Correction. Holding ESPP’s is worse than I thought

This doesn’t happen very often.

I was corrected — on Twitter of all places. Turns out, my advice to you about selling ESPPs was spot on but my reasoning was wrong. I am here humbled in front of you and I stand corrected. Thank you Tom Larson for setting me straight.

Tax treatment for ESPPs is more complicated than I initially thought. My whole argument was centered around the idea that keeping the ESPP shares to pay long term capital gains tax was misguided because the savings are minuscule. The math is certainly impeccable. The tax treatment on the other hand is wrong.

Turns out, any discount given to you by your employer, is always taxed as regular income — regardless of how long you kept it for. That’s a bummer for Aaron.

It gets even nastier. My buddy Bob pointed another provision in the tax code. But first, a few definitions:

1. Offering period: the period of time the participant is locked in to a particular stock purchase plan; typically this is 12 months.
2. Purchase period: the frequency in which you purchase stock within your offering period; typically this is 6 months (meaning there’s two purchase periods in a typical offering period).

Great, now that we’re up to speed, let’s pretend your company stock doubled between the beginning of the offering period and the purchase date 6 months later. Here’s the kicker: to get a long term capital gains rate on the gain beyond the company discount, you must meet two criteria.

1. Hold the shares for 12 months from the purchase date AND
2. Hold the shares for 24 months from the beginning of the offering period.

That means, half the time you must hold your company stock for a full 18 months before you get to enjoy the lower tax rate.

To summarize for the skimmers: any discount given to you by the employer is always taxed as regular income. Any gain beyond that may be taxed as long term capital gains but the shares must be held for 24 months after offering period starts.

If the stock price went down between the offering date and the purchase date, the decisions becomes a complete no-brainer. Sell immediately. There is no advantages to be gained.

If the stock is up and you’re thinking of holding on to save a couple of bucks, consider these:

1. Would you buy the stock today at the current price?
2. Are you willing to hold on for up to 18 months to save around 10% of your gains?

If it’s a resounding yes to both questions, go ahead and wait. If any of them is a no, sell immediately; then go ahead and open up a betterment account.

Written by Leon Tager who lives and works in Seattle writing about a better life. You should follow him on Twitter