Wisdom of the Ages

It’s Better to Have A Tax Problem Than An Income Problem

We have been telling our clients this for years. When heard for the first time, clients laugh and nod their heads in agreement. Easy to say but hard to swallow. Writing a six-figure check for taxes is painful, and we never want our clients to be surprised. To help our clients stay organized, our team tracks taxable events throughout the year, and we report them to our clients’ accounting firms to ensure our clients set aside the appropriate amount of funds for taxes. Even though cash is on hand, cutting a six-figure check to the IRS is shocking – and that doesn’t even include the checks made out to the revenue departments in our clients’ states of residence!

Aside from high cash compensation via salary and bonuses, our clients also experience yearly income via stock option exercising and the vesting of restricted stock units. Stock options carry a 10-year life, so there can be a period when clients first begin to earn option awards, and they are not exercising because they are hoping for further appreciation of the stock beyond the strike price. Eventually, each client hits a point where they can no longer avoid the inevitable, and they need to start exercising option grants every year so that an award does not expire worthless. In most cases, options are exercised via a “cashless” exercise whereby the company settles the grant in net shares. Notably, companies only withhold the statutory minimum state and federal tax, so our team always asks for confirmation statements so we can calculate the portion of the tax due but not yet collected. This helps our clients and their accountants avoid the surprise of finding they owe an additional $50,000 to the IRS!

After decades of experience, we observe that senior leaders with equity-based compensation have difficulty diversifying out of their single-security, concentrated wealth positions. Many clients have holding requirements to concentrate the executive within employer stock forcefully. Other hurdles to diversification are the quarterly earnings reporting periods that block trading and “off-schedule” periods where an officer can be blocked from trading based on their possession of material non-public information, which restricts them from exercising options on their schedule. Our job is to provide clients with creative solutions along the way to mitigate taxes as much as possible. In the end, we nonetheless believe diversifying is predominantly a risk control issue. Clients who seek the benefits of portfolio diversification generally accept that tax is the price for reducing single-security risk.

The question becomes: how can we diversify without triggering an unnecessary additional tax?

The first and simplest step is to diversify all vesting restricted stock units immediately instead of holding the newly vested units as company shares.

Being strategic about one’s philanthropy is the second simple step toward tax-effective portfolio diversification and risk reduction. Immediately STOP engaging in “checkbook philanthropy.” Checkbook philanthropy means writing checks to one’s philanthropic interests from cash which has already been run through the tax ringer a minimum of once as ordinary income and perhaps a second time as capital gain before turning it into checkbook cash to make that charitable donation. Checkbook philanthropy is all fine and dandy, except it is not the most optimal way to give tax efficiently.

With some forethought, one can obtain a full tax deduction on appreciated stock holdings without paying capital gains tax – a double tax benefit! Preparing for this, we rank 100% of our clients’ taxable securities in a spreadsheet arranged with those positions with the GREATEST gain as a percent of current market value at the top of the spreadsheet. The ranking continues declining to those positions with the LOWEST gain as a percent of current market value at the bottom of the spreadsheet. Frequently, those positions with the most significant gain as a percent of current market value are, you guessed it, long-term held shares from the single security concentrated company stock portfolio.

This built-in gain, tax-ranking of our clients’ portfolios is a powerful tool that sheds light

on potential tax planning and diversification possibilities.

  1. We can use highly appreciated shares from the single security company stock positions at the TOP of the ranking and donate them to charity to achieve a tax deduction on the built-in gain. We use this same strategy within our clients’ diversified portfolios.
    • This technique ends the era of checkbook philanthropy and begins the era of strategic philanthropy while reducing concentrated portfolio risk.
  2. Charitable deductions can be used to offset income from selling additional concentrated shares from the BOTTOM of the built-in gain ranking, thus creating tax-effective cash for further diversification.
  3. Many philanthropic strategies carry surprisingly significant tax and portfolio diversification benefits. For an example of a more complex yet engaging idea, please read our blog on The Greatest Diversification Story Never Told! The NIMCRUT. Stay tuned for part II of this NIMCRUT blog series, focusing on a little-known ability to take and make loans from the NIMCRUT! We have to admit; the NIMCRUT is Getting Better all the time, as The Beatles would say!

In conclusion, THE simplest and least expensive philanthropic tax and portfolio diversification tool is the Donor Advised Fund (DAF). Anecdotally, 95% of our clients set up DAFs immediately upon coming onboard. The Donor Advised Fund is the doorway to thoughtful, strategic, purposeful philanthropic planning and tax-effective portfolio diversification.

We will help any client, or prospective client who wants to open a Donor Advised Fund to get it accomplished. Once opened, we will demonstrate how to navigate the donor portal and help you make your first donation, not to mention your first diversification!

Stoddard Barnhill, CFP®
sbarnhill@thebahnsengroup.com

Sarah Leitzke, CFP®
sleitzke@thebahnsengroup.com

Phillip Barnhill, CLU®
pbarnhill@thebahnsengroup.com

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The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. The team and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

Third-party links and references are provided solely to share social, cultural and educational information. Any reference in this post to any person, or organization, or activities, products, or services related to such person or organization, or any linkages from this post to the web site of another party, do not constitute or imply the endorsement, recommendation, or favoring of The Bahnsen Group or Hightower Advisors, LLC, or any of its affiliates, employees or contractors acting on their behalf. Hightower Advisors, LLC, do not guarantee the accuracy or safety of any linked site.

Hightower Advisors do not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client’s individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor for related questions.

This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.

About the Authors

Stoddard Barnhill, CFP®

Private Wealth Advisor

Sarah Leitzke, CFP®

Private Wealth Advisor

Phil Barnhill, CLU®

Director of Risk Management

For nearly 25 years Phil has worked exclusively with senior leaders of public and large private companies. Over the past seven years Stoddard has been carefully mentored in this niche market and is now mentoring Sarah, leading to a highly-specialized practice knowledge within the team. This focus on corporate executives and their family dynamics comes with significant insights into executive compensation, stock concentration, equity monetization, and the full life-cycle of a career in the C-Suite.

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