Section 9: Planning for Executives Flashcards by Timothy Meyer

What are some advantages and disadvantages of a variable prepaid forward contract?

This is a solution to diversifying a concentrated stock position

Advantages:
-Substantial liquidity up front
- no tax event until maturity of the contract
-provides floor for stock price
-investor retains ownership, dividends (NOT at qualified rate), and voting rights
-can reinvest proceeds immiediately into a diversified portfolio

Disadvantages:
-ceiling on upside exposure; investor does not participate in any appreciation of the stock above the cap
-Self financing; no separate loan vehicle required
-Premium for liquidity can be high

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What is a disqualifying disposition of ISO’s?

Gift to another person

Using these shares to exercise other stock options

Transfer shares into irrevocable trust

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What is rule 16-b?

“short term swings profit rule”

Prohibits senior officers, directors, or beneficial owners of greater then 10% from profiting from purchase of company shares with any period less then 6 months

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What is a variable prepaid forward contract?

Regarding concentrated stock positions

Objectives/Strategy
-Monetizes concentrated position without selling the shares upfront
-Diversifies a large, appreciated equity position while deferring taxation
-Variable contract to sell a specific value of a security in the future i.e. the number of shares to be delivered will depend on the stock’s value at the time of delivery)
-Retains appreciation up to an upper limit (cap) as defined by client
-Protects against depreciation in stock below a lower limit (floor price)

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What are the potential Charitable giving options?

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Overview of Flow through exchange fund

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Restricted Stock Sale Considerations

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ISO Taxation

Taxation is deferred until the stock is sold- at that point taxed at LTCG at difference between sale price and exercise price

*AMT possible at year of exercize

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What is a phantom stock plan?

Incentive to align company and EE- does not dilute the stock, no stock is part of this plan, but provided upside of stock appreciation

“appreciation only” and “full value” options

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How is restricted stock taxed?

OI on the year it vests, however 83b election can be made at time granted to calculate the OI tax

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How are dividends treated on restricted stock?

Dividends may be collected, even if shares are not vested- taxed at OI, once vested EE will owe CG taxes- same goes for sale of stock after on year from vesting

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RSA’s vs RSU’s

RSAs- actual shares issued to someone but have restrictions on when they can sell (can earn dividends and have voting rights)

RSUs- basically promises of shares at a future date if they meet certain requirements e.g. tenure, performance

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RSU’s

Taxed @
Grant
Vesting
Sale

Grant: None

Vesting- OI on current share value

Sale- LTCG held over one year otherwise OI

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RSA’s

Taxed @
Grant
Vesting
Sale

Grant- if 83b OI on FMV otherwise none

Vesting- if 83b elected: none or OI on FMV upon vesting

Sale- LTCG if sold after one year, less then one year is OI

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ISO’s
Taxed @

Grant
Vesting
Exercise
Sale

Grant- none
Vesting- none
Exercise- AMT on bargain element, no OI, CG, or employment tax
Sale- LTCG if held one year past exercise and two years past grant date, otherwise OI on disqualified sale

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NQSO

Tax @
Grant
Vesting
Exercise
Sale

Grant: none
vesting: none
exercise: OI on bargain element, employment taxes as well
Sale: LTCG if held one year past sale- otherwise OI

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What is an exchange traded fund?

Exchange funds that allow qualified investors to pool shares into a partnership, with each investor receiving a pro- rata share of the fund. There is no immediate tax liability. The downside is they have limited liquidity due to the lock-up period of seven years.

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What is a prepaid variable forward?

Prepaid variable forward in which shares are sold at a future date in exchange for cash advance at the present date. This method provides immediate liquidity from the cash advance and deferral of capital gains.

What is an equity collar?

Equity collars which involves a purchase of long-date put option combined with the sale of long-dated call option. The collar should leave enough room for potential gains/losses so as not be in violation of the IRS constructive sale rule, section 1259

How does a prepaid variable forward contract work?

NQSO’s are not subject to:

vesting, disclosure, funding, and coverage

What is rule 144?

The # of shares sold in any 3 month period is limited to 1% of outstanding shares and average weekly volume during previous 4 weeks

*unregistered shares must be held a minimum of 12 months

Rule 144 shares must be held at a minimum of _____ months before they are publicly sold.

12 months

What is Rule 10b-5(1)?

Allows a client to execute programmed sales when otherwise not allowed-

It must include: # shares to be sold, date to sell, prices at which shares will be sold

The federal income tax system is based on two primary income classifications _____and ____.

Ordinary & Capital The technique of converting income from ordinary to capital can allow a taxpayer to benefit from reduced rates that capital income enjoys On the loss side OI is preferred Executives may benefit to structure income w/ capital

How are investor and trader losses and expenses handled?

Capital Gain assets includes any property except:

1. Inventory 2. Depreciable or real property in taxpayer’s trade/business 3. Specified literary or artistic property 4. business account or notes receivable 5. Certain US publications 6. Any hedging transaction 7.Supplies ordinarily used in tax payers business 8. Certain commodities derivatives/financial instruments held by a dealer

What are nested capital gains?

When buying mutual funds they have capital gains already built up

What are the benefits of NQSOs?

Holder benefits from appreciation of underlying securities without investing any cash

What is section 1244 Stock?

Certain stock issued by small business corporations defined under IRC section 1244- may receive preferential ordinary loss treatment (to encourage small business startups) Loss is limited to $50k individual/100$k joint per year limited to first $1 million of capital- after no more 1244 treatment Stock must be issued after 1967 and loss can not be transferred

What are the ISO requirements?

1. Must be approved by shareholders and eligible employees must be identified 2. Options must be granted with in 10 years and must be exercised within 10 years of grant 3. Exercise price must equal or exceed FMV of the stock on grant date 4. Restriction to transfer only at death of employee 5. If employee owns more then 10% of shares option must be 110% of FMV and exercised within 5 years 6. Limited to $100k per year- FMV determined at grant date- if exceed treated treated as NQSO

What is a 83b election?

When issued- restricted stock no later then 30 days after the transfer the election must be made 3 copies are required- 1. employer with receipt 2. IRS by deadline 3. Attach to tax return No dividends received until election is made- if stock has high dividend want to elect- OI on gain @ time of election then start cap gain treatment

ISO overview

must meet all requirements of section 422- no income recognized at exercise, instead when shares are sold Gain typically LTCG- can create AMT concerns at exercise and can be costly- need to plan when and how much to minimize Issuing company does not receive compensation deduction

What is a disqualifying disposition of a ISO?

Qualifying disposition is more then 2 years after grant and more then one year after date of exercise Employee must be continually employed If not- it will be treated like a NQSO- OI on fmv of exercise date and exercise cost- CG on exercise price to FMV

What are some strategies for exercising ISOs?

1. Staggering ISO exercises over a number of years 2. Planning for restricted sale 3. Use of leverage to buy dividend paying stock 4. Exchanging stock for stock

Comparison of ISO vs NQSO

Questions to help determine the best exercise strategy

What is a disqualifying disposition?

What are the possible ISO vesting schedules?

Cliff- all at once Step or graduated- % available each year

What is the bargain element?

Watch the John N. Video on concentrated positions

Restricted Stock Shares vs Restricted Stock Units

Employee Stock Purchase Plan vs Non-qualified deffered compensation