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Let me start off giving some of the details of the ESPP my employer offers:

  • Stock Price Discount: 15%
  • Employee Salary Contribution: 3-10% (in whole value increments)
  • Holding Period: 12 months (cannot sell before)
  • Buying Fee: Free
  • Selling Fee: $18
  • Offering Periods: Monthly

I should also note that I work for a large global conglomerate with a good reputation for growth. The stocks generally trend with the DOW.

I have this idea of compounding the profits back into my ESPP to take advantage of the 15% discount.

Let's assume I invest $750 of my own money into the ESPP for a given month, which means that I am able to purchase $862.50 worth of stock. Let's also assume that the stock price does not change at all within 12 months, at which point I sell. Therefore I have $112.50 in before tax/fee profits.

Correct me if I'm wrong, but (as I understand) because I sell before 24 months, this profit is taxed as ordinary income. I am assuming a third of that goes to Uncle Sam and I also must account for the selling fee. Therefore: Profit = $112.50 - $112.50*0.33 - $18 = $57.37. This means that I now have $750 + $57.37 = $807.37 in my pocket.

What I am considering doing is reinvesting that $807.37 into my ESPP. This would again take advantage of the 15% discount, which means I have $807.37 + $807.37*0.15 = $928.48 in purchasing power. I plan to sell and reinvest year after year until I match my 10% employee contribution limit, after which point I would continue to do this but reinvest the earnings into other things like regular stocks, ETFs, gold, etc. Basically I would use my ESPP as a source of regular income.

My questions are: is this a sound strategy? How do I calculate the "break even" point at which I should not sell for a given month? Is it better to simply invest 10% of my salary every month and forget about it? What about waiting until 24 months to take advantage of capital gains taxes?

Also, if you can't tell I don't feel like I completely understand the taxation of ESPPs. If the stock price increased, how is that taxed after 12 months? After 24 months? What if the stock price decreased, but still technically profitable due to the 15% discount?

I apologize that this is a long one. This is something I have been contemplating for some time. Any advice would be much appreciated!

  • One possible relevant point: what is your marginal tax rate? You say "a third", but I assume that's just a guess? – Joe Oct 15 '15 at 18:20
  • It is more of a conservative estimate :) – YardStick Oct 15 '15 at 19:06
  • But, the point is: how much savings comes from converting tax rates into capital gains tax rates depends on what your marginal tax rate is. If that is 15%, then you don't care at all. If it's 25%, you save some. If it's 35%-39.6%, you save 20%, which is pretty substantial. – Joe Oct 15 '15 at 19:07
  • OK fair point. Just did a quick calculation considering federal and state tax brackets. Looks to be about 26%. Is the profit subject to SS and Medicare taxes as well? – YardStick Oct 15 '15 at 19:21
  • You're getting past what I'm familiar with. But the question of state is separate from that of federal, and varies by state - you'd have to specify that. My state (IL) doesn't have a separate treatment of CGs so only the federal rate difference matters (my 28% or whatever vs 15%). The 4.33% or whatever IL tax is constant. I would just update the original post with your federal marginal tax rate and what state you're in. – Joe Oct 15 '15 at 19:27

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