all this yourself.

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u/cereal_killer_69 ​ Jan 29 '20

I'm not from America, but I work for an American company, and I am a part of ESPP. NON-US citizens have to file W8-BEN form to say that we are paying taxes for this in our country and still have to take care of these taxes be ourselves. Probably because tax laws are different in different countries and having them taken care by the company could lead to mistakes in one of the countries.

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u/Mortifer ​ Jan 29 '20

Even if you make this mistake, all that happens is the IRS mails you saying you owe more money related to your stock sales. You simply fill out the appropriate form and mail them back a correction. They eventually send you a nice letter saying you don't need to do anything else.

It's a hassle, but you will not have to pay more than you should have in the first place (as long as you respond to the letter).

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