concentrated equity

5 Steps to Managing Concentrated Equity in Company Stock and Stock Options

Last Updated on November 23, 2020 by Daniel Zajac, CFP®, AIF®, CLU® 2 Comments

Concentrated equity, also known as owning a large position in one company stock, can exist in many forms. One form of concentrated equity may be the result of working for an employer who has issued stock ownership via restricted stock and stock options.

These types of stock ownership and stock rights allow an employee to participate in the growth of the company via an appreciating stock price. If you are issued many shares or are issued shares of a company that has experienced meteoric growth, you may find yourself with a concentrated equity position rather quickly.

So what do you do if you find yourself with a large position of one company stock? Possibly seek help. Because managing concentrated equity positions may prove difficult. In fact, managing concentrated equity may require complex strategies and a deep understanding of plan rules, tax rules, selling restrictions, and overall portfolio impact.

With so many moving parts, it’s easy to understand why many owners of concentrated equity positions may feel overwhelmed. The combination of a large portion of wealth, a minimal understanding of the issues, and the fear of making a mistake can leave even the most sophisticated investor paralyzed.

Often you can start by taking stock of what you have.

Step 1 – What Do You Actually Own?

It’s not uncommon for a client to lack a full understanding of what they own. They know they own company stock in some form or fashion, but the details are lacking.

A first step is often to take inventory of what you actually own. Some common forms of company stock ownership and stock rights include the following:

Outright ownership of company stock
Company stock as part of an employee stock purchase plan (ESPP)
Restricted Stock Units or Awards
Incentive stock options
Non-qualified stock options
Shares in an Employee Stock Ownership Plan (ESOP)

It’s important to know exactly what is owned for many reasons. Primarily, it’s important because the rules and regulations governing each type of company stock ownership may be different. Different in terms of liquidity, accessibility, and tax.

Through this process it’s important to evaluate what has already occurred. For example, have you exercised stock options? If so, it’s important to know key dates and values for those actions.

Without knowing what you own and what has already occurred, it’s difficult to evaluate and create a strategic plan to manage your concentrated equity position.

Step 2 – What is the Cost Basis?

Cost basis is important because it impacts income taxes. Knowing the cost basis will help determine what type of tax will be paid and how much tax may be owed. From this, you can calculate how much you will receive net of income tax from the sale of your stock, or in other words, how much you have to spend.

Capital gain is what you have earned on the company stock over what you paid for it. When you sell your company stock, the gain (or loss) is subject to capital gains tax.

In its most simple format, cost basis is calculated as what you paid for the stock when you purchased it.

However it’s not always that easy. In fact, a more complicated cost basis scenario is that of incentive stock options. With incentive stock options, it’s possible your stock may have both a regular cost basis and an alternative minimum tax (AMT) cost basis, both of which should be tracked until liquidation of the stock. And both of which may have a material impact on income tax.

Other complicated cost basis scenarios may include net unrealized appreciation, which involves the tracking of cost basis for company stock purchased inside a 401(k) plan or cost basis for restricted stock with an 83(b) election.

Furthermore, for every lot of stock options or stock shares that are owned outright, it’s possible you will have a different cost basis.

Step 3 – What Key Dates Do You Need to Know?

It’s very common for company stock ownership to have key dates that should be tracked.

For calculating capital gains tax on the sale of shares that are owned outright, one year is an important date in that shares may be eligible for preferential long-term capital gains treatment.

Other important dates include vesting dates, expiration dates, and dates associated with a qualified disposition.

A vesting schedule is used to determine when you can take action on restricted stock and/or stock option plans. Prior to shares vesting there is a substantial risk of forfeiture. What you own is likely a future promise should you meet certain criteria. Once vested, that promise is fulfilled and you gain the ability to control your shares.

Vesting schedules may also drive taxability (depending on the type of company stock you have). For example, restricted stock is often taxable when it vests.

For stock options, a vesting schedule is important because it dictates when you can exercise your options. Prior to this date, you have no ability to exercise. Post vest, you can exercise as you wish.

The expiration date is on the other end of the spectrum as compared to vesting. The expiration date of stock options is the date on which the option goes away should you not exercise.

If your stock options are underwater and the expiration date passes, the stock options will disappear and be worthless.

If your stock options are in the money and you approach an expiration date, it likely makes sense to exercise the shares regardless of impending taxability. Otherwise, any in the money value will evaporate upon expiration.

A third set of dates that should be considered are those associated with a qualified disposition. For shares owned via an employee stock purchase plan and/or incentive stock options, meeting the standard required of a qualified disposition is likely advantageous from a tax standpoint.

However, seeking a tax advantage requires assuming risk – the risk of holding company stock for a certain period of time. During this time, the shareholder (you) is subject to market risk, or the risk of the stock price going down.

What you seek to save in tax may be lost due to a declining stock price.

