Realizing Long-Term Capital Gains With Stock Based Compensation

Below are certain strategies that have worked well for us over the years:
  • It takes 18 months after the purchase date for ESPP stock purchases to qualify for long-term capital gains tax treatment. Holding on to them allows for the following positive scenarios to play out:
    • Not selling in the first 18-month cycle (typically three purchases) can result in perpetual long-term gains using the following strategy – at the time of the 4th purchase, sell the 1st purchase as any gains realized will be long-term capital gains - repeat the process for the 5th and following purchases.
    • For restricted stocks, ordinary income tax is paid already at the time of purchase of the shares. Sell such stock immediately to minimize additional tax - tax will apply to only the appreciated portion of the restricted stock sale and can easily be calculated using an online tax calc. Also, this strategy helps with overall liquidity as ESPP amounts are tied up.
    • In case of exercised stock options that were held for more than a year, the tax on the difference between the strike price and the sale price will be long-term gains, which turn out to be better than ordinary income tax rates in most situations. Here again, selling such stock helps with overall liquidity while the ESPP amounts are tied up.
  • Exercise stock options without selling when they are significantly in the money. This allows flexibility with regards to selling in a tax-optimized fashion at a later time.
  • Sell restricted stock allocations as quickly as possible. As the tax is paid at the time of the stock purchase, it makes sense to realize cash from this type of compensation as quickly as possible as holding on has two significant negatives if the stock goes down from the time of purchase:
    • It directly impacts your total compensation as the value of stock at the time of stock purchase is counted as part of your total compensation and taxed upfront.
    • The tax was paid based on the higher purchase price and so the tax impact is higher.
The primary risk with all these strategies is the potential increase in exposure to company stock as a percentage of total assets. To mitigate this risk, a selling strategy that limits total exposure to company stock as a percentage of total assets to a range (typically 2-5%) based on an individual’s risk-profile should be used.


Related Posts:
  1. Flexible Spending Accounts (FSA) – Great Benefit with a few caveats!.
  2. Writing Covered Calls against Employer Stock Plan Shares (ESPP, Restricted Stock, and Stock Options) – A Primer.
  3. Employee Stock Purchase Plan (ESPP) and 401K Retirement Plan Annual Enrollment and Contribution Review.
  4. Employee Stock Purchase Plan (ESPP) - Immediate Selling Strategy.
  5. Realizing Long-Term Capital Gains With Stock Based Compensation.
  6. Stock Based Compensation Tax Optimization Strategies.

Last Updated: 03/2016.

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