By Joni Lndquist
Whether you inherited a large holding, exercised options to buy your company’s stock, sold a private business, hold restricted stock, or have benefitted from repeated stock splits over the years, having a large position in a single stock carries unique challenges. Even if the stock has done well, you may want more diversification, or have new financial goals that require a shift in strategy.
When a single stock dominates your portfolio, however, selling the stock may be complicated by more than just the associated tax consequences. There also may be legal constraints on your ability to sell, contractual obligations such as lock-up agreements, or practical considerations, such as the possibility that a large sale could overwhelm the market for a thinly traded stock. The choices appropriate for you are complex and will depend on your own situation and tax considerations, but here is a brief overview of some of your options.
Sell your shares
Selling obviously frees up funds that can be used to diversify a portfolio. However, if you have a low cost basis, you may be concerned about capital gains taxes. Or you may want to avoid any perception of market manipulation or insider trading. You might consider selling shares over time, which can help you manage the tax bite in any one year, yet allow you to participate in any future growth.
You’ll need to consider the tax consequences of any sale. The American Tax Relief Act of 2012 set the maximum tax rate on long-term capital gains at 20% for those in the 39.6% federal income tax bracket; a 15% rate will generally apply for individuals in the 25%, 28%, 33%, or 35% tax brackets, and a 0% rate will generally apply for those in the 10% and 15% brackets. Also, if your adjusted gross income exceeds $200,000 ($250,000 for married couples filing jointly), your net investment income will be subject to an additional 3.8% Medicare contribution tax. In contrast to previous years, these rates are not scheduled to expire at a certain date. That increased certainty should simplify planning.
If you hold restricted shares, you might set up a 10b5-1 plan, which spells out a predetermined schedule for selling shares over time. Such written plans specify in advance the dates, prices and amounts of each sale, and comply with SEC Rule 144, which governs the sale of restricted stock and was designed to prevent insider trading. A 10b5-1 plan demonstrates that your selling decisions were made prior to your having any insider knowledge that could influence specific transactions. (However, terminating the plan early or selling too much too quickly could raise questions about the plan’s legitimacy.)
You might also be able to avoid some of the restrictions on how much and when you can sell by selling shares privately rather than on the public market. However, you would likely have to sell at less than the market value, and would still face capital gains taxes.
Borrow to diversify
If you want to keep your stock but need money to build a more diversified portfolio, you could use your stock as collateral to buy other securities on margin. However, trading securities in a margin account involves risks which you should discuss with a financial professional before considering this strategy.
Exchange your shares
Another possibility is to trade some of your stock for shares in an exchange fund (a private placement limited partnership that pools your shares with those contributed by other investors who also may have concentrated stock positions). This possibility is complex and can tie up your money for many years. After a set period, generally seven years, each of the exchange fund’s shareholders is entitled to a prorated portion of its portfolio. Taxes are postponed until you sell those shares; you pay taxes on the difference between the value of the stock you contributed and the price received for your exchange fund shares. Though it provides no liquidity, an exchange fund may help minimize taxes while providing greater diversification (though diversification alone does not guarantee a profit or ensure against a loss). Be sure to check on the costs involved with an exchange fund as well as what other securities it holds. At least 20% must be in nonpublicly traded assets or real estate, and the more overlap between your shares and those already in the fund, the less diversification you achieve.
Donate shares to a trust
If you want income rather than growth from your stock, you might transfer shares to a trust. If you have highly appreciated stock, consider donating it to a charitable remainder trust (CRT). You receive a tax deduction when you make the contribution. Typically, the trust can sell the stock without paying capital gains taxes, and reinvest the proceeds to provide an income stream for you as the donor. When the trust is terminated, the charity retains the remaining assets. You can set a payout rate that meets both your financial objectives and your philanthropic goals; however, the donation is irrevocable.
Another option is a charitable lead trust (CLT), which in many ways is a mirror image of a CRT. With a typical CLT, the charity receives the income stream for a specified time; the rest goes to your beneficiaries. You receive no tax deduction for transferring assets unless you name yourself the trust’s owner, in which case you will pay taxes on the annual income. Other philanthropic options include donating directly to a charity or private foundation and taking a tax deduction.
Managing a concentrated stock position is a complex task that may involve investment, tax, and legal issues. Consult professionals who can help you navigate the maze. For help with your compensation planning, schedule a meeting by clicking below, contact Joni Lindquist –firstname.lastname@example.org, or call (913) 345-1881.
Options involve risk and are not suitable for all investors, and investors may lose the entire amount of invested principal in a relatively short period of time. Prior to buying or selling an option, a person must receive a copy of “Characteristics and Risks of Standardized Options.” Copies of this document may be obtained from your financial professional and are also available at http://www.theocc.com.
This information was developed by Forefield, Inc. an independent third party. It is general in nature, is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. Investments and strategies mentioned may not be suitable for all investors. Past performance may not be indicative of future results.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016
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