ESPP

When one sells stock purchased through the Employee Stock Purchase Plan (ESPP), there are couple of things to take into account. The main one is that folks usually forget is that there are two part to the benefit/loss, the discount portion and the earnings/losses portion beyond that. How are these taxed depends on how long one held the stock.

From the TaxAct help:

"Qualifying vs. Disqualifying Disposition

A qualifying disposition means both of the following are true regarding your sale:

• It is more than a year after the purchase of the stock.
• It is more than two years after the grant date. This would be the first day of the offering period, sometimes referred to as the enrollment date

The compensation income for a qualifying disposition is the lesser of two amounts. The first amount is the discount allowed on the purchase of the stock. This would be the difference between the fair market value (FMV) of the stock on the grant date and the actual amount you paid for the shares. The second amount is the difference between the FMV of the stock when you disposed of it and the actual amount you paid for the shares.

For a disqualifying disposition, the compensation income is calculated as the value of those shares on the date of purchase minus the amount you paid for them. Generally, this would be the discount you received on the stock purchase."

Although seems common sense, it is actually quite more tricky than it looks. See Fidelity's detailed explanation

Actually I took guidance from the UBS document that had an example. I can't go here through all the combinations but just let me highlight the major difference. On non-qualifying disposition, the whole discount goes into income. In qualifying, truth is that it is not much different. The income ends-up being in many cases 15% of the FMV at start of offering. If the stock went up during the contribution period, then that 15% is better (lower). In my case the discount is always on the exercise date, so, if it goes down in price during the contribution period, then you end up paying the same as non-qualifying... In the case of losses, I believe there is an advantage for qualifying (see links...).

Cheers!

Taxing mutual funds

Man, one more year where my mutual fund barely moves but I get a letter from the fund company telling me that I made $3k!?! So, pay tax for that... Anyhow, to understand how to account for this, read this good explanation.

Basically, when the fund manager sells a winning stock, you pay tax for that. As long as he/she doesn't sell the losing ones, you can see the fund lower with a bunch of unrealized losses (same as would happen if you held the basket of stocks).

So, sure, pay year by year, but keep track of that, so, that in the end, the earnings that you pay tax for become part of the investment capital (!). So, when you finally sell it and realize the losses, your investment is higher than it was, and your losses are higher than they look like if you just looking at the price you paid for the mutual fund at the very beginning.

Basically, avoid double taxation... The link above gives an example where you actually made money overall, but it is the same concept...

Cheers!