CPWA BM > Section 9 Planning for Executives > Flashcards

Section 9 Planning for Executives Flashcards

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1
Q

Which type of stock option creates AMT exposure?

A

Incentive Stock Options (ISOs) → NQSOs/NSOs do NOT trigger AMT

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2
Q

What event triggers AMT for ISOs?

A

Exercise of ISOs → Bargain element (FMV – strike) is an AMT preference item

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3
Q

What is the bargain element in ISOs?

A

FMV at exercise – strike price → amount included in AMT calculation

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4
Q

Why can exercising ISOs create a liquidity issue?

A

Exercising ISOs creates a bargain element (FMV – strike price) that is taxed under AMT, even if the shares are not sold → tax owed without receiving cash.

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5
Q

What is the key planning tradeoff with ISOs and AMT?

A

Holding shares may qualify for long-term capital gains, but triggers AMT on the bargain element at exercise and creates risk of paying tax on unrealized gains.

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6
Q

How does AMT basis differ after exercising ISOs?

A

Regular basis = strike
AMT basis = FMV at exercise (strike + spread)

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7
Q

What happens if stock declines after paying AMT on ISO exercise?

A

Client may have paid tax on value that disappears → can recover via AMT credit, but timing is uncertain

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8
Q

What is a Section 83(b) election?

A

Election to pay tax at grant (instead of vesting) on restricted stock

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9
Q

How are restricted stock and RSUs taxed by default (no 83(b))?

A

Taxed as ordinary income at vesting based on FMV

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10
Q

When is an 83(b) election most beneficial?

A
  • Low value at grant * High expected appreciation → future gain taxed as capital gain
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11
Q

What is the main risk of making an 83(b) election?

A
  • Pay tax upfront * No refund if forfeited
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12
Q

What is the deadline and key requirement for an 83(b) election?

A

Must file within 30 days of grant → applies only to restricted stock (not RSUs)

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13
Q

What are the main types of executive equity compensation?

A
  • Stock options: ISOs, NQSOs * Restricted stock / RSUs * Stock appreciation rights (SARs) / Phantom stock
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14
Q

Key difference: Restricted stock vs RSUs

A
  • Restricted stock: Ownership at grant, eligible for 83(b) * RSUs: No ownership until vesting, taxed at vesting
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15
Q

How are stock options (ISOs vs NQSOs) generally taxed?

A
  • ISOs: Favorable tax treatment, potential AMT * NQSOs: Ordinary income at exercise
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16
Q

What are Stock Appreciation Rights (SARs)?

A

Right to receive increase in stock value → typically paid in cash, taxed as ordinary income

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17
Q

What is phantom stock?

A

Promise of cash tied to stock value → no actual shares, taxed as ordinary income when paid

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18
Q

When is nonqualified deferred compensation taxed?

A

When paid/received; taxed as ordinary income

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19
Q

What is the key tax advantage of deferred compensation?

A

Tax deferral → income recognized in a future year (potentially lower tax bracket)

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20
Q

What is the primary risk of deferred compensation plans?

A

Employer credit risk → assets are unsecured promises

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21
Q

How does timing impact tax planning with deferred compensation?

A

Client can choose when income is recognized → manage tax brackets and retirement income

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22
Q

What happens if deferred compensation rules (e.g., 409A) are violated?

A

Immediate taxation + penalties and interest

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23
Q

How is restricted stock taxed vs RSUs?

A

Restricted stock → taxed at grant (if 83b) or vesting; RSUs → always taxed at vesting

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24
Q

How is phantom stock taxed vs restricted stock?

