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The 2013 dilemma: highly appreciated company stock and rising tax rates.

In 2012, investors learned that Congress doesn't mind playing hot potato with capital gains rates. Facing volatile markets. executives continue to find themselves under pressure to sell their company stock and diversify and doing so in an ever-changing tax landscape.

At press time. Congress and the President are still negotiating tax rates. Whatever happens. taxes will rise significantly for many affluent households. According to a Jan. 25 Ezra Klean article in the Washington Post, the cost Of Congressional inaction would result in the federal capital gains rate increasing from 15 percent to 25 percent: a combination of the Bush tax cut lapse, a 3.8 percent surcharge levied via the Affordable Health Care Act and 1.2 percent due to reinstatement or the itemize deduction limitations. Couple this with the passage of Prop. 30 in California and the combined effective rate on capital gains transactions may reach 38.3 percent for those with a taxable income of more than $1 million.

Perhaps one of the most overlooked tools to defray the tax cost associated with diversifying a concentrated. low-basis stock position is a professionally managed Active Tax Index strategy (ATI) .

How it Works

Using ATI executives can lock in long-term capital gains from company stock at 2013 rates. engage an adviser to diversify then' holdings and use potential future losses to offset additional gains while not having to worry about a volatile capital pills tax rate.

ATI involves selling some, if not all. of the concentrated position of an investor. and using the proceeds to build a portfolio of individual stocks meant to mirror the returns of a particular index. such as S&P500.

Due to the trading costs associated with purchasing every security in the index, the ATI portfolio will consist of a sufficiently large cross-section of stocks so as to minimize tracking error from the broader index. Over time, some stocks rise and some will fall.

As certain stocks within the portfolio drop, losses can be "harvested" to offset gains from other stocks, including additional shares of the executives heavily appreciated company stock. With careful management of the ATI portfolio, an investor might be able to capture losses equal to 10 percent to 50 percent of the initial investment over a four-to five-year period, according to a May 2012 Aperio Group webinar. Of course. the speed for capturing losses will be a function of general market conditions during the investment period.

Ideally the initial sale of the concentrated stock would be made near the beginning of the year to give the investor the maximum amount of time to harvest losses -and gains from the initial sale of concentrated stock gain can be offset with losses in the ATI portfolio that first year. hi subsequent years, as losses are realized. remaining portions of the concentrated position can be sold with little or no tax cost, based on potentially higher post-2013 rates, and can be reinvested into a more diversified port folio.

Pros and Cons.

Among ATI benefits:

* Investors are able to begin diversifying their holdings in year one.

Instead merely deferring tax consequences from liquidating concentrated stock, the investor has the opportunity to avoid a portion of the tax.

* The portfolio is liquid.

* The costs or simple buys and sells should be lower than more complex models of risk avoidance, such as options.

* Investors do not have to give up control of the asset as when using charitable remainder trusts to defer tax.

The main ATI drawback is that there may be some initial tax pain. While there is opportunity to minimize tax, there will be taxes owed for at least the first yean and then interest and dividends for the following Years. Also, ATI is a long-selling process and the opportunity for loss selling diminishes as the tax selling weeds out the initially underperforming stocks. The adequately performing stocks, winch were not sold. may be sitting on substantial enough gains that even should the market drop substantially, would not be eligible for loss harvesting.

Whether ATI is a fit for your clients, the most important action executives is to work with a well-established adviser with a strong tax background to determine the right plan for them to deal with their highly appreciated stock in these taxing times.


Aaron Rubin, CPA, CFP JD is a senior wealth manager at Werba Rubin Wealth Management, LLC. You can reach him at
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Title Annotation:taxationadvice
Author:Rubin, Aaron
Publication:California CPA
Date:Jan 1, 2013
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