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Scott Murphy CPWA > Planning for Executives - Section IV.A (10%) (12-13 questions) > Flashcards

Planning for Executives - Section IV.A (10%) (12-13 questions) Flashcards

1
Q

Incentive Stock Options (ISO)

A
  • More rules and restrictions than NSOs
  • Can only be given to employees
  • No ordinary income tax at exercise
  • Spread between FMV and exercise price is AMT
    preference item
  • Not transferable except in event of death
  • Annual $100,000 limit
  • Long-term capital gains treatment
    If sold more than 1 year after exercise
    And if sold more than 2 years after grant.
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2
Q

Disqualifying Disposition

A
  • Results when one does not adhere to the “2-year from grant” and “1 year from exercise” holding requirement.
  • Potentential taxation includes orginary income tax treatment as compensation and possible capital gains tax on the transaction.
  • There are situations in which this may be a preferred strategy (based on expectation of stock price)
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3
Q

Non-Qualified Stock Options (NSOs)

A
  • Few rules and regulations apply
  • Do not qualify for income tax deferral on exercise
  • Income tax due on spread between exercise price
    and FMV
  • Can be granted to employees or non-employees
  • No holding period requirement for stock
  • Can be transferred.
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4
Q

NSO and ISO Comparisons

A
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5
Q

Stock Option Strategies

A
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6
Q

NSOs - Exercise and Sell

A

** Considerations:
- Available cash to pay for stock and taxes
– Risk of remaining invested in stock
– Opportunity to “lock in” gains vs. opportunity for
further appreciation
– Potential for higher marginal tax bracket
** Cashless Exercise
– Simultaneous option exercise and stock sale
– Used any time after vesting and before expiration.

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7
Q

Exercise and Hold - NSOs

A
  • Exercise stock options to buy shares of company stock
    and then hold
    ▪ Applicable:
    – Prior to expiration
    – To capture dividends
    – Recognize income in a specific year
    – To produce LTCG on future appreciation
    – To meet company requirements.
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8
Q

Stock Swap - Pyramiding

A
  • Plan specific provision - must specifically allow
  • Available for NSOs and ISOs
  • Client pays exercise cost with existing shares
  • Bargain element on options taxable at exercise (same as
    with cash exercise)
  • Avoids capital gain and AGI lift from sale of stock
  • “Reload” feature replaces stock used to exercise options,
    offers future appreciation opportunity
  • Works best if client intends to exercise and hold.
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9
Q

Option Gifting to Family

A
  • Plan specific provision
  • Can be made outright, to trust, to FLP
  • Applies only to NSOs
  • Provides significant estate tax benefits
  • Shifts future appreciation out of the taxable estate
  • Vested options are easiest
  • Donor remains responsible for income tax on spread at
    exercise
    14© Dobbs Education, LLC.
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10
Q

Tandem Exercise

A
  • For option holders with NSOs and ISOs.
  • Goal: AMT Tax minimization on ISO exercise and hold.
  • Raise ordinary income to level greater than potential AMT with combination ISO/NSO exercise.
  • Potential downside = pay income tax on NSOs.
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11
Q

ISO Tax Ramifications

A
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12
Q

AMT Planning on ISO Exercise

A

ISO Sale to pay AMT
- Exercise ISOs in first quarter of year 1
- Triggers potential AMT due April 15 of Year 2
- Hold stock 1 year to meet ISO requirement.
- Sell stock before April 15 to pay tax.
- Downside risk is stock price declines in year.
Personal AMT Exclusion
- Calculate potential regular income tax and AMT to determine upper limit exercised ISOs below trigger point.

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13
Q

NSO Tax Ramifications

A
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14
Q

Section 83(b) Election

A
  • Plan specific provision
  • Exercise stock options prior to vesting
  • Must be elected within 30 days of grant
  • Stock subject to control and resale restrictions until vesting
  • Opportunity to reduce taxes on bargain element with 83(b)
    election
    – NSOs: tax on bargain element
    – ISOs: AMT liability
  • Big risk if stock declines in value.
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15
Q

83b Election

A
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16
Q

Section 457 Deferred Compensation Plans

A
  • Must be government organization or 501(c) tax-
    exempt organization.
  • Contribution limit $19,500 (2021), $20,500 for (2022),
    $22,500 (2023).
  • Tax on contributions and tax on account earnings
    are tax-deferred.
  • Section 457 plans can allow for Roth contributions
    and in-plan rollovers to designated Roth accounts.
17
Q

NUA

A
  • A strategy for retirement asset distribution under
    Internal Revenue Code 402(e)4
  • Applies to employer securities held in a qualified
    retirement plan (ESOP, pension, 401K, etc.)
  • Means to trade ordinary income taxation on
    retirement assets for long-term capital gains
    treatment.
18
Q

NUA - How does it work?

