At the beginning of the year, I started participating in my company’s newly-offered employee stock purchase plan, which gives us the opportunity to automatically deduct up to 10% of our paychecks and defer that money for use at the end of the quarter. At that time, we are able to purchase stock at a 15% discount off the lower of either the price at the beginning or the price at the end of the quarter.
The quarter ended over a month ago, but I was restricted from selling stock until a few days ago. The transaction settled today, and I got a decent price on the stock, but definitely not the highest of the day I executed the trade.
Nevertheless, with the discount, I was able to buy the shares at around $70 and the selling price was over $100. Even though E-Trade charges a $19.95 commission for selling these shares, and the SEC felt the need to charge me an additional $0.03, I feel it is a worthwhile short term investment.
As far as the tax implications go, E-Trade has a detailed ESPP tax guide [pdf] that explains things more succinctly than I’ve seen anywhere else. Since I haven’t been enrolled in the ESPP program for two years before selling and I haven’t held onto the stock for a year, I’ll have to pay a portion of my gain as ordinary income (the difference in the discounted stock price and the market price at the time of purchase) and short-term capital gains (the difference between the market price at the time of purchase and the price I paid to sell).
Thankfully, the guide I linked to has a step by step procedure for using the information reported on W2s and 1099s to report the taxes correctly to the IRS.
I have a few reasons for not holding ESPP shares longer to take advantage of long-term capital gains rates. First of all, I’m already invested in my company’s stock through my 401(k), and while I believe the 20-year prospects for my company are very good, I don’t want to overload on one specific company. My salary is also tied into my company’s performance, so I’d like to limit all-around risk.
I also don’t believe the 15% tax rate for long-term gains will be around forever, but that’s just a hunch.
Updated June 8, 2008 and originally published May 10, 2007. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.
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{ 6 comments… read them below or add one }
My company offers a lousy 5% discount on our stock. As the stock is quite volatile, this basically makes it a worthless benefit. But 15% isn’t bad.
I used be in a plan with the same parameters. Unforutnately it was in 1999 when I bought and I had to wait until 2003 before I could sell at break even. I think you were smart to take the profits that were there.
I think ESPPs are great. You got a 15% return (before taxes and fees) for doing nothing really. If we had one, I’d participate for sure. My wife’s old company had one and I loved it. We always did what you did – sold the day we could.
@KMC: It's actually a 17.6% return before taxes and fees instantly.
Example: You receive $100 of stock for $85.00. If you were able to sell immediately you'd make $15.00 which is a 17.65% realized return.
This might seem pedantic, but investors hem and haw over every percent.
@ Coder
While your numbers are correct they aren’t “real”. ETrade’s commission to sell shares is $25. So technically, you’d be losing money in your example. Sorry to hem and haw, but a 17.6% return is much different than a $10 loss.
Yes, but the $25 is the fee regardless of the number of shares… so if this hypothetical investor received 200 shares of this $100-priced stock, the $25 fee to sell wouldn’t result in a loss. Coder didn’t say how many shares, just that the price of a share was $100. That’s the way I interpreted the comment, anyway, and granted, it wasn’t clear.