Microsoft’s Employee Stock Purchase Plan (ESPP) is a great perk. Employee’s receive a 10% discount on Microsoft stock, which essentially means you can get free money!
An ESPP is a company sponsored benefit program that allows employees to purchase stock in their employer at a discounted price via after tax salary deferrals. Microsoft employees can contribute up to 15% of their salary to purchase Microsoft shares (up to the IRS limit of $25K). At the end of each quarter the money you set aside into the ESPP program purchases Microsoft stock at a 10% discount to the stock’s closing price at the end of the period.
Selling your shares as soon as they vest locks in your return based on the discount you received on the shares. From a tax standpoint, the 10% discount you receive on your shares is taxable as ordinary income in the year you sell the shares. That 10% discount will be taxed as ordinary income regardless of how long the shares are held.
Let’s look at a hypothetical example. If an employee with a $150K salary contributed 15% into the ESPP they’d be setting aside $5,625 to purchase Microsoft stock each quarter. Thanks to the 10% discount on Microsoft shares, the employee would receive $6,250 of Microsoft stock each quarter. That means the employee would have ordinary income of $625 on the date the shares are received (but this ordinary income is only realized in the year shares are sold). If the shares are sold on the date they are received there is no additional tax impact, it just means the ordinary income of $625 will be realized in the current year. If the employee instead elects to hold onto their shares, there will be a future capital gain or loss equal to the difference in the future selling price and the $6,250 cost basis.
Because there is no lookback provision in the Microsoft plan, there is no additional tax burden to selling your shares as soon as you receive them. Thus I would frame the decision to hold onto your shares as an active decision to purchase Microsoft stock on the date you receive those shares.
I almost always recommend employees sell these shares. You’re already heavily tied to Microsoft’s fortunes through your unvested RSUs and future compensation. You don’t need to add additional financial exposure to your employer by holding your ESPP shares. The investment hurdle to invest in your own employer should be an extremely high one. You’d only want to buy shares in the company when you’re highly confident the stock is significantly undervalued. To gain such confidence you would need the time and experience in investing to believe that you can consistently outperform the market by making active investments. The vast majority of people are better off sticking to a low cost passive strategy.
If you want to discuss your Microsoft stock or benefits, schedule a complimentary call today.
Scott Caufield, CFA, CPA