A
  • Must elect lump sum, in-kind distribution from plan
    (total distribution of all assets in single calendar year)
  • Original basis (i.e., contributions to plan) immediately
    taxable as ordinary income
  • Remaining value (Net Unrealized Appreciation) taxed at
    long-term capital gain rates
  • Subject to premature distribution penalty rules for
    qualified plans (applies only to original basis)
  • No step-up of basis at death on NUA portion. Subject to
    Income in Respect of Decedent (IRD).
19
Q

Restricted Stock Sale

A

Advantages:
- Increased liquidity
- Improved diversification
-Reduced price exposure
Disadvantages:
- Capital gains taxes
- Immediate transaction costs
- No upside price participation
- Public disclosure.

20
Q

Registered Restricted Stok

A
21
Q

Restricted Stock Sale - Rule 144

A
  • Holding period: One year if non reporting company, 6 months if reporting company.
    -Trading volume: Number of shares sold during 3 month period can’t exceed:
    - The greater of 1% of outstanding shares of same class.
    - The greater of 1% or the average reported weekly trading volume during the 4 weeks preceding the filing notice of the sale on form 144.
  • Filing notice with SEC: Must file with the SEC on form 144 if sale involve more than 5000 shares or aggregate is more than $50,000.
22
Q

Exective Compensation

A
23
Q

Matching Solutions to Needs

A
24
Q

Hedging: Zero Premium Collar

A
  • Investor wants to continue to own underlying equity but
    hedge price risk
    ▪ Purchases put option and sells call option against holdings
    for net zero premium
    ▪ Specifies option maturities and degree of downside
    protection and upside appreciation.
25
Q

Hedging: Zero Premium Collar

A

Advantages
▪ Hedges Downside Risk Below Put Strike Price
▪ Retains Ownership Benefits of Dividend Income and Voting Rights
Disadvantages
▪ Interim Price Risk
▪ Limited Upside Price Participation
▪ Collateral Requirements for Payment Due at Maturity
▪ Potential for Capital Gains Taxes on Underlying Stock
Position Upon Exercise
▪ “Hard to Borrow” Risk.

26
Q

Short Against the Box

A
  • Occurs when an investor borrows shares of stock and sells them short, while at the same time owning shares in the same stock.
  • Rules have been established to make this strategy (within certain contraints) illegal, but new strategies have been developed to accomplish the same goals.
27
Q

Diversification: Prepaid Variable Forward

A
  • 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).
28
Q

Prepaid Variable Forward

A

Advantages:
- Substantial liquidity generated upfront.
- No tax event until maturity
- Provides floor for stock price
- Investor retains ownership, dividends and voting rights until maturity date.
Disadvantages:
- Ceiling on upside exposure; investor does not participate in any appreciation of the stock above the cap.
- Self-financing; No seperate loan vehicle required.

29
Q

Exchange Fund

A
  • 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.
    ▪ Diversification may, however, not be optimal.
    ▪ Shares of a publicly traded company exchanged for an
    interest in the Fund.
30
Q

Exchange Fund

A

Advantages
▪ No potential to depress market price
▪ Tax savings compared to open market sale
▪ May accept contributions of restricted securities
▪ Units receive step up basis at death
▪ May offer attractive diversification benefits
Disadvantages
▪ Illiquid for first seven years
▪ May limit total amount of restricted securities
▪ FMV of restricted securities discounted
▪ Acceptance of shares determined by fund manager
▪ May not offer desired diversification benefits.

31
Q

Charitable Remainder Trust

A
  • Highly appreciated assets gifted to charitable remainder
    trust in return for ongoing income stream for life or trust
    term
  • Investor receives income tax deduction for charitable gift in year gift is made
  • Concentrated position is liquidated and reinvested in a
    diversified portfolio
  • At end of trust, remainder goes to favorite charity or to
    family foundation.
32
Q

Charitable Remainder Trust

A

Advantages:
- Beneficial capital gains treatment.
- Increase after-tax, net spendable income.
- Reduction of grantor’s taxable estate.
- Diverdifies investment portfolio.
- Potential income tax deductions.
Disadvantages:
- Irrevocable trust
- Principal passes to charity not heirs.
- Minimal tax deduction reduces benefits for younger investors.

33
Q

10b5-1 Plans

A
  • Pre-arranged trading plans for insiders and affiliiates, specifies amount, price and date at which securities should be traded.
  • Allows trading during “blackout periods”
  • May provide public with greater disclosure.

Scott Murphy CPWA (11 decks)

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