Many professionals in the bay area have amassed significant personal wealth through an equity compensation structure, Employee Stock Purchase Plan or other employer granted stock. This often results in a high concentration of assets in a single investment. However, the very asset responsible for creating significant wealth may eventually become the biggest risk to financial peace of mind. This leads to the question, “How to unwind and diversify a concentrated stock position in a tax-efficient manner”?
Among some strategies that can be employed there are:
- Hedging strategies, such as options and collars, to protect against downside risk
- Use of Private Placement Limited Partnerships
- Sales strategy to decrease stock concentration in a tax-smart manner
- Gifting strategies to reduce concentration and taxes
Option Strategy – The Collar
This strategy does not directly solve the diversification issue, however, it does help to create a floor to minimize losses. The stockholder places stock with a high basis in the account in which the collar will be constructed. Then use covered call as an exit strategy for the stock. This creates a systematic selling arrangement where the stockholder parts with certain shares based on market movements and is paid the premiums while waiting. The call income is then used to fund the purchase of the protective put. The put creates downside protection if the stockholder desires to insure against a down market.
Limited Partnership Private Placement
A private placement limited partnership pools shares with those contributed by others who may also be in a similar concentrated status. After a set period of time, each shareholder is given a prorated portion of the fund. This action provides no immediate liquidity but does help minimize taxes while providing greater diversification. Stock is contributed to the Private Placement fund which does not create a taxable event. At the conclusion of the lock-up period, the client receives a diversified basket of stocks which has the same cost basis as when the original stock was contributed.
Comprehensive Sales Strategy
With a comprehensive sales strategy, the stockholder’s goal is to reduce the total stock owned to a predetermined level. Stock is sold in the highest basis first out/lowest cost basis last out method. The stockholder orders the stock by tax lots, with the highest basis stocks first. The tax lots with the largest losses should be sold first, followed by lots with the smallest gains. This manages the capital gains tax while also creating a structured and consistent method to diversify the concentrated stock position.
Rather than selling stock and gifting the cash a stockholder can gift the appreciated concentrated stock directly to the chosen charity. This permanently avoids capital gains tax and reduces the concentrated position. There is an annual limit of $17,000 per person you may gift without having to file a gift tax return to the IRS.
The stockholder may also donate highly appreciated stock to a charitable remainder trust (CRT). The stockholder can set a payout rate conducive to their income needs. Upon termination of the trust, the remaining value goes to the designated charitable organization.
In either case, the stockholder qualifies for an income tax deduction subject to AGI limits. Any tax deduction not taken may be carried over for 5 years.
Sierra Pacific Financial Advisors, LLC (SPFA) is offering a complimentary webinar to address the issues of concentrated corporate stock where we will delve into each of these options in greater detail. Please join us on Thursday, August 24th at 11:30 am Pacific time to learn about challenges and potential solutions to the concentrated stock puzzle.
To watch a replay of this webinar click here or visit our YouTube channel @SierraPacificFinancialAdvisors
Daniel graduated from San Jose State University with Honors with degrees in Economics, Business Finance and Humanities. He also holds an MBA from Santa Clara University with a concentration in Behavioral Finance and Quantitative Decision Methods.
Daniel is both a Certified Financial Planner and Chartered Life Underwriter. He is the Director of Financial Planning and a Wealth Advisor at Sierra Pacific Financial Advisors, LLC.
He has over 20 years of experience in the financial planning industry and enjoys using his extensive financial planning and investment knowledge to champion financial literacy and help clients achieve their personal and custom financial dreams.
Daniel, his wife, and three daughters live in Livermore. They enjoy gardening and raising chickens. Daniel was the owner of The Good Brewer, a small homebrew and winemaking shop in Livermore.