By Dan Trumbower
Restricted stock awards are an increasingly popular form of executive compensation, but they do require a bit of maintenance to make sure one company does not dominate your investment plan. When your salary, your portfolio, stock incentives, and possibly even a pension all lay in the hands of one company, it is prudent to diversify, but many overlook the importance of creating a sound strategy.
The most common issue people encounter with restricted stock awards is that they are out of sight, out of mind. It is easy to end up with an overly concentrated position in one stock – particularly if your shares are still sitting idle with the transfer agent. This exposes the portfolio to outsize influence from one particular company. Every company is different so it is important to carefully weigh the nuances of your particular plan.
Here are a few ways to help optimize tax planning and diversification opportunities over the near term, while allowing for longer-term growth combined with an element of downside protection.
This is your first tax planning opportunity that must be weighed carefully within a very short window. The clock starts ticking when shares are granted and you have up to 30 days to make this election. Basically, you can choose to pay ordinary income tax on the value of your shares at the time of grant rather than pay ordinary income taxes at fair market value on their vesting dates. In what specific situations would this election be appropriate for you?
- You are an initial investor of a company, a founder of a startup company, or receiving stock in a company that anticipates future growth. Samantha Deangler, CPA, a tax consultant with Squire Lemkin + Company in Rockville, Maryland, advises that since “the value of the stock is minimal while getting the company up and running, making the 83(b) election would allow you to pay tax at ordinary income tax rates on the date of the grant instead of on the date when shares vest. Any increase in value after the grant date will be taxed, either at ordinary income tax rates or at the preferential capital gains tax rates if held at least a year after the grant date. If you choose to forgo the election, you must wait a year after the vest date in order to sell at the preferential long term capital gain rates.”
- You are in a situation where you can control the timing of your tax burden: You may choose to make the election during a year when you know your tax situation and can plan accordingly with your tax and financial advisors. You can determine the value (or amount of ordinary income) by multiplying the number of shares by the price at grant date, and from there project the tax liability. “If you do not make an 83(b) election, you will be subject to an uncertain future tax liability when the shares vest when you may be in a higher tax bracket,” says Deangler.
Diversifying after the shares vest
If an 83(b) election does not make sense for your situation, you can still implement a tax-efficient diversification strategy after shares vest.
- Assuming that you have accumulated restricted awards over the years, review your holdings by tax lot – taking into account those shares subject to short and long-term capital gains. After you identify the most tax-efficient lots to sell, it is time to put a trading strategy into place.
- Consider placing a “Trailing Stop Limit” (TSL) order to sell your shares targeted for diversification. Why? A TSL automatically recalculates the stop trigger price – hedging your downside while still allowing upside potential. Your order will only trigger if the stock price falls below a stated percentage of your choosing from the price at the time your order is placed.
For example: You own a $10 stock and place a TSL at -10%. If the stock steadily declines, your order will execute at $9. However, if the stock price experiences a steady increase to $12, the new -10% trigger price will adjust upward to $10.80. TSLs combined with targeted outright sales can also be appropriate.
Consider whether these strategies would be suitable for you in light of the rest of your financial picture. A trusted fiduciary, independent, fee-only financial advisor can help you to create a plan that fits with the rest of your portfolio and financial planning goals. These are complex issues that may or may not be appropriate for you, so it’s critical that you consult with your tax practitioner and financial advisor prior to making any decisions.
About the author: Dan Trumbower
Dan Trumbower, CFP® is a Senior Wealth Advisor at Halpern Financial, a fee-only, independent, fiduciary wealth management firm in Rockville, MD and Ashburn, VA.