Planning for Executives - 10 Value, risks, and tax implications of utilizing exchange funds in concentrated stock situations Flashcards
What is an exchange fund?
An exchange fund, also known as a swap fund, is an arrangement between concentrated shareholders of different companies that pools shares and allows an investor to exchange their large holding of a single stock for units in the entire pool’s portfolio. Exchange funds provide investors with an easy way to diversify their holdings while deferring taxes from capital gains.
Exchange funds should not be confused with exchange traded funds (ETFs), which are mutual fund-like securities that trade on stock exchanges.
What does the strategy of exchange funds entail?
Strategy
* Private placement, exempt from registration
* Avoids publicity since contribution is not public sale and does not require Rule 144 filing
* Diversifies a large, appreciated equity position while deferring taxation
* Diversification occurs because many investors from different sectors contribute their
shares into a common pool
* Shares of a publicly traded company exchanged for an interest in the Fund
* IRC 352C: requires 20% exposure to non-liquid holdings to avoid constructive sale
* To participate in sophisticated transactions including private placements, exchange funds,
etc. investors must meet the standard of an Accredited Investor (SEC 501):
— Has a net worth of $1 million, excluding the value of any residences, or…
— Earns an individual income of more than $200,000 per year, or a joint income of
$300,000, in each of the last two years
— Corporation, trust, partnership with assets over $5 million
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What are the advantages of an exchange fund?
Avoid sale that may depress market
price
* Potential tax savings compared to
open market sale
* Restricted securities may be
accepted
* Units receive step up basis at death
What are the disadvantages of an exchange fund?
Limited liquidity for first seven years
* May limit total amount of restricted
securities
* Restricted shares may be
discounted when accepted
* Acceptance of shares determined by
fund manager
Depict how an exchange fund would work?
In exchange funds IRC 352C requires ________% exposure to non-liquid holdings to avoid constructive sale?
20%
What is Rule 144 filing?
Rule 144 regulates transactions dealing with restricted, unregistered, and control securities. (Control securities are held by insiders or others with significant influence on the issuer.) These types of securities are typically acquired over the counter (OTC) or through private sales.
What is IRC 352C?
Payment of Unemployment Benefits.—
(i)Generally.—
Except as otherwise provided in this subparagraph, benefits shall be payable to any qualified employee for each day of unemployment in excess of 4 during any registration period within a period of continuing unemployment.
(ii)Waiting period for first registration period.—
Benefits shall be payable to any qualified employee for each day of unemployment in excess of 7 during that employee’s first registration period in a period of continuing unemployment if such period of continuing unemployment is the employee’s initial period of continuing unemployment commencing in the benefit year.
What is rule 144 filing?
Rule 144 provides an exemption and permits the public resale of restricted or control securities if a number of conditions are met, including how long the securities are held, the way in which they are sold, and the amount that can be sold at any one time.
What does IRC 352C require?
20% exposure to non-liquid holdings to avoid constructive sale
To participate in sophisticated transactions including private placements, exchange funds,
etc. investors must meet the standard of an Accredited Investor (SEC 501): How does the SEC define this accredited investor?
Has a net worth of $1 million, excluding the value of any residences, or…
— Earns an individual income of more than $200,000 per year, or a joint income of
$300,000, in each of the last two years
— Corporation, trust, partnership with assets over $5 million
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For what types of investments do investors need to meet the requirements of an accredited investor?
