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

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)

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).

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

employer stock capital gainsStock 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 consolidated 1099-B 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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