Potential Double Taxation and the Employee Stock Purchase Plan (ESPP)

Many large companies offer their employees the opportunity to purchase company stock at a discount. These discounts can range from a few percent to up to 15%. This presents a good opportunity for employees to make a long-term investment in their employer, at a discount. But, some employees choose to sell the ESPP stock immediately after purchase and use the discount as additional income. Correctly determining the stock’s basis (cost) is a little tricky. And this is where many people can end up paying tax twice on the discounted amount.

When the stock is first purchased for you at a discount, no taxes are owed. However, after you sell the stock, taxes are owed. How the stock sale is taxed depends on hold long you held the stock. If you sell the stock within 1 year or less after purchase, the sale is considered a disqualifying disposition. In this case your employer will add the discount that you received (also known as the bargain element) to your compensation for the year. If you look closely at your pay check stub after the sale, you should see that your gross income increased by the bargain element. And, your W-2 should also show the additional income as an increase in the Box 1 amount.

This stock sale must be reported on your individual tax return, Form 8949 and Schedule D. Reporting the correct stock basis (cost) is the tricky part. Here is an example of what should be done.

Suppose that your employer’s stock is selling for $100 per share. Your employer purchases 10 shares for you ($1000) and sells it to you for $850 (15% discount). Then you immediately sell the stock for $1000. Even though you bought the stock for $850, this is not your basis. In fact the 1099-B that you receive from your broker may even (incorrectly) report your basis as $850, or not report the basis at all. Your correct basis is $1000, not $850. Why? Remember, your employer has added the bargain element to your compensation and it appears on your W-2, added to your Box 1 income. So, you are taxed on the bargain element through your W-2 and if you report your basis as $850, you will be taxed again on the same bargain element.

In this example, the correct way of reporting the stock transaction is to show the sales price as $1000 and the cost as $1000. In actuality, there is almost always a brokerage fee for the transaction. So, these types of transactions typically result in a small short-term capital loss.

If you prepare you own tax return and have sold stocks from your ESSP, you may want to double check your reported transactions. And, if you pay a professional preparer to do your return for you, there could still be a mistake if your preparer was unaware that the stock sales came from an ESPP. If you discover a mistake in a prior year tax return, you may still be able to correct it and claim a refund. But there is generally a 3 year statute of limitations for claiming refunds, so don’t wait too long.

Reporting the sale of stocks purchased through an ESPP can get more complicated if you sell the stock in what is known as a qualifying disposition, or you sell the stock after you leave the employer from whom you purchased the stocks.

If you need help preparing your tax return, please contact us at 512-293-4170 or through email at service@brycast.com.  We are tax professionals licensed through the IRS.  

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Disclaimer: The information provided in this article is only for educational purposes. It may not reflect all rules, regulations, or laws for the tax year discussed and it may not pertain to your situation. It is not intended as investment or tax advice. Please consult a professional tax preparer or financial advisor to assist you.