Tax planning and compliance for investors
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By Kaye A. Thomas
Updated June 20, 2010
Pay no tax at this time.
Your purchase of shares through an employee stock purchase plan can provide a significant financial benefit. The shares may be offered at a discount, providing an immediate boost in your net worth. At some companies you can do better still, taking advantage of a "lookback" provision. With this type of plan, if the stock price goes up during the offering period, you get the benefit of the lower price that was in effect at the beginning of the offering period.
Example: At a company that maintains an ESPP with a 15% discount and a lookback provision, you might decide to contribute $850 during an offering period. At today's price, that will buy $1,000 worth of stock. But if the stock goes up 20% during the offering period, the lookback provision lets you buy at the original price, and now you'll be getting $1,200 worth of stock for the same $850 cost.
Not all companies offer discounts, and some offer discounts smaller than 15%. Furthermore, not all companies offer a lookback provision. Without the lookback provision, you would still end up with $1,000 worth of stock in the example above. You receive a valuable benefit in either case, but it's potentially richer with the lookback provision.
Even though the $850 is withheld from your paycheck, it is still treated as part of your income. In other words, it's the same as if you received the $850 in your paycheck and then decided to use it to buy stock. This isn't like a flex plan or 401k where your contributions can reduce your taxable income.
Here's the really good news: you don't report any income at the time you purchase these shares. Normally, if your company provides shares at a bargain price, you have to report the economic benefit as income, even before you sell the shares. In the example above, we saw that the purchase can increase your wealth because you buy the shares for an amount that's less than their current value. Yet you don't have to report income or pay tax at the time of purchase.
Better still, the alternative minimum tax (AMT) doesn't apply to this benefit. Your only obligation at this time is to keep a record of your purchase, because you'll have a tax obligation when you sell the shares, or even if you give them away.
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