Step 4 – How Much of Your Overall Investment Portfolio Is Invested in One Company?

Concentration risk is the risk of owning too much of one thing. In our discussion, this means too much of one company stock. This risk may result from a variety of situations including the focus of this article, company stock that is accumulated through employment.

Concentration risk isn’t all bad. In fact, concentration risk presents both opportunity and risk. When the company is doing well and valuations are going up, you will likely benefit from concentration risk.

However, during periods of poor company performance or enhanced volatility, concentration risk can lead to unpredictability and potential financial insecurity.

Furthermore, one could argue concentration risk is enhanced for someone who owns too much company stock AND is employed by said company. In a bad scenario, the stock price may drop precipitously as you get laid off and lose your income and benefits.

For these reasons, it’s important to understand how much concentration risk you have and how much concentration risk you are comfortable assuming. One rule of thumb in the industry suggests someone may want to own between 10-15% of any one company in a portfolio.

A more complete analysis of concentration risk and individual suitability would likely consider your overall net worth, your liquidity needs, your life stage, and your future plans.

Step 5 – Plan for Concentration Risk and Financial Planning

Managing your overall investment portfolio and financial plan requires a thorough analysis of your company stock and stock options. By combining the details of your plan with the goals of your financial plan, it’s possible to create an arrangement that strives to maximize value.

While there is no assurance that a diversified portfolio will produce better returns than an undiversified portfolio, and it does not assure against market loss, a diversified portfolio may reduce a portfolio’s volatility and potential loss. None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation.

How to Strategically Liquidate Company Stock and Employee Stock Options

Last Updated on November 23, 2020 by Daniel Zajac, CFP®, AIF®, CLU® 1 Comment

Many financial planners will suggest that you allocate no more than 10-15% of your investable net worth into a single stock position. That range can allow you to benefit from the potential upside of a growing, successful company, without leaving your assets too vulnerable to a less-desirable outcome if the company underperforms.

If you want to follow that guideline and you receive equity compensation, that means understanding how to strategically liquidate company stock whenever you could potentially exceed that suggested threshold.

That’s a task that can get complicated, and fast. To help you manage it, here’s what you need to know.

Liquidating Company Stock Requires Consideration of Several Variables

The suggested guideline for how much exposure to a particular stock that’s safe to maintain is just that: a guideline. The 10-15% range is not a hard and fast rule, so the first thing to understand is that you don’t have to maintain this all the time with no exceptions.

There may be times when you intentionally hold your shares in hopes that the stock price increases. Other times, holding period requirements, unvested shares, stock price fluctuations, blackout or lockup periods, and other factors may prevent you from having complete control over what percentage of your net worth is exposed to those shares at any given moment.

The second major consideration when thinking about how to strategically liquidate company stock is potential tax impacts. The tax rules that apply will vary depending on whether you have an employee stock purchase plan, non-qualified stock options, incentive stock options, or restricted stock.

For example, you may want to consider questions like:

Should I recognize ordinary income now, or defer it until later?
Do I have stock with a basis that is equal to the market value of the stock that I can liquidate with little or no tax consequences?
Do I have stock at a loss?
Should I exercise and hold options to take advantage of long-term capital gain rates in the future?
What is the AMT impact if I exercise and hold my incentive stock options?

There is no single“right” answer to these questions. But it is possible to develop a strategic way to liquidate company stock by considering what type of equity comp you have and what tax considerations apply to your situation based on what you have — and your overall investment goals and objectives.

The Tax Impact of Liquidating Shares of Company Stock You Own Outright

If you don’t receive equity compensation, you can still own company stock by purchasing it on the open market through a brokerage account or other investment account. When you purchase any stock, from your company or otherwise, the price you pay for shares is known as the cost basis. Generally speaking, the tax implications when you sell your shares will be based on the cost basis and the fair market value when you sell.

Before selling out of any positions, you’ll want to consider whether the action will result in a short-term capital gain (or loss) or a long-term capital gain (or loss).

Short-term capital gains (and losses) will be recognized if you sell the shares within one year of purchase, and will be taxed at ordinary income tax rates. You’ll have a long-term capital gain (or loss) if you sell the shares one or more years after the date of purchase.

Long-term capital gains are taxed at different rates than ordinary income. If you have a long-term capital gain or loss, the tax rate can be as low as 0% or as high as 20% (for 2021), but you’ll commonly see these at 15%.

Tax Considerations for Liquidating Company Stock from an ESPP

An employee stock purchase plan (ESPP) is a benefit that allows employees to purchase shares of company stock through convenient payroll deductions. If the plan is a qualified ESPP, you may be able to purchase shares at a discount of up to 15%.

Some plans also allow participants to take advantage of a lookback provision as well. This benefit allows you to purchase shares at the offering date price or the purchase date price, whichever is lowest and therefore best for you as the buyer.

