How to manage US Company ESPP when you move overseas?

In a previous post, I addressed how to manage US company stock options or RSU when your US tax residency or physical location changes. However, I left Employee Stock Purchase Plans (ESPP) out of the discussion.

The reason is that ESPP requires you to make the decision to purchase in addition to sell. This is distinct from RSU and Stock Options awards that take the purchase decision out of your hands. Therefore, we are going to discuss ESPP in this standalone post.

What is ESPP?

ESPP allows employees of a US public company to purchase the employer’s stocks at a discount through payroll deduction. While there are other potential reasons, this is the #1 economic reason for you as an employee to buy your company’s stocks through ESPP, instead of through your own brokerage account.

What is a Qualified ESPP?

In addition, the US company can offer Qualified ESPP as defined under IRC Sec 423 that offers further tax benefits for the employee participants. One major tax benefit is that the value of discount is not considered income until sale happens. The employer does not withhold taxes at purchase, even though you technically received an economic benefit that equals the discount.

On the other hand, if the ESPP plan itself does not meet the IRC requirements, the participant is considered receiving the economic benefit at purchase. Your employer will report the discount as ordinary income like salary on W-2 in the year you purchase and withhold income and FICA tax.

What is Qualifying Disposition?

To meet the qualifying disposition rule, you need to hold the ESPP shares for at least one year from purchase date AND at least two years from the date the offering period of the ESPP began.

If you meet the Qualifying Disposition rules on your Qualified ESPP shares when you sell, only the discount portion will be taxed as ordinary income; the rest will be taxed as capital gains. You will receive a W-2 from your employer, and 1099 from the custodian that hold your shares. Here’s a pretty detail explanation on the forms and info you will receive from Fidelity.

(Note that there are two Qualifications! The plan needs to be qualified and your sale needs to be qualifying.)

If you do not meet the holding periods above, your sale is deemed disqualifying. In this case, the entire economic gain from ESPP purchase will be taxed as ordinary income.

US vs Foreign Payroll?

The tax treatment mentioned in the previous section apply to those under US payroll, whether you are physically in the US or are US citizens overseas.

The US company may also offer the same ESPP plan for their foreign subsidiary employees. However, the employees under foreign payroll likely need to follow the tax law in those jurisdictions.

This means that if you are a US citizen under foreign payroll, you may recognize income differently on your foreign tax return. You may not receive the same IRS forms as your US colleagues, but you may declare your ESPP income on US tax return the same way, as long as the plan is qualified and the disposal is qualifying.

Taking Discount or Waiting for Growth?

Before I move on to the international considerations, I also want to discuss the economic decision to meet the holding period for qualifying disposition without additional complications.

The required holding period can be two years from when the offering began. Since the discount is taxed as ordinary income regardless of when you sell, for you to wait potentially two years to lock in benefit from discount, you must expect the company stock price to grow significantly in two years. However, this is far from guaranteed.

While RSUs and Stock Options are historically offered by high growth tech firms, ESPP can come from any type of publicly trading US company. Whether waiting for the tax benefit on growth beyond the discount has to do with your expectation of the stock price. Most employees I know don’t have an objective evaluation method like an investment analyst. If you don’t have a conviction for the growth, I’d recommend considering locking-in the discount without meeting the holding period for qualifying disposal. After all, it’s equally likely the stock price might fall below what you purchased it for.

How to manage US Company ESPP when you move overseas

Many US companies that offer ESPP are multinational and have employees with various US immigration status, tax residencies, or physically outside of the US. It’s likely that participants will have different tax status between the time they purchase the shares and when they sell. This mismatch is where you may have planning opportunity or may get tripped up if you didn’t keep track of your status and actions.