A

Phantom stock → ordinary income when paid (cash); restricted stock → potential capital gains

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25
How are performance shares taxed compared to RSUs?
Performance shares → taxed when performance conditions + vesting are met; RSUs → taxed at vesting
26
Which equity compensation types can generate capital gains?
Restricted stock (especially with 83b) and stock options (after exercise)
27
Which compensation types are always taxed as ordinary income?
RSUs, phantom stock, SARs, deferred compensation payouts
28
What key factors should be evaluated when comparing equity compensation types?
Timing of taxation, ordinary vs capital gains treatment, and risk (forfeiture or employer credit risk)
29
What is the short-swing profit rule under Section 16(b)?
Insiders must give back any short-term trading profits made within 6 months.
30
Who is subject to Section 16 rules?
Corporate insiders → officers, directors, and >10% shareholders
31
What is insider trading?
Trading based on material nonpublic information (MNPI)
32
What is an exercise window (trading window)?
Period when insiders are allowed to trade, typically after earnings releases
33
What is a blackout period?
Period when insiders are prohibited from trading due to MNPI risk
34
How can executives legally sell stock while avoiding insider trading risk?
Use a Rule 10b5-1 trading plan (pre-scheduled trades)
35
What is a cashless collar?
Strategy using a protective put + covered call to limit downside and upside
36
What is the goal of a cashless collar?
Reduce downside risk while giving up some upside, often with little/no net cost
37
How does a cashless collar impact upside and downside?
* Downside protected (put) * Upside capped (call)
38
What is a key tax consideration with collars on concentrated stock?
May trigger constructive sale rules if structured improperly
39
When is a cashless collar most appropriate?
Client has large concentrated position and wants risk reduction without selling
40
What is a prepaid variable forward (PVF)?
Contract to receive cash now in exchange for delivering variable shares later
41
What is the goal of a PVF strategy?
* Monetize stock without immediate sale * Defer taxes * Reduce downside risk
42
How does a PVF provide downside protection?
Share delivery varies → client keeps more shares if price rises, fewer if it falls
43
What is a key tax benefit of a PVF?
Defers capital gains tax (no immediate sale)
44
What is a key risk or tradeoff of a PVF?
** * Limited upside * Complexity *
45
What is the goal of using portfolio margin in concentrated stock positions?
Generate liquidity without selling the stock
46
What is the key benefit of portfolio margin strategies?
Access to low-cost borrowing while maintaining market exposure
47
What is the primary risk of using portfolio margin?
Margin calls if stock value declines
48
When is portfolio margin most appropriate?
Client wants liquidity but expects stock to appreciate
49
What is an exchange fund?
Pool of investors contributing concentrated stock in exchange for a diversified portfolio interest
50
What is the primary goal of exchange funds?
Diversification without triggering capital gains tax
51
What is a key requirement to receive tax deferral in an exchange fund?
Must hold fund interest for ~7 years
52
What is a key drawback of exchange funds?
Illiquidity + lack of control over holdings
53
What is the goal of using a CRT with concentrated stock?
* Sell stock tax-deferred inside trust * Generate income stream * Provide charitable benefit
54
What is the key tax benefit of contributing stock to a CRT?
* Avoid immediate capital gains tax * Receive charitable income tax deduction
55
What income feature does a CRT provide?
Client receives income for life or term, remainder goes to charity
56
What is a key tradeoff of a CRT?
* Irrevocable * Assets ultimately go to charity (not heirs)
57
What is the purpose of a Rule 10b5-1 plan?
Allow insiders to sell stock under a pre-set plan, avoiding insider trading violations
58
What is the key benefit of a 10b5-1 plan in concentrated stock?
Enables systematic diversification over time
59
What is a key requirement for a valid 10b5-1 plan?
Must be established when not in possession of material nonpublic information
60
What is the goal of gifting appreciated stock?
* Remove appreciation from estate * Shift future growth to beneficiaries
61
What is the key tax consideration when gifting stock?
* Carryover basis transfers to recipient
62
When is gifting stock most effective?
When stock is expected to continue appreciating
63
Cashless option exercise – how does it work?
A broker pays the exercise price to the issuer, sells enough shares from the option exercise to cover the exercise price and taxes, and delivers the remaining proceeds to the executive in a same-day transaction. Broker handles everything → sells shares → no loan → same-day event