There’s no reportable tax event when a qualified ESPP purchases shares on your behalf. However, you do create a taxable event once you sell these shares. The type of tax you need to report and how much you owe depends on a few key factors, including:

The timeline between the offering date, the purchase date, and the sale date of your shares
The discount received
The purchase price and the sale price of the stock.

You may need to claim ordinary income and capital gains (or losses) when you sell your shares. Because so much depends on each individual situation, you may be best served by speaking with a financial advisor and CPA with experience in helping clients managing equity compensation so you know precisely how much you may owe.

How You’re Taxed When You Sell Restricted Stock Units (RSUs)

If you receive restricted stock units (RSUs) as part of your equity compensation, nothing is taxable until your shares vest. Once vested, the total value of the RSUs is subject to being taxed at your ordinary income rate.

Many employers automatically withhold 22% of the value of RSUs once they vest to help employees manage this tax burden. This withholding will cover some or all of the taxes you owe from your vested RSUs, although you may owe more depending on your income tax bracket.

The remaining value of the RSUs will typically be given to you as shares of stock that are deposited into an investment account. The shares often have a cost basis that is equal to the share price when the RSUs vested.

Once RSUs vest, the shares you receive look and act like shares that were purchased outright. If the shares are sold within a year, short-term capital gain/loss tax rules apply. If you hold the shares for longer than a year, the shares will qualify for long-term capital gains/losses when you eventually sell.

Understanding Taxes on Non-Qualified Stock Options

Restricted stock units limit your control over when you can recognize income from them and therefore when you owe taxes, because they’re subject to a vesting schedule. Non-qualified stock options (NQSOs), on the other hand, give you more control over triggering a taxable event.

NQSOs are issued with an exercise price, or the cost of buying the shares. If the current share price of the stock exceeds the exercise price, the stock option is “in-the-money.” If the current share price of the stock is less than the exercise price, it may not make sense to exercise the option and you don’t have to do so.

Your NQSOs become taxable when you exercise them. The spread between the exercise price and the fair market value at exercise is the amount subject to ordinary income and payroll taxes.

Using an example to illustrate, assume your company grants you 1,000 NQSOs with an exercise price of $5. Three years later, the market price of the stock is $50. If you exercised your options at that point, you’d need to claim the following as ordinary income on your tax return:

Ordinary Income = Number of Shares Exercised x (Fair Market Value at Exercise – Exercise Price)

1,000 x ($50 – $5)

=$45,000

Non-qualified stock options can be attractive because there is some control regarding what calendar year the income is recognized. Should you be a high-income tax year, it may make sense to not exercise because it could push your taxable income even higher. Exercising in a lower-income year can make more sense if it saves you on taxes.

If you hold your shares after you exercise your NQSOs, the cost basis of the stock is commonly equal to the fair market value at exercise. Like RSUs that are retained post-vesting, stock you own after exercising looks like shares that were purchased outright.

The Taxes You May Owe on Incentive Stock Options (ISO)

Incentive stock options are often the most challenging in terms of income recognition and subsequent taxation. The taxes you owe can be subject to the timelines between when ISOs are granted, exercised, and sold. The type of tax you’ll owe can vary, too.

With ISOs, you may need to pay ordinary income tax, capital gains tax, the alternative minimum tax (AMT), and potentially other types of taxes as well.

While incentive stock options can present added complications when compared to other types of equity compensation, they also provide some tax opportunities. If you exercise your ISOs according to certain rules, you could secure a lower tax rate on what you owe.

To have your liquidation of shares received from ISOs qualify for long-term capital gains tax rates (rather than ordinary income tax rates), you will need to need to meet the following criteria:

The final sale of stock occurs at least two years past the grant date, AND
At least one year past the exercise date of the option.

Doing so provides you with a qualifying disposition. But if you do exercise and hold shares from your ISOs for one year to achieve this, you may then need to pay the alternative minimum tax (AMT).

You can trigger owing AMT in the year you exercise your shares. The amount you owe is commonly based on the spread between the exercise price of the option and the fair market value when you exercise.

For more information about the alternative minimum tax, you may want to dive deeper into the topic here .

What Does This All Mean?

If you want to strategically liquidate company stock you received through some kind of equity compensation, you need to consider exactly what type of equity you have, where the shares came from, and what the tax implications for your actions may be.

A good strategy to unwind concentrated equity will likely consider both short- and long-term tax implications, current financial conditions, future financial expectations, all the available holding positions, and a shareholder’s overall investment goals and objectives.

*Asset allocation or diversification do not guarantee a profit or protect against loss.

None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation. Tax services are not offered through, or supervised by Lincoln Investment, or Capital Analysts

The above hypothetical examples are for illustrative purposes only and do not attempt to predict actual results of any particular investment.