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 percent for those in the 39.6 percent federal income tax bracket; a 15 percent rate will generally apply for individuals in the 25 percent, 28 percent, 33 percent or 35 percent tax brackets, and a zero percent rate will generally apply for those in the 10 percent and 15 percent 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 percent 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.
HEDGE YOUR POSITION
You may want to try to protect yourself in the short term against the risk of a substantial drop in price. There are multiple ways to try to manage that risk by using options, which can be especially useful if you’re legally restricted from selling your shares. However, bear in mind that the use of options is not appropriate for all investors.
Buying a protective put essentially puts a floor under the value of your shares by giving you the right to sell your shares at a predetermined price. Buying put options that can be exercised at a price below your stock’s current market value can help limit potential losses on the underlying equity while allowing you to continue to participate in any potential appreciation. However, you also would lose money on the option itself if the stock’s price remains above the put’s strike price.
Selling covered calls with a strike price above the market price can provide additional income from your holdings that could help offset potential losses if the stock’s price drops. However, the call limits the extent to which you can benefit from any price appreciation. And if the share price reaches the call’s strike price, you would have to be prepared to meet that call.
A collar involves buying not only protective puts but also selling call options whose premiums offset the cost of buying the puts. However, as with a covered call, the upside appreciation for your holding is then limited to the call’s strike price. If that price is reached before the collar’s expiration date, you would not only lose the premium you paid for the put, but would also face capital gains on any shares you sold. Also, remember that transaction costs in multiple leg options strategies, such as a collar, can be significant and should be considered.
MONETIZE THE POSITION
If you want immediate liquidity, you might be able to use a prepaid variable forward (PVF) agreement. With a PVF, you contract to sell your shares later at a minimum specified price. You receive most of the payment for those shares–typically 80 percent to 90 percent of their value–when the agreement is signed. However, you are not obligated to turn over the shares or pay taxes on the sale until the PVF’s maturity date, which might be years in the future. When that date is reached, you must either settle the agreement by making a cash payment, or turn over the appropriate number of shares, which will vary depending on the stock’s price at the time of delivery. In the meantime, your stock is held as collateral, and you can use the upfront payment to purchase other securities that can help diversify your portfolio. In addition, a PVF still allows you to benefit to some extent from any price appreciation during that time, though there may be a cap on that amount.
DONATE SHARES TO A TRUST
If you want income rather than growth from your stock, you might transfer shares to some form of 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.
Provided by Ed Wettig, CFP, Wettig Capital Management which offers investment management, financial planning and retirement income strategies. Securities and investment advisory services offered through Royal Alliance Associates, Inc. Member FINRA/SIPC and a Registered Investment Advisor. Wettig Capital Management is independent of Royal Alliance Associates, Inc. and not registered as a broker/dealer or investment advisor.
