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Beginning Employee Stock Purchase Plan

This article was written by in Investing. 13 comments.


Although it was first announced in 2005 to begin in 2006, my company’s employee stock purchase plan was not finalized until a few months ago, and scheduled begin this month. On Friday, I’ll receive my first paycheck with 10% of my salary automatically deducted and transferred to a holding account at E*Trade. There it will collect minimal interest until the end of the quarter, at which point there will be an automatic purchase of company shares at a 15% discount of the stock’s price from either the beginning or the end of the quarter.

I’m already deducting a large amount from my paycheck, including a 16% 401(k) investment and savings. In order to cover the shortfall in cash flow, I’ll transfer the 10% of my salary from the side income. Once I purchase and immediately sell the shares at the end of the quarter, I can pay back my savings account with the proceeds.

Updated September 2, 2011 and originally published January 4, 2007. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 13 comments… read them below or add one }

avatar SAM

It’s a great decision to join this. I am planing to do this as a way to fund my Roths. I’ll post my intentions with this soon, I also agree with the idea of selling right away. I do the same.

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avatar Dave

I’m participating in the stock plan at my company as well, and considered selling my shares to realize my profit immediately. I was told however, although there is no vesting period, it would count as income and thus I would pay more taxes on it then if I waited a year and simply paid capital gains. I’m not sure if this is true, and I’m curious if you investigated when you planned your immediate selloff?

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avatar Luke Landes ♦127,505 (Platinum)

Dave: I did consider waiting a year for the tax benefit. The toss-up is between the difference in tax and the added risk of having company stock in the ESPP in addition to in my 401(k), and the fact my day job income also depends on my company. That’s a lot of exposure, so I’d rather just dump the stock as soon as possible.

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avatar Dus10

I have the a preliminary interview today for a position. If I am correct about the company (this is through a headhunter, and I will be able to verify after the interview), it will be a large publicly traded company that offers a ESPP with a 15% discount, like yours. I will also be getting about a $10K raise. I am pretty sure I will get the job, as the headhunter had been trying to reach me for about a month about this job, and I did not solicit his assistance. Unfortunately, I rarely ever check my home voicemail, though my wife does; she forgot to tell me about it. One day, I decided I was going to update my resume and fire it off to a few headhunters. When I came home, I looked at the phone, and then it rang a couple of seconds later, and it was this headhunter.

I am not familiar with the workings of ESPP other than the general idea that they give you a discount off of the price from the beginning or the end of the quarter, and how they are taxed. I was unaware that it could be done through outside brokerages, though. Obviously, you probably have to use the brokerage firm that they work with, though.

Could you share a little more about how it works? I definitely plan on participating, and I am definitely looking into a buy and sell immediately mindset. While the company is decent, the stock is pretty stagnant, and I don’t need a bunch of their stock sitting around. Though, I may build up a few shares here and there just because I like to have stocks of local companies, and they are headquartered here in Indy.

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avatar Sun

Is there any way that you can change the paycheck deduction time? It seems that the deduction happens at the beginning of the quarter, but the investment occurs at the end of the period. That’s a lot time for the money to “collect minimal interest.”

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avatar Luke Landes ♦127,505 (Platinum)

Dus10: I’ll follow up with a detailed post, probably at the end of the quarter.

Sun: 10% of each paycheck is deducted each pay period. So my take home cash is smaller, and every two weeks, more is added into the holding money market fund.

When I signed up with E*Trade, I tried to select a higher paying MMF, but the website kept botting me out, so I’ll probably make the change at some point to earn around 4.5% tax-free while the funds are waiting to be used for the stock purchase.

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avatar Toby

A stock purchase plan is usually an awesome deal. If you are getting the stock at a 15% discount, and they discount the price at the end of the purchase period, you are making a 60% annualized return! You read that right!

Consider a 15% discount.

The average time your money is tied up in the account before stock purchase is 3 months. Your first paycheck deduction is there for 6 months, but the last one is there for perhaps a day or two. 3 goes into 12 months 4 times.

15% x 4 = 60% annualized returns!!!

On taxes:

I’m simplifying a little bit here, but if you sell your stock right away your gains are considered income and not short-term capital gains so they increase your earned income on your W-2. Also, keep in mind that the rules for short/long term gains on stock purchase plans are different then regular stock purchases. You may have to hold the shares for more than two years before your 15% discount is treated as a long term capital gain.

When deciding whether to hold the stock for an extended period of time to avoid paying income or short-term gains taxes on the gain, read up on the taxation rules. E*Trade actually has a wonderful tutorial on how ESPP taxes work on their ESPP site (may be available on their standard site as well, I’m not sure).

In addition, consider whether you own company stock in your 401k already or have vesting stock options. Company performance should also be considered. Is the company doing well or are they floundering. Is the stock rising steadily or does it jump around. It may make sense to liquidate the ESPP shares (and take the tax hit) to keep from having all your eggs in one basket **cough** Enron **cough**.

Good luck!
Toby

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avatar Craig

Flexo, is there no mandatory holding period on your plan? I believe my plan requires a 3-month hold on sales after purchase.

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avatar Luke Landes ♦127,505 (Platinum)

There is no mandatory holding period, but I am a “designated person” within the company and I’ll need to wait for an open trading window.

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avatar M.

My ESPP does not have a holding period that I’m aware of, but to achieve a “qualifying disposition” for taxes (the majority having the long-term capital gains rate applicable instead of regular income or short-term gains), the stock has to be held at least one year from the date of purchase and at least two years from the “grant date” — the date that the company approved the ESPP.

I didn’t pay as much attention to personal finance back when I started at my company, so I have quite a bit of company stock accumulated. About a year ago, I started unloading it, and will continue to do so as the qualifying dates pass so that I can get the favorable rates and decrease the amount of my portfolio in company stock.

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avatar Dus10

Toby and all,

We must consider that purchasing at a 15% discount is not a 15% gain, but a 17.59% gain, because 15 is 17.59% of 85 (since the purchase would be at 85% of the cost).

Also, you can calculate that as 17.59% x 4 for a 70.36% return, but remember that it is a 70.36% on only 25% of your deferment, if it is purchased quarterly. In any event, though, it is only 17.59% of your total annual deferment. And then again, you hopefully purchase it at a lower amount than it is currently trading, plus the 15% discount.

For an easy equation, consider that your purchase is based on a quarterly entrance/exit low of $100 per share. So, you purchase one share for 85$. However, let’s assume that it is trading at $103, when your purchase is exercised. That is an $18 gain, or 18/85, or a 21.18% immediate gain!

This makes it even better!

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avatar Charles Thor

As you already mentioned you have considered the tax implications.

However, for your readers here is a good link from turbotax about the tax implications of ESPPs.

http://turbotax.intuit.com/tax_help/employee_stock_purchase_plans_turbotax/article

-Thor

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avatar RT

The thing to look out for is whether it is a qualifying of disqualifying disposition when you sell. If you hold on to the stock for two years, it is then considered long term gain and not compensatory income thus taxed at long term capital gain (15%) instead of INCOME TAX rate as compensatory income. So if you have confidence that the stock price will increase or hold you are better off holding on to the stock for the prescribed period of time.

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