SPEED ROUND: Stock Compensation: ESPPs + Phantom Stock

Podcast Transcript

tax simpletons. Hello. My name is chase Berkey, CEO of dark horse CPAs. We're back for another speed round, which will be the last in our series on stock compensation. And honestly, I'm kinda sad about it. Don't get too fat. I'm sure there will be lots of other topics for us to discuss on future episodes.

Indeed. Well today's series finale episode is on employee stock purchase plans, otherwise known as ESPs and Phantom stock. Sounds scary. I can assure you. It's not. All right. Let's start the clock for five minutes, Natalie. Let's start with ESPs specifically. What is an ESP? So as he mentioned, an ESP is short for employee stock purchase program.

This program allows for employees to purchase stock at up to a 15% discount from the fair market value. And it's only available to employees of publicly traded companies. And how exactly does an employee buy the stock? Usually they specify how much of their paycheck they want to allocate to buying a stock.

Then on one of the company's purchase dates, those payroll deferrals will be used to buy the stock. Most companies have multiple purchase dates, which they'll make you aware of. So is that allocation a percentage of their salary or a flat dollar amount? It's a percentage of salary. Some plans have a minimum of 2% to allow space participation in the program.

It's a percentage of salary. Some plans have a minimum of 2% to allow participation in the program. The maximum that an employee can diverse 15% of their salary up to $25,000 a year. Gotcha. And you mentioned that there are predetermined purchase dates for these shares. So how exactly does that work?

Typically a company will have a one-year offering period composed of two, six month purchase periods at the end of a purchase period, you'll have the option to buy the stock at 85% of its value on the first or last day of that six month purchase period, obviously you'll select the lower of those two prices.

And when they purchased the stock on one of those purchase days, what happens. When they purchased the shares, they will have to pay tax on the discount between the fair market value and the purchase price. This tax was paid the additional paycheck withholdings. And do those tax withholdings include FICA taxes?

Yes, they do. I go, of course being social security tax and Medicare tax. So regardless if an employee is offered an ESP shouldn't, they always participate. Absolutely. The reality is they're entering a pre-tax gain of 15%. If they sell, as soon as they buy, where else can you get a return like this? The only caveat is that you have to be able to live on the reduced amount of your paycheck because of the deferral, until you can buy in the meat and immediately sell the stock.

And you say pretax because the 15% gain would be reduced by the amount of taxes paid upon exercise. Right? Yep. Good clarification. So even if you had to put the deficit and your personal budget on a credit card, to be able to max out your deferral to your ESP would still make sense, right? Yep. As long as the credit card didn't have an astronomically high interest rate, that wouldn't be an option.

So I'd say yes. Okay. Let's move on to Phantom stock. Is this stock given out by Batman? Hardly. Basically. It's usually kinda stock appreciation rate. It's not actual stock. Hmm. Well, I would imagine our listeners are wondering why they would want this big stock. So it's far from fake what it allows us for the recipient to participate in the increase of the stock price for a certain number of shares.

In some plans through Sapient would get the entire value of the share, not just the increase of the bat. Okay. Okay. Now we're talking. Is there any tax on this? Nope. Not when you receive Phantom stock, only when they get paid on it. But how could one sell Phantom stock if it's not actual stock? Oftentimes a liquidation event has to occur for the Phantom stock holder to be paid.

This is usually the sale of the company or a merger or in the fandom stock may pay out a predetermined maturity date. So how are they paid when such a liquidation event occurs or when the Phantom stock matures, they usually get paid in the form of bonus through payroll for the amount of the stock appreciation.

Or they receive an equivalent amount in stock, either way income and FICA tax are due on the full value of the cash or stock received. So does vesting come into play with Phantom shares often times? Yes. Even though it's not actual stock, it's still has potential value. So companies are keen to make sure that you stay around to help create that value.

Boom, nailed it. Once again, this completes our speed round series on stock compensation. So we'll say goodbye to Natalie for now, but I can assure you that she'll be back again with more need to know tax education, Natalie. Thank you so much. Once again, for being our Guinea pig on speed rounds, yours will be a tough act to follow.

Thanks for having me chase. I know we covered a lot of information in these last type of sessions, so I encourage our listeners to please reach out. If you have any questions, I'm always happy to chat. Indeed interested listeners can reach Natalie directly by emailing her at Natalie at dark horse dot CPA.

And that's Natalie spelled N a T a L I E. And thank you, tack simpletons for tuning into TMS, or if you're not into the whole brevity thing, taxes made simple because there's TMI and then there's TMS.