Employee stock purchase program: Free money? Am I just bad at math?

My job allows me to participate in an employee stock purchase program (ESPP) which entitles me to purchase company stock for 85% of the market rate. Anecdotally, people claim you’d be crazy not to participate because it’s FREE MONEY!!!

But I got to thinking that there must be a catch. Well, catches:[ul][li]Like every investment, you’re betting that you’ll sell for more than you paid; if the stock price tanks, I’ll lose money[]There are taxes to consider; short-term capital gains and long-term capital gains are taxed differently[/ul][/li]“You don’t even have to hold the stock for two years!”*, they say, “you’ll make money even if you sell right away and are taxed the higher rate!” This is music to my ears; I get money right away and don’t have to watch the stock ticker for two years!

Suddenly, math…
Scenario #1: I buy $10k worth of stock for $8.5k. I immediately sell my $10k investment at market rates and pay something like 25% in taxes (short-term capital gains are taxed like ordinary income), walking away with $7.5k. Terrible! I’ve lost money!

Scenario #2: I hold my $10k investment for two years and pay the more favorable long-term capital gains rate of 15% and end up with $8.5k. Terrible! I incurred all that risk for nothing!

…Which leads me to wonder if the people who claim this is some kind of “Can’t lose” proposition just aren’t really paying attention? Sure, if the stock suddenly tripled in value I’d be rolling in it, but I’m trying to be pragmatic here: this is a large company with a plodding, upward trend that you can see on loooong timescales.

(These numbers all assume I’m in the 25% tax bracket)

No, you only pay capital gains on your gains, i.e. the $1500. At 25%, that’s $375, so you’re down to $9625.

Again, no, you’re down $225 in taxes or $9775.

I think you can see why people say it’s free money. Even if the stock drops to $8500, you’ve gained and lost nothing, i.e. no taxes on it.

The company itself has a liability for selling stock to employees at under the market price, but that’s not your problem.

I will note that if the company gives you stock directly, there can be an issue, because that counts as taxable income, and you need cash to pay that. My company works it so direct stock awards are half cash (value equal to half your stock award) and half stock so you can pay taxes without digging into your own liquid savings.

You have most of it right except one very important part that ruins your examples and it is why you aren’t understanding what they are saying. You don’t pay long or short term capital gains on the whole sale amount. You only pay capital gains on the gains. It is impossible to lose money when you only pay a tax on the gains.

The only real risk to you is that the stock will drop to less you paid for it before you sell.

Great Antibob, Shagnasty, I’m a fool! Ignorance fought! I guess it ought to be clear that capital gains refers to, well, gains…

Sigh. I’ll just keep waiting for the world to realize that I only appear to be a responsible adult. :wink:

Many years ago I was a low-level manager at a big company (at the time, it was one of the USA’s thirty largest industrial companies). At the time, that company would match an employee purchase of its stock (up to a limit of, as I dimly recall, $1000). You did have to hold your stock for a certain period of time (and I forget how long that was; maybe two years) before you’d be vested in the company match portion.

To my mind, it was a buy one, get one free sale on money, and every year I purchased company stock under that plan up to the matching limit. But try as much as I could, I simply could not convince any of my employes to do the same. It’s not because they were broke or anything; they just all felt that they’d rather spend their money on other stuff.

Go figure.

Are you sure you can sell immediately? I believe it’s common for stock purchase plans to require you to hold it for some period.

Is everyone else sure that you don’t have to pay tax on the discount you receive?

I mean, if my employer “sold” me a house for $100, the rest of the market value of the house would clearly be income, right? The difference between the market price and what you pay should be taxed as part of your compensation

According to this TurboTax page, you do have to pay taxes on the discount you received (as normal income) when you sell the stock.

So, essentially, this lets you get a small amount of leverage, which doesn’t seem worth it to me.

Doesn’t that imply I’d be taxed on the same money twice?

If I buy $10K in stock for $8.5k and then sell the stock for $10k, I end up paying capital gains tax on my profit of $1.5k. Are you suggesting that I’d also pay the regular tax rate on my profit in addition to capital gains?

It depends on the particular plan. Plans vary. YMMV, etc.

In our system, before our ESPP went away (long story, not worth telling), you could sell immediately and not pay tax on the discount. That was because the company itself paid on the discount. After all, you don’t pay full sales tax on discounted goods, even if that money has to show up on somebody else’s ledger. They paid on the taxes for the extra income (which was nice of them).

Just as a high-level observation, an employee stock plan is no more or less “free money” than the paycheck that you get every month (which most people are happy to accept even though it, too, carries tax liabilities! :D). In general, unless you believe that your company’s stock is going to tank, it’s foolish to refuse what is basically optional compensation – free money just like your paycheck! It’s especially persuasive if the company’s stock price is historically very stable.

