Financial Planning: Year-End Planning

Year-end planning can be tricky. We asked five financial advisors for their ideas on planning for year-end 2011 and beyond. Below are their responses, presented in their own words.

Richard Friedman
The Ayco Company
Albany, New York

Unlike that of recent years, year-end planning for 2011 should not involve as much guesswork about tax rates for 2012. Federal rates are expected to remain essentially the same as this year, with increases expected in 2013 (income tax and FICA). However, that does not mean there shouldn't be planning with respect to company stock before year-end. Here are a few issues to consider:

Stock option exercise strategy. It always makes sense to review which valuable stock options will be expiring in the next year or two, as well as which options are deeply in the money, to determine whether it makes sense to exercise before year-end and recognize income in 2011. This analysis should include a projection of both federal and state income taxes for 2011 compared to 2012. The tax rules for each state need to be considered if the employee travels for work among several states that tax nonresidents, as well as if a possible relocation to another state is planned for 2012.

	It always makes sense to review which valuable stock options will be expiring in the next year or two.

Review share ownership guidelines and procedures. For those executives who are subject to share ownership requirements, it makes sense to review how and when targets are measured. In some cases, this is done at year-end, while in other cases it is done every quarter or at some other time during the year. If ownership in company stock needs to be increased, consider various alternatives to achieve this objective. This can include transferring into company stock within the 401(k) plan (which will have no tax consequences), exercising and holding stock options, or deferring into company stock units within a deferred compensation plan or excess 401(k) plan. (An advantage of deferring RSUs to meet share ownership guidelines is that the entire pre-tax value is used to acquire stock units, which almost always count toward meeting the guidelines.) As a general rule, a Section 16 insider should never have an open-market purchase of company stock to minimize the risk of an inadvertent Section 16(b) violation relating to a previous or subsequent sale of company stock within six months.

Deferring RSUs or other long-term incentive awards. If the company allows for the deferral of RSUs, performance share units, or other elements of compensation, review the procedure and timing of making a deferral election. Under IRC Section 409A, deferral generally needs to be made in the year before the compensation is earned. For most companies, these deferral periods are in late November or in December for compensation to be earned the following year. However, a special alternative election is permitted for the deferral of restricted stock/RSUs. This allows for a deferral within 30 days of the date of grant. Thus, an executive should review their company's procedures if they are considering deferring any compensation.

10b5-1 planning. Any employee in possession of material nonpublic information may want to consider the advantages of entering into a 10b5-1 trading plan during the next open window period, or when not in possession of important confidential information. This can help to reduce the risk of violating the insider-trading rules.

	Beginning in 2012 (for stock sales in 2011), there will be new rules for reporting your tax basis on IRS Form 1099-B.

New basis reporting rules. Beginning in 2012 (for stock sales in 2011), stockbrokers and others will have new rules for reporting your tax basis on IRS Form 1099-B that should make it easier for keeping and reporting transactions involving company stock.

Roth conversions and recharacterizations. Volatile markets have led to some taking advantage of the recharacterization election (essentially undoing a Roth conversion) available to those who made Roth elections within their IRAs. Roth conversions will continue to be an important opportunity for many people in 2012. Those individuals with Roth IRAs will want to review whether a conversion or recharacterization election is appropriate before year-end.

Miscellaneous planning opportunities. Some other planning opportunities involving company stock can be considered at any time. These include using appreciated company stock for charitable gift purposes or funding a GRAT; and electing dividend-flow, if permitted, under a 401(k) plan to meet cash-flow needs without incurring the 10% early distribution penalty. As always, wash sale rules need to be considered before sales at a loss are taken.

Sheri Iannetta Cupo, CFP
SAGE Advisory Group
Morristown, New Jersey

We advise creating a multi-year tax projection using your best estimate of what your 2011 and 2012 tax situations will look like and then using the tax-planning strategies for your stock options and company stock that seem most appropriate. Some ideas are below.

	Wash sale rules apply only to losses. You can harvest gains by selling an appreciated position and then buying back the stock.

