Hold ESPP Shares for Qualifying Disposition
If you have a qualified ESPP program that offers a lookback provision and the shares increased during the offering period, holding for a qualifying disposition can provide preferential tax treatment
Strategy Overview
If you you have a qualified ESPP plan, holding the shares purchased through the plan until you achieve a qualifying disposition may offer tax benefits; most notably if your plan has a lookback provision and the shares increased in value during the offering period (perhaps substantially).
Tax Details
ESPP taxation is somewhat complex, with the tax treatment of shares purchased through an ESPP program depending on multiple factors. As noted in (Typically) Sell ESPP Shares Upon Purchase, in most circumstances it is recommended that you divest of the shares immediately upon their purchase to capture the nearly "free money" via the discounted purchase price (assuming the plan has a discount).
But in select circumstances, mainly (1) a qualified ESPP, (2) that has a lookback provision, (3) and the shares increased during the offering period, tax benefits can be achieved by holding the shares purchased through the ESPP until a qualifying disposition. Primarily, the discounted purchase price received via the lookback provision would be taxed as a long-term capital gain (instead of income). Secondarily, the income tax owed for the discounted purchase price would be deferred (until the stock is sold).
Key Benefits
Long-term capital gains taxation on the lookback benefit (versus income tax). Qualifying dispositions have different and more beneficial taxation than disqualified dispositions do.
Deferred income tax bill. Qualifying disposition rules specify that the income tax due from the discounted purchase price (e.g. 15%) of a qualified ESPP plan is triggered when the shares are sold. Holding the shares defers the recognition of this income (and thus taxation) to a future year.
Key Considerations/Flags
Concentration risk. Holding the shares increases your (likely already large) investment concentration risk to your company stock.
Strategy: When to Consider This and When to Avoid It
🟢When to Consider This Strategy:
If your ESPP is a qualified plan, and has a lookback, and the stock price increased (perhaps substantially) during the offering period. You should weigh the tax benefits of holding the shares to achieve a qualifying disposition against the incremental concentration risk you will take on.
If your ESPP is a non-qualified plan. There is no tax benefit to holding shares of a company after purchase if the plan is non-qualified.
If your ESPP is a qualified plan, but (1) does not have a lookback, or (2) the stock was down or flat during the offering period. The lookback (if applicable) did not provide any benefit during this offering period. As such, there are minimal tax benefits to be achieved by holding (just deferred recognition of the income) versus selling immediately.
Example
For examples see ESPP Taxation/Qualified ESPP Plan Taxation Examples
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