There was a request from my well-respected person to have a post for tax implication for ESPP. Therefore, this blog post is dedicated to that person. The post will not go to the definition of the ESPP and how does ESPP work and it only focuses on the calculation of the tax report and adjustment on the schedule D of the 1040 tax return. The post Company’s Benefits – How to maximize the benefits- Finance 101 also discuss about other company’s benefits and why we should maximize these benefits.
For ESPP, if the company buys the stock on the employees’ behalf, nothing will happen as the taxpayer doesn’t owe any taxes. However, if the taxpayer sells any ESPP stocks in any year, a W2 will be issued for that year which reflects the stock sale.
Depending of how long stock was hold, the box 14 of W2 may show ESPP-DD (qualifying disposition) or/and ESPP-QD (disqualifying disposition). Please note that box 14 is for information only as these numbers are already included in box 1 of the W2
What are ESPP-DD and ESPP-QD?
Disqualifying disposition (ESPP-DD):
If the stock is sold within two years after the offering date or less than one year from the purchase date, the bargain will be on W2 as a compensation which will be taxed at ordinary income tax rate. The bargain is the difference between the purchase price and market price on the purchase date. Any additional gain is considered capital gain. However, whether it’s long-term or short-term capital gain depends on the length of the stock was hold.
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Example 1:
| Disqualifying disposition resulting in short-term capital gain | Date | Fair Market Value (FMV) | Discount (15%) | Actual cost |
|---|---|---|---|---|
| Offering Date | 1/2/2016 | $38.86 | $33.03 | |
| Purchase Date | 06/29/2016 | $43.03 | $33.03 | |
| Transaction Date (Sale Date) | 9/7/2016 | $50 | ||
| Number of Shares | 225 |
The above example is a disqualifying disposition because the stock owner sold the stock in less than two year after the offering date and less than one year from the purchase date.
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Example 2:
| Disqualifying disposition resulting in long-term capital gain | Date | Fair Market Value (FMV) | Discount (15%) | Actual cost |
|---|---|---|---|---|
| Offering Date | 1/2/2016 | $38.86 | $33.03 | |
| Purchase Date | 6/29/2016 | $43.03 | $33.03 | |
| Transaction Date (Sale Date) | 7/1/2017 | $50 | ||
| Number of Shares | 225 |
This example is pretty much the same with the example, except the sale date is in 07/2017 rather than 09/2016
This is a disqualifying disposition because the stock owner sold the stock less than two years after the offering date. However, it would result in long-term capital gain as the stock was hold more than 1 year since the purchase date
Box 14 of the W2 will be the same as the example 1- $2,250
The amount reports on the schedule D is the same – $1,558.25. The only difference is that this amount is long-term capital gain (lower tax rate – good) rather than short-term capital again (same as ordinary tax rate) in the example 1
Qualifying disposition (ESPP-QD)
If the stock is sold at least two years after the offering date and at least one year after the purchase date, the bargain is also taxed at ordinary income tax rate. The bargain is the difference between the purchase price and market price on the purchase date. Any additional gain will be considered long-term capital gain which is taxed at lower rate than ordinary income tax rate.
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Example 3:
| Qualifying disposition with stock price increased between offering date and purchase date | Date | Fair Market Value (FMV) | Discount (15%) | Actual cost |
|---|---|---|---|---|
| Offering Date | 1/2/2016 | $38.86 | $33.03 | |
| Purchase Date | 06/29/2016 | $43.03 | $33.03 | |
| Transaction Date (Sale Date) | 9/7/2018 | $50 | ||
| Number of Shares | 225 |
This example is a qualifying disposition because the stock owner sold the stock more than 2 years after the offering date and more than one year from the purchase date.
The calculation for qualifying disposition a bit different than disqualified disposition
Box 14 of W2 is ESPPQD $1,311.75 . Here is how it is calculated
The lesser amount of
- Number of shares sold x market price on the sold date – commission paid to broker – Number of shares sold x purchase price
Bottom Line
Below is the summary of tax treatment for ESPP.
- No tax reports until the year of the sale
- Qualifying dispositions
- the discounted amount: Ordinary income tax rate
- the remainder : Long-term capital gain (lower tax rate)
- Disqualifying dispositions
- most of the sale proceeds as ordinary income
All three above examples are pretty much the same., just manipulating the sale date would result in reducing the tax as it would result long-term capital gain (lower tax rate: 0%, 15% and 20% depending on the income)
To make it simple: Assumption that the taxpayer is in 24% tax bracket for ordinary income and 15% for long-term capital gain
Example 1 would result in ($2,250 + $1,558.25) x 24% = $913.98 of tax
Example 2 would result in $2,250 x 24% + $1,558.25 x 15% = $796.24 of tax
Example 3 would result in $1,311.75 x 24% + $2,496.5 x 15% = $689.30 of tax
For tax planning purpose, if the ESPP stock meet Qualifying disposition (stock hold at least two years after the offering date and at least one year after the purchase date) would result the lowest tax.
Khanh Le, preferred name as Jessica Le, is a licensed Certified Public Accountant (CPA). Jessica also earned a Master of Business Administration (MBA) from San Jose State University.