Capital gains: for people with appreciated positions in their company stock holdings. For higher-income clients with an appreciated stock position and no loss carry-forwards:

• If it is likely the funds will be used sooner rather than later (e.g. college) or because you anticipate you will change the investment in the near future (e.g. concentrated position in employer stock, so you plan to sell to invest proceeds in a diversified portfolio), then consider harvesting gains now at a 15% federal rate.
• Keep in mind that wash sale rules apply only to losses. You can harvest the gain by selling the appreciated position and then buying back the investment, thereby resetting the cost basis higher to help with any future sales.

For higher-income clients with an appreciated stock position and substantial loss carry-forwards, if you expect we will see higher tax rates in the future:

• Consider preserving the loss carry-forwards by deferring them to a year when they can be applied against a higher capital gains rate, providing you with greater tax savings.
• Alternatively, you may wish to absorb ALL of your loss carry-forwards this year and then recognize additional capital gains at the 15% rate.

Alternative minimum tax: for people in it now and likely to stay in it. When planning for AMT, create a tax projection to find the break-even point where your regular tax liability and your AMT liability are equal. Then you can better understand how the AMT affects your tax liability.

The AMT exemption amount is subject to a phaseout. This phaseout can cause even higher tax rates (marginal rates between 32.5% and 35%) because each additional dollar amount of income causes $0.25 of the AMT exemption to phase out until the full AMT exemption amount has been phased out.

• You can try to shift income (e.g. stock option exercises) into years when it will not phase out the AMT exemption.
• Conversely, you may wish to shift more income into high-income years when the AMT exemption has already been phased out and you would benefit from paying tax at the 28% top AMT rate rather than at a higher tax rate on ordinary income.

Henry E. Zapisek, CFP
Financial Network Investment Corporation
San Diego, California

	Faced with the specter of higher tax rates after 2012, minimize taxes by selling company stock that has aged enough to qualify for the current favorable (15%) capital gains rate.

Company stock. Every investment plan calls for adequate diversification to reduce risk while capturing a positive return. A review should be made to determine the ratio of company stock to your total investment portfolio. If the ratio is deemed too high, then sales must occur to bring the ratios back in line. Another goal is to minimize taxes by selling company stock that qualifies for the lower 15% long-term capital gains rate, which is set to expire after 2012. Unless Congress acts otherwise, the new capital gains rate could rise to 20% or more in 2013. Thus, you must sell stock held longer than one year in most cases. Due to the specter of higher tax rates in our future, now may be the time to keep more of what you have earned. Thus, review your ratios and minimize the taxes on any sales by choosing company stock that has aged enough to qualify for favorable capital gains treatment.

Alert: If company stock was purchased in an ESPP, your firm now reports the information to the IRS using IRS Form 3922. Thus you must be careful to match IRS Form 3922 with your tax return. (For more on Form 3922, see a related FAQ elsewhere on this website.)

Incentive stock options. Review your option grants to determine if you should exercise in the first few days of 2012. If you exercise and hold the ISO stock early in the year, you can avail yourself of two key strategies. First, if the stock price does not perform to your expectations during the year, you could sell the stock before December 31 to disqualify the ISO and thus avoid the AMT issue. Secondly, if the stock price performs well, you could sell the stock in the following year in time to create the cash to pay for the AMT and get long-term capital gains treatment.

Alert: Companies now report to the IRS on ISOs exercised in 2011. IRS Form 3921 includes information such as the grant date and the exercise price. (For more on Form 3921, see a related FAQ elsewhere on this website.)

Nonqualified stock options. A subtle strategy could be to plan your NQSO exercise in the first quarter of 2012 to help meet the maximum limits for Social Security tax withholding. In this way, you could realize greater take-home amounts later in the year.

One final note of planning for 2011. Alternative minimum tax (AMT) can still be a problem, and thus you must review your AMT exposure. Additional income incurred due to stock transactions could bump you into the AMT category even with the adjusted AMT exemption limits. Please seek a review from your tax professional prior to year-end for additional strategies to cope with this exposure.

Planning for 2013 tax provisions in the new health-care laws. All the transactions discussed above need to incorporate the issue of the 3.8% surtax on net investment income that will become effective in 2013. Capital gains are considered investment income under the modified adjusted gross income (MAGI) threshold amounts. Joint filers above $250,000 and individuals above $200,000 will pay the 3.8% surtax on net investment income when the MAGI exceeds the threshold limits. A word of caution: NQSO exercises could inadvertently push your MAGI above the threshold and make smaller amounts of investment income subject to the 3.8% surtax. Multi-year planning is critical.