The tax liabilities may depend on when you sell, as it may determine whether the proceeds are taxed as capital gains or as income, but that’s about all there is to it. All that that Turbotax link is saying about the employee discount is that of course it affects the imputed purchase price, so it increases your capital gains.

Beyond that I’d just say that the normal rules of investing apply – anyone in such dire financial straits that he can’t afford the risk of any kind of loss should probably not be in the stock market, even at a discount.

Agreed. This is very much in the vein of “diversifying.” I could afford to lose it all; I’m just trying to understand the parameters of what I stand to gain.

To go back to the first example to help illustrate.

$10000 worth of stock. Purchased at $8500. Sold immediately.

$1500 in discount income, which is added to your 1040, line 7. So, you pay 25% on this $1500. But you won’t have any capital gains (your cost basis is $10000, not $8500 for purposes of the capital gains tax) to tax.

And apparently this will be true (25% on the $1500) no matter what if the stock price stays the same, though you may have some complications on your Schedule D and 1040 to deal with. And it may show up on your W-2 or not depending on how you sell.

If the stock rises, you will definitely pay capital gains (whether short or long term) on the amount that goes beyond the cost basis (which again is $10000, not $8500).

So, no, don’t worry about getting taxed twice on the same amount. It shouldn’t happen if you figure your taxes right. That is a tricky part, though, if you do your own taxes.

Oh, OK. I think I’m seeing it now. So I buy $10k in stock at the discounted price of $8.5k, which I sell immediately- I can do that, I checked. Right off, I’m paying taxes on $1.5k at the normal taxable income rate of 25%. But if the stock is now worth $12k, I must also pay capital gains tax on that additional $2k to the tune of 25%.

Which is really just me paying 25% tax on the difference between the sale price and the purchase price so I end up paying:
($12k - $8.5k) * .25 = $875 in taxes for a profit of $2625

…a portion of which I can give to a tax preparer so I don’t end up in jail. :wink:

(Ignoring transaction fees and assuming the $1.5k discount and $2k profit are taxed at the same rate which they might not be, I’ll allow)

In the UK, the first £10,600 is tax free and it is 18% after that.

Assuming you sell as soon as possible and there are no shifts in price, this seems to be the case. It’s still free-ish money.

And like the others have said, there may be a vest period or a minimum waiting period, so those would be good to investigate.

You’ve been supremely helpful. Thank you!

The real issue with these plans is that if you hold on to stock, and the company tanks, you’re probably out your savings AND your job. See Enron, where for many employees, their savings were completely wiped out along with their job.

This statement by me was clearly wrong. Even if the discount is taxed as normal income, it’s still additional income that you wouldn’t have gotten, so it’s free money, just free money that gets taxed.

On the other side of the coin… a few years ago a company in my town who encouraged (or maybe even made it part of the pay package) share ownership were sold and many workers got five and six figure sums for their shares and kept their jobs.

I think it’s a good idea for firms to encourage the workforce to invest in their companies shares. Bigger dividends and higher share prices motivates people more than a standard salary.

The John Lewis Partnership in the UK is a very successful business owned by its workers.

Enron was run by crooks.

It doesn’t take a crook for a company’s stock to fall a lot. I worked for a company with an ESPP. I got into the habit of immediately selling my ESPP shares when they were awarded.

Others at my company let them accumulate. For a while, our share price was up at $110. Over several years, that price declined, and declined, and declined, until it was in the teens. Those people who had accumulated lost lots of money, even with the 15% discount.

Note also that the company was mostly profitable during this decline, even though the company was shrinking.

You never really know what the stock price is going to do. Keeping a lot of company stock while you are still working for the company is not that wise, which is why I sold the shares that* I had to buy with my money*.

During this time I also got stock options. These were just awarded to me and didn’t cost me anything. (Options like this are rarely given anymore due to changing tax and accounting rules.) THESE options I did accumulate because I wasn’t going to lose any money if I did. When the stock price first hit $110 a share … heeeelllloooo new condo! :slight_smile:

Anyway, getting back to the OP. Any time your company wants to give you free money, even if you are taxed on it, take it! :slight_smile:


Not a bad idea. You probably won’t make a ton of money, but you can almost guarantee not losing money.

I’ve seen it work both ways before our ESPP went away. Some people bought at the bottom of a recession and made hundreds of thousands of dollars when the market recovered. Others bought near the top of a bull market and haven’t made their money back yet.

Most just bought and sold as soon as possible and made a small but steady profit.

Such sagacity! :wink: