Have you ever wondered about direct share purchase programs (DSPPs)? These plans allow you to purchase shares directly from a company, without a broker. DSPPs are a great option for individual investors, as they require very little money to get started, and most have small or no fees involved. As such, they’re a simple way to invest in shares.
While DSPPs usually allow shares to be purchased by institutional investors, the plans can be diverse. For instance, Reddit is breaking this mold by allowing active users and site moderators to buy stock.
But what are the broader tax implications of this and other direct share purchase programs?
Understanding Direct Share Purchase Programs
Usually, when an investor wants to purchase stock from a company, they’d work through a brokerage, like a bank or online investment program. While a broker can provide you with a range of stock options from a single platform, the downside is that you’ll be paying commission or currency exchange fees on every transaction.
Essentially, direct share purchase programs let you invest by cutting out the middleman. As such, you can buy shares directly from a company, saving on commissions and related fees. However, there are still other considerations to keep in mind.
How direct share purchase programs work
Like traditional stock purchases, direct stock purchase programs are overseen by the Securities and Exchange Commission (SEC). Because DSPPs are between you and a specific business, there can be a number of different requirements when buying shares. Also, these plans generally have minimum investment requirements, limiting the number of shares that can be bought in a transaction.
The trades for these shares are usually dollar-based rather than share-based. This means that instead of buying a set number of shares, you’ll usually purchase them according to a monetary value, so you could buy fractions of shares. It’s also worth noting that unlike traditional shares, which are priced according to the market, DSPPs offer shares that are valued according to an average price over a period of time. Funds from investors are pooled, and used to buy stock at daily, weekly or monthly intervals. Once they’re purchased, you’ll be issued with a certificate outlining the number of shares bought, as well as relevant information such as possible dividends.
Any information about how shares are priced and when they are sold must be disclosed by the company, in its program plan.
Advantages for individual investors
One of the biggest advantages of DSPPs is cost savings. Without brokerage fees, you save money on transactions. Some companies also offer discounts on bulk purchases, and the option to reinvest dividends.
Similarly, without a broker, direct share purchase programs simplify the actual purchase process. This also means the shares cannot be short-sold. In other words, there’s no risk of a trader borrowing stock from a broker and then selling in the hopes that the price will fall, to buy them back at a lower rate.
Finally, because you are purchasing directly from the seller, DSPPs offer you the chance to manage your investment directly. This includes easier communication and exchange of information between you and the business.
Advantages for companies
It’s possible to invest in DSPPs (or other IPOs) through Special Purpose Vehicles (SPVs). An SPV is a subsidiary created by a parent company to isolate financial risk. When structured as a partnership, an SPV is treated as a pass-through entity for tax purposes, meaning the entity itself doesn’t pay taxes. Instead, profits and losses are passed through to the individual investors. As such, investors become limited partners, with the SPV acting as the general partner.
This can provide tax efficiency, as income is only taxed once at the investor’s personal rate. It also means that investors can pool resources to access investment opportunities.
Risks of DSPPs
Despite the advantages, there are a few potential pitfalls in direct share purchase programs. Firstly, while you won’t have to pay a broker, there may be other costs, like setting up your account or transaction fees.
Moreover, by surpassing a broker and their access to a variety of stock options, you may be limiting your portfolio. This can make it difficult to diversify your investments.
Also, because it’s difficult to know the exact price of the shares you’re purchasing, it can be challenging to time the market and sell your stock.
Finally, because each business has its own plan for buying and selling, there could be limits to selling shares or liquidating. To prevent this, make sure that you read the disclosure plans thoroughly before investing.
For companies investing via SVPs, there are added challenges. It’s worth noting that there’s a risk of the K-1 you receive from the investment delaying the timing of your tax filing. Moreover, reporting such investments on the state and federal level can be complex, especially as they’re considered passive investments. This means that your positive net income isn’t subject to self employment taxes, but any losses are limited to passive income allocations.
Tax Implications of Direct Share Purchase Programs
Generally, there are two ways that you can benefit from investing in stock. The first is appreciation, in which the actual value of the shares increases. The second is through the payment of dividends which can grow. These benefits will affect how you’re taxed.
Capital gains and losses
If you sell appreciated shares and make a profit, you’re liable for capital gains tax. The specific rate you’ll pay depends on how long you held the stock before selling, and your tax bracket.
