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Employee Stock Purchase Plan Dilemma

This article was written by in Investing. 28 comments.


For the last few years, I have been participating in my company’s stock purchase plan at the maximum level. Every paycheck, ten percent of my gross salary is withheld. At the end of each quarter the funds are used to buy my company’s stock at a 15 percent discount from the lower price of either the first day or last day of the quarter. As my company’s stock declined mostly due to the economy at large and the industry in which I work, this was a losing proposition. I decided not to sell the company stock until prices returned, rather than selling at the first available opportunity as I had been earlier.

So now I have company stock that I have been holding since December 31, 2007. About half of the shared purchased then and since then are in a losing position while half are now in a winning position. My only opportunity to sell this quarter is closing soon, so I should decide what to do. Here are some of my options:

  • Sell all of it. It’s risky to hold so much in one stock, and I already have company stock in my 401(k). I can write off the losses against the gains to reduce tax liability.
  • Sell the shares in a losing position. I can write off the losses against any realized gains if I sell stocks later this year.
  • Sell nothing until they are held for two years. The stock will probably go up, and after two years, they will be long-term capital gains, taxed at a lower rate.
  • Sell the shares in a winning position. This would help my cash flow, but I’ll owe income tax.

What would you do?

Updated September 17, 2011 and originally published August 27, 2009. 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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About the author

Luke Landes, also known as Flexo, 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 him and follow Luke Landes on Twitter. View all articles by .

{ 28 comments… read them below or add one }

avatar Matthew

Sell nothing for two years.

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avatar mapgirl

I sold shares in a winning position because I decided the tax hit on short term capital gains was small enough not to matter. (Less than $50) The cash flow for me was a good thing for financing renovations to my condo with cash vs on credit. So what’s your alternative with this money and will it cost you more if you don’t cash it out?

The opportunity to use this money is lost when tied up in securities. Can you get a better return on it elsewhere or is it ok where it is? (Personally my ESPP is paying better dividends than ING so I don’t mind saving money in my ESPP.)

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avatar Mr. ToughMoneyLove

You can’t expect an informed answer to this question without identifying the company. For some companies, I might advise you to sell and stop buying entirely.

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avatar Frank

At the end of every purchase period you had the opportunity to sell and make a profit, even though the stock had declined. Why you did not do this is beyond me….that is, unless you have such a large portfolio that holding individual shares of a certain company makes sense. Why not sell each quarter and invest in an index fund (preferably in a 401K or Roth IRA)?

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avatar Luke Landes ♦127,495 (Platinum)

I cannot sell right after purchasing because my job function prevents me from doing so. I’d be happy locking in an instant 17.6% gain or more. However, I am a Designated Person and can only trade company stock a few times each year. The trading window is closing soon, which prompted this post.

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avatar Frank

Sorry for the invalid assumptions.

In that case, how do buying these shares fit into your financial plan? If you don’t want to keep them, should you really be buying them in the first place? It sounds like you’re already overweighted to your company’s shares based on your 401K investments…

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avatar Ken

Long term capital gains is 1 year or longer.

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avatar Luke Landes ♦127,495 (Platinum)

Well there’s no way I’m going to identify the company. It’s financial in nature, did not receive any bailout money from the government, and is competitive in its fields. General commentary is fine, everyone has an opinion they can share.

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avatar Lynn

I agree that it would help to know the company but the sector is fine too. If it was me I would probably sell it if you needed it now but keep it if you can wait a couple of years. I have this sneaking suspicion that the market is going to decline again soon. We have a lot of stock in the company my husband works for in the healthcare sector and I am in the same boat. Sell or Keep? I want to sell, my husband wants to keep it.

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avatar Steve

If I was in this situation:

First, if my total company stock, both ESPP and 401(k), was more than a fraction of my assets (maybe 5%), I would sell some to bring it down to that level. Or depending on how often the ESPP purchases are and how frequent the trading windows happen, I might sell a little more such that my exposure would never go much above the target e.g. 5%.

As to which shares I would sell I would either sell complete lots to make future tax tracking easier; and/or I would sell any that were held long enough to be long-term gains; and/or I would sell enough winners and losers to balance each other out plus $3,000 more losses.

