Tax Consequences of Donating Employee Stock
Q. My client is looking to donate stock that he acquired through an Employee stock purchase plan (ESPP) at a 15% discount. If he donates these now, what are the income tax consequences to him?
A. ESPP shares can be an important source for charitable giving, but they are complicated, and donors need to understand the rules and consequences.
Shares acquired through an Employee Stock Purchase Plan (ESPP) are entitled to special tax treatment under the Internal Revenue Code. That special treatment includes deferral of recognition of gain on the shares until the shares are sold (rather than recognizing any gain upon the purchase), and the potential for the gain (other than the discount amount) to be taxed as capital gains subject to capital gains rates, rather than as ordinary income. In order to achieve those benefits, the employee may not make a "disposition" of the shares — including a transfer by means of a charitable gift — within one year from the date of purchase or 2 years from the date of the grant, whichever is later.
If the ESPP shares have been held for the required holding period, then upon any "disposition" — including a charitable contribution — the employee will be treated as having received compensation income (taxed at ordinary income rates) equal to the amount of the discount, and will also be entitled to a charitable contribution deduction for the full fair market value of the shares at the time of the contribution.
For example, if the employee purchased a share on December 31, 2010 for $85.00 (at a 15% discount from its fair market value of $100), and the employee were to contribute the share on December 1, 2012 (after the holding periods), and on December 1, 2012 the stock had a fair market value of $150.00, the employee would recognize $15.00 in ordinary compensation income (the discount amount), and would be entitled to a charitable contribution deduction of $150.00.
If the employee has not held the shares for the required holding period, any disposition is treated as a "disqualifying disposition" under the Internal Revenue Code. As a result of a disqualifying disposition, the employee would be treated as having received ordinary compensation income at the time of the initial purchase under the ESPP equal to the difference between the fair market value of the stock at the time of purchase and the amount the employee paid for it (here the difference between $100 and $85, or $15). Subsequent gain (or loss) would be treated as capital gain (or loss), and almost inevitably short-term capital gain (or loss) (given the 1 year holding period requirement). Since short-term capital gain property is not entitled to the beneficial tax treatment upon charitable contributions as long-term capital gain property, the amount of the deduction for making a charitable contribution would be reduced by the amount of unrealized gain that would not constitute long-term capital gain.
For example, if the employee purchased a share on December 31, 2011 for $102.00 (at a 15% discount from its fair market value of $120), and the employee were to contribute the share on December 1, 2012 (before the holding period, thus a "disqualifying disposition"), and on December 1, 2012 the stock had a fair market value of $150, the employee would be treated as having received ordinary compensation income at the time of the initial purchase of $18.00 (the difference between its fair market value at purchase of $120 and the $102 paid for the share), and would be entitled to a charitable contribution deduction of $120 (the $150 fair market value of the stock reduced by the amount that would not constitute long-term capital gain, or $30). (You should note at the same time that the employee is not obligated to include that $30 in short-term capital gain in taxable income.)
The rules are complicated, and each individual’s situation will depend on the facts particular to that individual, including comparison to other potential sources of charitable contributions. As a general rule, contributions of ESPP shares are more beneficial when the employee has met the required holding period, and a greater portion of any gain is made up of long-term capital gain (rather than “discount” or short-term gain).