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Tax Deductions for Employer Owned Stocks (RSUs/Stock Options/ESPPs)

Updated for Tax Year 2019


OVERVIEW

Holding stock or stock options in an employer's business can be a lucrative fringe benefit, one that encourages employee participation in the company's success. Employee stock ownership plans also include some tax breaks for both the company and participating workers, particularly with plans intended to augment other retirement savings programs. Tax incentives include deductions and deferred tax scenarios.


Stock options

Non-qualified stock options (NSOs) may be offered to only a few employees, who pay tax on the difference between the stock price offered in the option and the stock's fair market value.

"Incentive stock options, or ISOs, have special tax treatment that NSOs don't," says U.S. tax preparation specialist John O'Neil. "When you buy the stock through an ISO, you're not immediately taxed on the investment gain, as long as you hold onto the shares a minimum of one year from the time of exercising the option and two years from the date the options were granted."

When you meet these holding periods, you pay capital gains tax when you sell the stock, which is usually a lower rate than personal income tax.

Employee Stock Purchase Plans (ESPPs)

Employee Stock Purchase Plans are similar to stock options, particularly in the way they are taxed, with holding periods usually applying to non-qualified plans. Some features of a typical ESPP include:

• stock may be discounted up to 15% of the fair market price
• stock may be purchased through payroll deductions
• the difference between the discount price and market value is not taxed at the time of purchase
• all employees are usually eligible to participate in an ESPP, excluding any employee holding 5% or more of the company stock
• federal tax rules limit stock purchases to $25,000 annually

Restricted Stock Units (RSUs)

ESPPs and stock options can, when exercised, have a diluting effect on a company's stock. One way that a company can prevent this is through a restricted stock unit plan. In an RSU plan, a grant made to an employee is valued in terms of company stock, but stock isn't issued at the time of the grant. Only after the employee completes the terms of vesting are shares or a cash equivalent to shares awarded.

Vesting usually takes a set time period, but it may also be based on performance targets. Employees generally aren’t taxed at the time of the grant, only when the grant becomes vested. Even then, the employee may only be liable for required government taxes, withheld by the employer, until receiving the shares or cash equivalent.

Employer tax benefits

Employers have tax incentives to provide employee stock ownership plans. Employer contributions are deductible, up to 25% of the payroll covered by stock ownership plans. Dividends paid to employee-owned stock are also deductible, as long as the dividends are what the Internal Revenue Service considers reasonable. Dividends are not subject to the 25% limit.

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