A short-term capital gain occurs when you sell any assets you’ve owned for a year or less. These gains are taxed using ordinary income tax rates of between 10 and 37%, depending on your taxable income.
If you hold the shares for over a year before selling them, it’s considered a long-term capital gain. Depending on your taxable income, these are taxed at rates of 0%, 15% or 20%. Clearly, these are more favorable rates than those for short-term gains, making it worthwhile to hold off on selling for as long as possible.
But what if you sell your shares at a lower rate than you paid for them? This is seen as a capital loss. These can be deducted against any capital gains in a tax year.
Dividends
Businesses usually pay out dividends quarterly or annually, to reward shareholders for investing. However, according to the IRS, dividends are considered a form of income and are thus taxable. How they’re taxed depends on whether they’re categorized as qualified or non-qualified, as well as how long you’ve held them, and your filing status.
- Qualified dividends are paid by US corporations and qualified foreign corporations. They’re taxed at 0%, 15%, and 20%.
- Non-qualified dividends do not meet IRS requirements to qualify for a lower tax rate. As such, they’re known as ordinary dividends, because they are taxed as ordinary income. This includes those paid by a regulated investment company (RIC), a real estate investment trust (REIT), or employer securities.
Reporting gains and dividends
When reporting capital gains to the IRS, use Form 8949 and Schedule D of Form 1040 on your tax return.
Form 8949 reports the sale or exchange of capital assets. On it, you’ll list capital transactions that resulted in a gain or loss. This includes information such as when you purchased the shares and sold them, and the fair market value of both transactions.
Schedule D of Form 1040 summarizes the sale, exchange, or involuntary conversions of capital assets, and capital gain distributions. In other words, it summarizes the overall gain or loss from shares reported on Form 8949. Note that all capital losses should be reported here to ensure they can be ‘claimed’ against any future gains.
Dividends are also reported on Form 1040, using Schedule B. This includes reinvested dividends.
Reddit’s Direct Shares Purchase Program
Despite being around for two decades, Reddit only recently filed to go public, and announced its DSPP for Class A common stock. The model being used is pretty unique. The company allows active US users to buy shares based on two different metrics; the number of actions a user has taken on a forum as a moderator, and their user-generated reputational score on the site. In other words, active posters and moderators have the first choice to make a purchase.
Other users or investors can pre-register to make purchases, and will be added to a waiting list. Interestingly, the DSPP is currently not available to Reddit employees.
While the company hasn’t yet set a stock price, it has provided an opt-out option for purchasers once the price is confirmed.
Tax considerations for Reddit investors
Because the company hasn’t set share prices, and currently has no intention of paying dividends, it’s difficult to list the current tax implications of buying shares in their direct share purchase program. However, if you do want to invest, we recommend keeping accurate financial records. This includes noting the prices and dates of transactions, as you’ll need to report these on your tax return.
Keep in mind that large investments (including shares) can trigger Alternative Minimum Tax (AMT). This is a parallel system designed to ensure that taxpayers with substantial deductions pay a minimum amount of tax.
If you have any questions about how investing in Reddit’s DSPP will affect your tax filings, speak to one of our CPAs.
Similarly, while it’s possible to invest in shares with a tax-advantaged account like an IRA or 401(k)s, this may have different tax treatments. As with all investments, consult with a tax professional for a thorough understanding of how buying shares can affect your tax liability.
Planning for Tax Efficiency
It’s important to maintain detailed records of purchases, sales, and dividends for tax purposes. Also, with careful planning of when to buy and sell shares from a DSPP, and using any losses to offset your gains, you can reduce your tax liability.
How to minimize your tax liability
Firstly, try to hold on to your shares for as long as possible. As discussed above, keeping shares for more than a year means you’ll pay long-term capital gains tax rates, which are lower than those for short-term gains.
Next, make use of tax-loss harvesting wherever possible. By selling shares at a loss, you can offset your capital gains tax liability on other investments, and reduce your taxable income for future returns. However, be aware of the wash-sale rule, which prevents you from buying similar assets within 30 days.
If you have shares that pay dividends, consider holding them in tax-advantaged accounts to avoid immediate taxation, by deferring your taxes.
Finally, gifting your shares to family members in a lower tax bracket can reduce your overall taxes. Donating them to a charity can help you avoid capital gains taxes and provide a charitable deduction.
For advice on best practices for tax efficiency around share purchases, schedule a Discovery Call with one of our CPAs.
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