64
Section 83(b) election – tax effect
Employee is taxed now on the value as ordinary income, and the employer gets a deduction in that same year
65
How are CRT distributions taxed?
Distributions are taxed under a 4-tier system: Ordinary income Capital gains Tax-free income Return of principal → Taxes are paid over time as income is received (no tax at sale inside the trust)
66
NQSOs vs ISOs (tax trigger, income type, AMT)
NQSOs vs ISOs * Tax trigger: NQSO → Exercise ISO → Sale of stock * Taxable income: NQSO → Ordinary income ISO → LTCG potential * AMT impact: NQSO → None ISO → Preference item at exercise
67
NQSOs vs ISOs (eligibility, transferability, grant limits)
NQSOs vs ISOs * Who: NQSO → Employees, directors, consultants ISO → Employees only * Transferability: NQSO → Transferable ISO → Non-transferable (except at death) * Grant limit: NQSO → None ISO → $100,000 rule
68
Another way of saying exercise is
purchase, exercising is when you purchase the shares
69
For ISO favorable (qualified) treatment, you must meet BOTH:
2 years from grant ✔️ 1 year from exercise ✔️
70
What happens in a qualified disposition of ISOs?
(Meets MORE than 2 years from grant + 1 year from exercise) * No ordinary income * Entire gain = LTCG (sale price − strike price) * Bargain element → never taxed as ordinary income * Prior AMT paid → may be recovered via AMT credit
71
What happens in a disqualifying disposition of ISOs?
(Fails holding period) * Bargain element → ordinary income * Additional gain → capital gain (ST or LT depending on holding after exercise) * No AMT issue if sold in same year as exercise
72
What is the maximum aggregate value of ISOs that can first become exercisable in a calendar year?
$100,000 limit (per year) * Based on grant date FMV * Excess → treated as NQSOs
73
What are the key tax rules for NQSOs (grant vs exercise)?
* Grant: Not taxed unless readily ascertainable FMV (rare) * Exercise: Bargain element → ordinary income * Not capital gain at exercise
74
Which statements about NQSOs are true?
* Exercise price can be below, at, or above FMV ✔️ * Typically transferable ✔️ * Not taxed at grant (unless rare FMV case) ✔️ * NOT capital gain at exercise ❌ (ordinary income)
75
What is a cashless exercise and what is its purpose?
* Broker fronts funds (Reg T) and immediately sells shares to cover exercise price + taxes (no extra margin) * Employee keeps remaining shares/cash Purpose: * Allows exercise without using personal cash * Provides immediate liquidity and reduces risk exposure
76
What is stock swapping (pyramiding) when exercising stock options?
* Employee uses existing shares instead of cash to exercise options * Shares are surrendered to cover exercise price * No out-of-pocket cash needed
77
What option exercise strategies are best for maximizing long-term wealth while minimizing cash outlay and taxes?
* 83(b) election → pay tax early at lower value * Stock swapping (pyramiding) → use existing shares instead of cash
78
What is the key risk of executive deferred compensation plans (nonqualified)?
* Deferred comp remains part of company’s general assets * Employee is an unsecured creditor * If company goes bankrupt → benefits may be lost
79
What are the key features of a SERP?
* Nonqualified, employer-funded executive plan * Taxed as ordinary income at distribution * Employee is unsecured creditor (bankruptcy risk) * Can be defined benefit or defined contribution
80
What is the best strategy when a client wants to exercise ISOs early and hold shares while managing tax risk?
* Gradually exercise ISOs * Manage AMT exposure * Avoid large tax hit in a single year
81
Under Rule 144, how long must unregistered (restricted) shares be held before they can be publicly sold?
* 6 months (for reporting companies) * 12 months (if non-reporting company)
82
What are key features of a Prepaid Variable Forward (PVF) contract?
* Defers capital gains taxes until contract settlement * Investor receives cash upfront (liquidity + diversification) * Limits upside & downside (price collar) * Does NOT receive dividends (or may receive reduced/adjusted benefits) * Cost = “premium” for liquidity/deferral
83
Why use an equity swap with a collar for a concentrated stock position?
It hedges downside risk and limits upside without triggering immediate capital gains, while also allowing diversification of economic exposure (via the swap) and potentially improving after-tax outcomes compared to a simple collar or sale.
84
What is an Excess Benefit Plan (EBP) and why is it used?
An Excess Benefit Plan is a nonqualified employer plan that provides benefits above IRS limits on qualified plans (e.g., compensation or benefit caps), allowing highly compensated employees to receive their full intended retirement benefit, though it is unfunded and subject to employer credit risk.
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