As mentioned in the previous section, there are generally three categories of potential purchase and sale:

1. Qualified ESPP, Qualifying Disposition
2. Qualified ESPP, Disqualifying Disposition
3. Non-qualified ESPP

We’ll discuss below the planning opportunities based on tax residency and payroll status change within each of the three categories:

Qualified ESPP, Qualifying Disposition

US Citizen / GC Holder on US Payroll, living in the US <-> living outside of the US but not Foreign Tax Resident

Since you are on the US payroll the whole time you are part of the ESPP, the tax withholding and reporting will follow the same rule discussed in the beginning of this post.

The main planning consideration here is that the Foreign Earned Income Exclusion (FEIE) will apply to the additional W-2 income from the sale. You may also avoid state tax by selling while still residing overseas.

On the flip side, if you began your participation while overseas and thinking about returning to the US, you may want to consider selling before you do if your income is below FEIE.

US Citizen / GC Holder on US Payroll, living in the US <-> on Foreign Payroll or Foreign Tax Resident

Since you purchased while on US payroll, you will receive all the same IRS forms and reporting when you sell, even though you’ve moved overseas. Depending on the foreign tax rate and whether the ESPP sale is a taxable event in the new residency country, you may want to consider selling your existing holding before moving.

If you purchased while on foreign payroll, depending on the tax law of your residency country, you may have already paid foreign taxes on the purchase before you sell. Since income isn’t recognized yet in the US at purchase, you likely need to keep record on the foreign tax paid to accrue until the income is recognized in the US. This is true even if you are claiming FEIE on US tax return while overseas.

US tax resident on US Payroll, living in the US <-> Nonresident Alien on foreign payroll

Like the previous group, since you purchased while on US payroll, you will receive 1099 showing US source income from your employer and the custodian holding the ESPP shares. You should provide W-8BEN to withholding agents when you become Nonresident Alien for US tax purpose. Withholding agents will withhold dividends from the ESPP shares at 30% or treaty rate before the sale. You are required to file 1040-NR to report US effectively connected income (discount) and dividend income. The capital gain portion may be tax-free if no treaty rate is applied, and you did not spend over 183 days in the US.

On the other hand, if you purchased while a non-US citizen / GC holder, foreign employee of the company, you may have already paid foreign taxes on part of the income. Unfortunately, the US tax law does not recognize the foreign tax paid before you become a US tax resident, even if the income is recognized again due to the sale when you become a tax resident. Therefore you may want to consider closing the position before moving to the US.

Qualified ESPP, Disqualifying Disposition

US Citizen / GC Holder on US Payroll, living in the US <-> living outside of the US but not Foreign Tax Resident

To recap, disqualifying disposition makes the entire difference between sale and purchase price ordinary income in the year of sale.

The same consideration discussed under qualifying disposition applies, and perhaps even more so. You may not have to worry about whether a disposition is qualifying if you have enough FEIE to offset the higher income reported on W-2 while overseas.

US Citizen / GC Holder on US Payroll, living in the US <-> on Foreign Payroll or Foreign Tax Resident

The same consideration discussed under qualifying disposition applies. In addition, since the ESPP income may potentially be taxed at a higher rate as ordinary income, the difference between US and foreign tax liability may not be huge enough for you to take actions before the move.

US tax resident on US Payroll, living in the US <-> Nonresident Alien on foreign payroll

You will not have the benefit of having tax-free capital gains when you become a nonresident alien. Instead, you’ll have higher US effectively connected income. It may still be beneficial to sell as a Nonresident Alien if you do not have other US source income and have the ordinary income taxed at a lower bracket.

Non-qualified ESPP

Regardless of your US tax status or location, you would have paid US or foreign tax (if applicable in that country) on the value of the discount when you purchased.

Any future gain or loss will be based on the Fair Market Value of the date you purchased the stock for, not on the discount price. This means you’ll consider the sale of ESPP the same way you consider selling other stocks you purchased with your own money. You may want to consider the capital gains tax rates based on holding period, tax loss/gain harvesting, capital gains taxation in foreign jurisdiction, and the tax-free treatment of US capital gains for Nonresident Alien.