Other than that, I would hold on to them for the 2 year period and then sell them as soon as possible after that. I would also sell any shares in my 401(k) if and as soon as possible, since there’s no tax implications of doing so. (Other than losing the special tax treatment of employer stock in a 401(k), but to me said special treatment is not worth the risk.)

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avatar RJ Weiss

I would hold the stock until it qualifies for long term capital gain. If you don’t need the money now, there is no reason to pay higher taxes on it.

Plus, since you have income coming in from different sources, you’re not putting all your eggs into one basket like many other people investing in employee stock are doing.

If you want to get rid of the stock, set up a plan to get rid of it after it reaches it long-term capital gain. Almost like reverse DCA. Just make sure to keep it simple for tax purposes.

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avatar Jim

For this kind of question I look at 1) do you need the money? and 2) do you really think it will go up /down?

First: Do you need the money now? Do you have debts to pay or big purchase item you will need money soon for? Do you have a full cash reserve in case of emergency? If you need or could really use the cash for something then go ahead and sell the stock instead of gambling it will go up further.

Second: If you don’t need the money right away then I’d base my decision on my expectations of what the company’s stock is likely to do. If the company is very strong financially and its stock is much lower than it would be normally then I’d probably conclude theres a decent chance it will recover further and I’d hang on to it. But if the company in question is on shaky ground and its stock has not gone up much and they are losing money then I wouldn’t see much reason to assume the price will go up much and I’d sell it.

I’m in the same situation with my company ESPP. I’m holding on to the stock since I don’t need the money at the moment and I have a strong reason to belive the stock will go up further in the next year or two.

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avatar Jeep

I worked for Lehman Brothers for 10 years, until 22 September 2008 (when it filed for bankruptcy). I put 10% of my salary into the stock purchase plan for about 5 years (until the plan ceased), plus 20% of any bonuses were paid in stock (3 – 5 year vesting); both provided stock at a discount. Never sold a share — great company, loved working there, stock went up and up, thought I had a great nest egg. Round about the time I lost my job, I sold those shares for about the price of a good meal for two in a decent restaurant. So, unsurprisingly, I’d sell what’s in the money and then, if you can afford it, hold onto the rest for two years. Then sell those. Oh, and stop contributing into the stock plan and start putting it into a decent mutual fund right now.

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avatar Ken

Again its after 1 year it is long term capital gains.

NOT 2!

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avatar Steve

That’s only for normal investment purchases. There are special rules for ESPPs that require a 2-year holding period to qualify them as capital gains. If you sell before that part of the increase is capital gains and part is ordinary income. I think the 2-year period starts at the beginning of the ESPP period. (I.e. if your plan is every 6 months, then you’d have to hold the shares for 18 months after purchase.)

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avatar Luke Landes ♦127,495 (Platinum)

ESPP shares must be held for at least two years from the grant and one year from the purchase in order to qualify as long term capital gains.

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avatar Ken

Flexo,

I would read up on ESPP plans.

Basically you do not want to sell any stock within the 2 years if you are taking a loss on it, selling it for less than the FMV on the offer date (not what you purchased it for). Or if your plan has a look back and the stock significantly increased in price over the offer period.

In the rest of the situations where you have a gain, its unlikely to make a difference in the taxes you pay. Any stock held longer than 1 year is still a long term capital gain.

Even after the 2 years you will also still have to report the discount as income on your 1040.

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avatar Ken
avatar DD

I agree with Jim(#12). If you need the money sell, if not, wait.
But I have an uncle who went through a situation like Jeep(#13), so I see that side of it as well.

If this is a concern perhaps you should stop participating in the plan at the maximum level.

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avatar traineeinvestor

I’ll defer to others on the US tax rules. Unless you think your tax rate will go up in the future, it would normally be better to sell the losing positions first (if you are going to sell at all).

Generally not a good idea to have too mch money in one stock (especially if it is the company you work for – if it gets into difficulties you could end up losing your job and your investment at the same time). I’d suggest setting a maximum exposure (somehwere between 5% and 10% of net worth and selling anything in excess of that when each window comes up. If there is a tax driven reason for deferring the sale, by all means delay if you are comfortable with the investment. but recognise that you are increasing your risk by doing so.

If it was me, I’d set my ceiling at 10% of net worth and sell anything above that at each availble window (starting with the losing positions) and keep buying to take advantage of the discount. Tax considerations would be secondary to risk management.

