Tax-Efficient ESPP Diversification for Tech Professionals

Imagine you’ve saved up a significant amount of company stocks through an Employee Stock Purchase Plan (ESPP), and suddenly, the stock prices take a dive. If you work for a stable tech company, this might be hard to grasp. But remember, even big companies like Apple can stumble – their stocks are down nearly 10% this year, all while the US tech industry as a whole is already up more than 12% for the year. Now,  if most of your savings were tied up in Apple stocks, your net worth would take a hit too.

While the shares you acquire from an ESPP can become very valuable over time, it’s important to diversify these shares in a tax-efficient way so that when your company stocks fall, as they inevitably will, you are still in control of your money and future. You can use this financial freedom to create and safeguard the life you truly love.

In this article, here are the key takeaways we will focus on:  

• Make sure only a portion, between 4-10%, of your total wealth is invested in a single stock. If too much of your money is tied up in your company’s stock through your ESPP, it could disrupt your plans for financial independence

• A donor advised fund can potentially help you save both on capital gains taxes as well as lower your income tax. Tax loss harvesting can decrease your capital gains
• Similarly, it can be helpful to sell company stocks over several years or focus sales in a year when your income is lower

What is an ESPP? 

Now, let’s break down what an ESPP plan is. It’s a benefit your employer might offer, allowing you to buy company stock at a discount, often through paycheck deductions. This can add up over time, becoming a substantial part of your savings.

Here are some steps to diversify your ESPP stocks

• Asset Allocation: Your money should align with your life goals such as retiring early and making work more flexible. Allocate your funds to achieve desired returns while shielding them from market fluctuations
• Sector Diversification: Tech professionals are already heavily exposed to high growth stocks. Hence, adding some value stocks can add new sources of return and protect your portfolio 
• Geographic Diversification: At True Root Financial, our portfolios are more overweight US stocks given our long-term outlook. But adding some stocks outside the US can provide enhanced returns
• Tax-Efficient Asset Allocation: Allocating ESPP funds into tax-efficient investments like index funds or ETFs can reduce capital gains distributions and taxable events

Let’s explore ways to keep your taxes low while diversifying your investments

• Qualifying Dispositions: The IRS offers special tax treatment for “qualifying dispositions” of ESPP shares. This means holding onto your shares for a specified period (typically one year from purchase and two years from the grant start) to benefit from more favorable long-term capital gains tax rates upon sale
• Tax Loss Harvesting: Look at other parts of your portfolio to see if you have any paper losses that you can realize. If you are able to accumulate these losses, you can offset it against the capital gains from selling your ESPP shares  
• Donor-Advised Fund (DAF): A donor advised fund allows you to donate cash or stock and get an income tax deduction the year you make a donation to your DAF. You can then use the funds to gift to charities in the future, giving you a lot of flexibility.  If you donate appreciated stocks held over a year, you can get a dollar for dollar income tax deduction up to 30% of adjusted gross income (AGI).  If you donate cash, you can get deductions for up to 60% of AGI. If your charitable deduction amount exceeds these AGI limits, you may carry the excess amount forward up to five additional tax years, subject to AGI limits in each year. If you donate appreciated ESPP stock to a DAF, you not only receive tax deductions for its market value but also avoid capital gains tax of another 15-20% on it. In this way, a donor advised fund can be an effective way to reduce taxes while empowering you to support causes you care about
• Strategic Timing of Sales: If you time ESPP share sales strategically based on tax brackets, holding periods, and anticipated tax changes, you can optimize tax outcomes. Also, selling during lower-income or capital gains tax rate years can minimize your tax liabilities
• Consult with a Financial Advisor: Seek advice from a financial advisor experienced in ESPP diversification. At True Root Financial, we assist clients in navigating ESPP tax complexities and managing risks associated with concentrated company stock holdings. A qualified advisor can help design a tailored strategy based on your circumstances and goals

Next steps for you

In thinking through your ESPP plan, your first step should be to evaluate the percentage of your net worth tied to ESPP shares. Ideally, no more than 4-10% of your net worth should be in company stock. If it exceeds this, create a diversification plan while considering the tax implications. You should strategize to minimize tax impact and/or spread it over time. If you’re interested in tax-efficient ESPP diversification, schedule a call with us for personalized guidance.

Let’s make sure your investments work for you while keeping tax considerations in mind. Book a call to discuss your ESPP diversification needs and craft a tax-efficient plan. Book a call below today. 

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