Alan Ungar, CFP
Critical Capital Management
Calabasas, California

The current crazy machinations in Washington do not portend well for knowing what is going to happen with tax rates. However, the various deficit commissions are recommending significant changes in the tax code with the objective of raising more revenue while at the same time lowering income tax rates. It is tempting to put off making decisions about when to exercise and when to sell until the dust settles, especially if there is a chance of taxes going down. But it is a mistake to let the tax tail wag the dog of financial prudence.

	It is a mistake to let the tax tail wag the dog of financial prudence.

The pertinent criteria for when to exercise and when to sell stock options is dependent on a person's overall portfolio and the amount of leverage. When leverage is high, exercising early nullifies the major advantage of options.

ISO holders should beware of exercising and holding late in the year. Doing so means you have less opportunity to get out of the hold if the stock decreases in value, while at the same time you will not be able to avoid AMT. ISO exercising and holding should take place at the first of the year, not the last!

If your restricted stock vests before the end of the year, sell when it vests. In fact, this should happen whenever restricted stock has vested. Since the value of the restricted stock is taxed as ordinary income, there is added risk to a "hold" position. Employees who are still holding their restricted stock should seriously consider selling, especially if they have positive capital gains. Even if they don't, $3,000 of the loss they incur can be used as a current writeoff.

John C. Lawson
Tompkins Financial Advisors
Rochester, New York

Executives contemplating transitions to new employers or to retirement during the year ahead should consider the impact of the transition on the potential after-tax value of their employer stock awards—especially as a new tax year approaches with so much uncertainty not only for personal income and investment tax rates but also for estate and corporate taxation as well.

	Executives contemplating job transitions or retirement during the year ahead should consider the impact on the potential after-tax value of stock awards, especially as a new tax year approaches with so much uncertainty.

For stock options, the impact could range from forfeiture of all vested and unvested grants upon separation, to retention of all grants to the original expiration date. The policy will vary from employer to employer, and your latitude to negotiate may be limited, but you should at least understand the rules so that your financial planning can be adjusted accordingly. You may well have planned to bank on the time value and tax deferral inherent in an option with three or more years left to expiration, but suddenly realize that your transition requires you to exercise vested options immediately or within a few years, and to forfeit all unvested options. Consequently, your tax planning is disrupted and potential gain reduced.

For restricted stock, restricted units, and performance share arrangements, the impact will range from forfeiture of unvested grants to continued vesting per the original schedule and pro rata performance awards. In any event, remember that vesting triggers taxation of the shares at the fair market value on the vesting date (unless you had previously elected to defer receipt, in which case only Social Security tax will apply at vesting). The market value is taxed as ordinary income, which then serves as the basis for the later sale of the shares at a capital gain or loss.

Suggested actions:

• Review your employer stock award notices to assess what grants will be forfeited upon separation, which grants will vest immediately, which will vest in accordance with the original schedule, which will retain their original term, or which will suffer a truncated term.
• If disposition of a grant upon separation is subject to employer discretion, seek a decision as soon as is practicable.
• Before separation, verify with the stock plan administrator that your account will properly reflect the correct post-employment status of each grant, and establish a contact for follow-up.
• Know the income breakpoints for personal marginal tax rates.
• When changing employers, investigate qualified and nonqualified pre-tax deferrals of salary and bonus at your new employer to offset the stock awards, severance, and SERPs that may be taxable in the same year upon separation from your current employer (see myNQDC.com for more on nonqualified deferred compensation).
• Try to time your separation to occur in the year that minimizes the tax burden of accelerated vesting and shortened option terms.
• However, don't let focus on tax-effectives blur considerations of stock potential and opportunity costs.

See other sections of this website for more details about stock compensation in both job termination and retirement planning.

Editor's Note: For more year-end ideas, see other articles and the FAQs in our content section on year-end planning.

The financial advisors who submitted written remarks to myStockOptions.com for this article were not compensated for their contributions. The statements made in this article do not constitute personal investment advice and may not apply to your individual circumstances. Consult a financial advisor directly to obtain guidance on your personal financial situation.