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avatar Ken

In this case you actually do not want to sell the shares at a loss in a disqualified disposition. As any discount is considered ordinary income that you pay taxes on, but you can take a capital loss on difference of the sale price and the FMV when the stock was bought.

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avatar ctreit

Two objective facts come to mind while reading this post. (1) Asset allocation contributes the most to your long term financial success. Some studies have shown that the contribution is as much as 90%. (The rest is stock selection and market timing.) (2) Making decisions based purely on tax issues are not a winning strategy. In light of (1) and (2) it makes logical sense to take the holdings in your company stock to a lower percentage of your total assets. – It also sounds like you are not going to stop participating in this stock purchase program which means that your holdings in your company stock will go back up over time again. If the stock will really increase in the next two years, you will be able to bank some profits in the future.

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avatar Stan

I worked for a major airline and bought into the ESOP for many years. I had a large sum of my retirement money tied up in it. My ESOP value sank like a stone after doing well for years. I was waiting for it to rebound so I could cash out and move it elsewhere. It got lower and lower then rumors of bankruptcy came around and that killed it. Before the employees could sell their stock the company had a judge freeze our “common stock” while the Top officers in the company bailed on all their “preferred stock” before filing for bankruptcy. The company’s hand picked bankruptcy judge eliminated our stock holdings and allowed the company to create and sell new stock.

Everyone who held the old stock lost it all, and was never given any consideration for our losses.

I am not even allowed to show it as a loss on my taxes? I lost a LOT of money, but I know some who lost much more than I. What can I say? be careful?

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avatar Tom

People have strong opinions about Jim Cramer, but I like his mantra of “Don’t Fear the Taxman” and “No one ever lost money taking a profit.”

That ESPP sounds nice! The company I worked for had a similar one (get it at a discount no matter what), but was then bought by a larger company whose plan includes them offering the stock at a certain price, then after 3 years of holding, they match one share for every 3 you own. Currently I’m way in the green on this deal because by happenstance the company picked pretty close to a 52 week low to offer the stock. I digress though. Good luck

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avatar Jim

Ken has hit a good point. Due to tax implications you might not want to sell the stock that has taken a loss until 2010. If you sell stock that is at a loss before the 2 year point you might be causing a tax problem. Whether or not that will be a real issue for you depends on the exact situation with the stock and how much its gone down.

Fairmark has an example:
http://www.fairmark.com/execcomp/espp/dispositions.htm

Example: You decide to contribute $10,000 during an offering period and that turns out to be a good choice: the stock price rises dramatically, and because of a lookback provision you’re able to buy $25,000 worth of stock, giving you a $15,000 benefit. You hold onto the stock and the price falls just as dramatically, leaving you with shares worth just $8,000.

In this situation, a disqualifying sale will require you to report $15,000 of compensation income. You’ll also have a $17,000 capital loss on the sale, but because of the capital loss limitation you can deduct only $3,000. Overall, you have an out-of-pocket loss of $2,000 but you had to pay tax on $12,000 of phantom income ($15,000 of compensation income minus $3,000 of capital loss). By contrast, if you hold the shares long enough to avoid a disqualifying disposition, you would report no compensation income in this situation, just a capital loss of $2,000.

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avatar Lucky One

I would choose to sell nothing until they are held for two years.

Ten percent of my income going to our ESPP program. That’s the max, but I wish I could make it 50% or even higher! Luckily, my company’s stock has skyrocketed, even in this down economy. It’s up on the order of 1000%’s of percentage points since I joined the company and I still have plenty of shares priced in the single digits, to someday sell. The trip vacation I am currently on and the Ferrari in my garage are all a result of me simply signing up for ESPP, as early as possible. It was one of the best decisions I ever made in my life.

Good luck with your decision. Don’t worry, things will improve!

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avatar Luke Landes ♦127,495 (Platinum)

Thanks for all the thoughts. It seems the consensus is to hold on for two years. Unfortunately I haven’t had as much luck as Lucky One.

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avatar Freed Income

I’d sell short term call options on it while you wait for it to return. Call options provide me with a regular residual income on my company shares. Just make sure that the strike price is high enough that should your stock hit it and trigger a sale that you will be happy with the return.

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