Facebook

Well, I would be excited too. Many of the employees became instant millionaires as a result of Facebook going public since as part of the company’s incentive plan, they were given Restricted Stock Units.

What Does This Mean for Overnight Millionaires and Their Taxes?

If you are ever so lucky to receive Restricted Stock Units, they are a promise to grant shares of stock, which are granted on a vesting schedule or meeting of certain milestones by you or company.  When vesting occurs, the value of the stock is included in your income as ordinary income and the employer is required to withhold taxes as soon as the RSU is vested whether you sell your shares or not.  If you later sell the shares, the change in value is a capital gain or capital loss.

Employee Stock Purchase Plans, on the other hand, are shares that you buy at a discount so you don’t have to pay taxes until you sell the stock.  When you sell the stock, the discount you received when you bought the stock is generally considered additional compensation to you and will be taxed as regular income.  If you sell your stock in less than one year, your gains will be considered compensation and taxed as ordinary income.  If however, you sell your shares after one year, your profit will be taxed at the lower capital gains rate.

If you are lucky enough to become an instant millionaire and you receive Restricted Stock Units you may be subject to higher taxes than under an Employee Stock Purchase Plan. Either way cha-ching. I really don’t think this would be a bad problem to have.  Stock options give you a chance to make more than your salary and they also give you a sense of ownership in the company.

Have you ever received employee stock options?  What type were they?

Employee Stock Purchase Programs (ESPP) allow employees to buy their company’s shares at a discounted rate . You make purchases with after tax money from your paycheck with payroll deductions. The company will purchase the shares at designated times at prices lower that the market price. This is usually referred to as grant or offer price.

An advantage right off the bat of participating in an employee stock purchase program is getting company shares at a lower price than the market. If you and the company are working hard and business is booming, you can come out ahead. It can be great help as you plan and save for retirement.

You want to make sure, though, that your portfolio is diversified and not too heavily invested in your company. While some employees became wealthy owning stock in companies like Google, if the company goes south you and you’re heavily invested in your company’s shares, you may be left with nothing as was the case with Enron.

What the Tax Implications Are

When you purchase shares through an Employee Stock Purchase Programs, you do not have to pay taxes on them. When you decide to sell your shares,though, expect to pay capital gains taxes. Keep in mind that the difference between discount you had purchased the shares at and the market price is considered taxable as if it were compensation.

To determine taxes owed with selling your shares, you must consider if it was a qualifying or disqualifying disposition. This is determined by how long you’ve held the shares and the time from the beginning of the offering period. Typically if you hold the company shares long enough to have a qualifying disposition you can reduce some of your tax burden (there are exceptions to that rule).

Employee Stock Purchase Programs can be a great tax deferred option for those hoping to build their retirement fund. If you have that option at work, seriously look into it.