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Home » Invest, Stocks, Taxes

Capital Gains and Selling Employee Stock: What you Don’t Know CAN Hurt you

Last updated by on 8 Comments

A while back, we covered capital gains tax basics. One thing I didn’t get in to that I thought deserved a post all of its own is capital gains on employee stock units – you know, those things that keep you from running out the door on a hectic Monday (if you’re lucky enough to get them).

Here’s an essential tax tip for anyone who gets employee stock units at work. I’ll try to keep this short and sweet without boring you with all of the details on capital gains and capital losses.

Remember, when you sell a capital asset (i.e. a stock unit that has fully vested or stock in a taxable investment account), you either have a capital gain (if the stock asset has appreciated in value) or a capital loss (if the stock asset has declined in value).

If you have a capital gain, it’s either considered a short-term capital gain or loss (if held for less than a year from the point of vesting) or a long-term capital gain or loss (if held for more than a year).

The difference between the two is SIGNIFICANT, when it comes to your taxes.

You see, short-term capital gains are taxed at your ordinary income rate. Long-term capital gains are not. They get preferential tax treatment at levels that are below ordinary tax rates. More specifically, here is the difference between the two at different tax brackets:

Ordinary Tax RateShort-Term Capital Gains Tax Rate (held <1 year)Long-Term Capital Gains Tax Rate (held 1+ year)
10%10%0%
15%15%0%
25%25%15%
28%28%15%
33%33%15%
35%35%15%
39.6%39.6%20%

So here’s where this comes in to play for those who have stock units.

Even if your stock unit took 4 years to vest, for example, and you sell it for a gain over the vesting price, as soon as it fully vests – it’s still considered a short-term capital gain. You have to hold it for a minimum of 1-year from when it fully vested in order for it to be considered a long-term capital gain (note: the way your employer grants stocks and reports and withholds taxes may vary – so you should definitely consult with a tax professional).

employer stock capital gainsThere are some pretty dramatic implications here and I’ve screwed up on this, so my goal is to prevent you from doing the same.

Stock units are supplemental income. And we should not count on them for ordinary living expenses. But after 4 long years (your vesting schedule may vary) of waiting for them to vest, the first urge is to sell them off within the first year. The cost of doing so is that you will pay your ordinary tax rate on them. Had you held off for a year or more, you would instead pay the long-term capital gains rate and significantly cut your taxes.

There are other considerations, of course. For example, if you have outstanding high APR debts to pay off and you intend to fully use all of your vested shares to pay off that debt, it might be worth selling shares. Or, if you’re overly invested in company shares, you might be at risk to a lack of diversification.

The choice is up to you, but at least now you can’t claim ignorance like I previously did. ;-)

Once you do sell, brokerages are required to send you capital gain and loss reporting via a 1099B form at the end of the year, so that you do not have to calculate the capital gains on your own.

From there, your capital gains and losses will be calculated on IRS Form 8949 and reported on the IRS’s 1040, Schedule D form.

That wasn’t so bad, was it?

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8 Comments »
  • Very useful post! I was actually wondering this myself when thinking about my employee stock purchase program.

  • Nick says:

    I’m not sure this is how stock options work tax-wise. It is my understanding that you must wait 1 year after actually exercising the options, not just when they vest. Vesting only means you are allowed to exercise.

    Normally options are exercised (you buy x number of stock at option specified price) and then immediately sold at market price. Because of the quick turnaround, brokers do not require any money from you. However, if you want to hold onto the options for 1 year, you must actually pay for the stock (at the option price) out of your own pocket. You then wait 1 year and then sell them at market price to avoid short term capital gains tax. This could mean putting several thousand dollars of your own money into a potentially risky investment. For the majority of people it is better to take the tax cut and avoid tying up capital that could be better used for other investments.

    The advantage of stock options is that you essentially have your money leveraged by the company. After you exercise, you lose the leverage, and thus any advantage over any other investment.

  • David says:

    When talking about RSU’s, my understanding is that they are taxed as regular income when they vest. Depending on how your employer does it, they can offer withhold-to-cover or sell-to-cover tax to withhold stock units for tax purposes (I found this document for reference: http://www.morganstanleyfa.com/public/facilityfiles/sb090312151937/c42a8320-7c58-4855-9465-85edcaf5d8eb.pdf). My employer exercises WTC so I actually get less stocks in my account when they vest.

    In that case, you only pay capital gains when you sell, and only the price difference from the vesting value. It would seem to me selling these ASAP is fine since the capital gains would be zero or minimal.

  • Patrick Sievert says:

    The other thing to consider is the stock price itself. My company stock is currently at an all-time high (and about 2.5x what it was 2 years ago). I’m selling all I have of it, even though some of that will be short-term capital gains, simply because I don’t have confidence that the price will remain high for another year. If the stock price drops 15%, that more than offsets the tax savings I would gain by waiting a year.

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