7 Year-End Tax Planning Strategies for Executives

Posted in , , , , , By David M. Smith

As we approach year-end, many executives and professionals will have the opportunity to make some financial decisions that can have a big impact.  Many of these decisions will have tax implications.  Here is a look at a few of these issues and seven strategies that can help. 

The strategies covered in this article: 

  1. Tax Loss Harvesting
  2. Exercising Options
  3. How to Handle Restricted Stock
  4. Tax Bracket Management
  5. Donating Appreciated Securities
  6. Bunching Charitable Donations and Using a Donor-Advised Fund
  7. College 529 Contributions & Gifting

1. Tax Loss harvesting

The end of the year is the perfect time to review your portfolio holdings.  Positions worth less than when they were purchased can be sold to realize a capital loss.  Realized losses can offset realized gains in your portfolio.

If a security is held less than one year, it is categorized as a short-term loss, and if held greater than one year, it is categorized as a long-term loss.  All short-term gains and losses are netted for the tax year and the same is done for long-term gains and losses.  If there are more losses than gains for any category, they can be used for the other category.   This reduces taxes which would have been due on the gains.  After netting out the transactions, if there are more realized losses than gains, $3000 of the capital loss can offset ordinary income and any remaining loss balance is carried forward to the next tax year. 

Now that you have sold some positions for losses, you may want to invest the proceeds.  But beware of the Wash Sale Rule which states if you sell a security and buy substantially the same security within 30 days before or after the date of sale, the loss is disallowed.  So, no transactions for the same security if you want to claim the loss.  Also, if you sell an S&P Index fund ETF do not buy a S&P Index Fund from another company.  Pick an investment that is "substantially different," there are plenty to choose from that will meet the same goal.

Losses aren't fun, but at least they can be put to some good when used to offset some of your investment gains.



2. Exercising Stock OPtions

Stock options come in two varieties:

  • Incentive stock options (ISO)
  • Non-qualified stock options (NSO)

For ISOs, there is no tax hit upon the exercise of the option itself. Taxes come into play when the stock is sold. The gain can be taxed as ordinary income if the shares are held for less than a full year after exercise or at preferential long-term capital gains rates if the shares are held for at least a year and a day.

The exercise of an ISO can trigger an alternative minimum tax (AMT) issue, however. The difference between the stock’s fair market value (FMV) and its exercise price is taxable under the AMT system. As a practical matter, this will probably have a lesser impact for 2018 and beyond given some of the changes to the AMT under the Tax Cuts and Jobs Act of 2017 (see more on the AMT changes below).  If the stock is sold within the same tax year in which it was exercised there is no AMT issue as the tax is on the sale transaction details.

For NSOs, there is no tax impact when the option is granted. Potential tax issues start when the options are exercised. The bargain element or spread is considered to be compensation at that time and is taxed at ordinary income tax rates. This, of course, assumes that the holder was fully vested in the options.

A second taxable event occurs when the shares of stock are sold. Depending upon the holding period, any gains from the time of exercise could be taxed at short-term rates (as ordinary income) or if held for at least a year and a day, at preferential long-term capital gains rates.

Stock options present tax and financial planning issues and opportunities as we approach year-end. We want to emphasize that these issues are intertwined, we never recommend looking at any situation with an eye only towards the tax implications.

A few things to consider in deciding whether to exercise options and whether to sell shares of stock already exercised:

  • Overall, tax brackets are lower across the board. This means the tax hit from any short-term gains would be less than in prior years.
  • While the AMT remains even after the enactment of the new tax code at the end of 2017, fewer taxpayers will be impacted. The maximum AMT tax rate was reduced and the thresholds for triggering the tax were raised.
  • As with any investment decision, the long-term investment implications should be considered along with any tax implications.
Special AMT Considerations for ISOs:

The new tax law raised the thresholds for individuals to be subject to the AMT, but the legislation did not eliminate the AMT.

For 2018 AMT thresholds include:

  • The maximum AMT tax rate was reduced from 39.6% to 28%. Additionally, the exemption on income not subject the AMT has been increased.
  • The amount of income exempt from the AMT has increased from $84,500 to $109,400 for those married filing jointly, and from $54,300 to $70,300 for single filers.
  • The level where the exemption phases out was raised to $1 million for married filers and $500,000 for others.

This all means that the tax bite for AMT items, like exercising ISOs, will be lower than in prior years.

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3. How to Handle Restricted Stock

Restricted stock units (RSUs) are shares of company stock granted to employees. There is generally a vesting schedule after which time they revert to full ownership by the employee to whom they were granted.

When the shares vest, they are assigned a fair market value and they are taxed as income to the employee. A portion of the shares is generally withheld to cover taxes. Once received, the shares are yours to sell or hold as you see fit.

As you can see, the potential tax hit on RSUs upon vesting is quite high as they will be taxed as ordinary income and likely at your highest marginal rate. For high-earning executives, it can cause a big tax blow, even with the lower tax rates under the new tax law.

A strategy to consider is the 83(b) election. This election means that you will pay tax on the fair market value of the shares at the time of the grant. The idea behind this is that the FMV of the stock will be lower at the time the RSUs are granted than down the road when they become vested. In theory, and often in practice, this allows you to pay taxes on the lower valuation at the time of the grant versus the appreciated value at the time of vesting. You must make the 83(b) election within 30 days of receiving the award.  So, this is not necessarily a year-end strategy, but a strategy any time you receive RSUs.

The 83(b) election can save you a lot of money in taxes if indeed the FMV of the shares does appreciate over time. If the value of the shares decreases over time, then you will have paid more in taxes than necessary by taking the 83(b) election.  An additional issue is that you will need to front the money from your own funds versus having some shares withheld from vested shares.

This is both a decision about potential tax savings as well as the prospects for the stock over the vesting period.



4. Controlling Your Income When You Can - Tax Bracket Management

One of the most powerful tools in the planning toolkit is controlling the timing of your income when you can.  A lot of compensation is uncontrollable, such as base salary and yearly bonuses.  But an employee can pick the timing of exercising stock options to manage their income.  You'll want to exercise in-the-money stock options before they expire anyway, so pick a good time to do so.  A lot of employees will exercise them just before they expire, but that is not always the best time to take the income.  The idea is to control how much income you receive in any given year and not exceed a certain tax bracket and pay a higher tax rate than necessary.  In a low-income year, exercise more stock options.  In a high-income year, exercise none or fewer stock options.  Use the Federal tax rate table as your guide and be aware of the impact of state taxes as well.  With a little planning, you can shift income from one year to another to reap tax savings.


5. Donating Appreciated Securities

Donating appreciated securities, such as mutual funds, ETFs and shares of individual stocks, has long been an excellent way to make charitable contributions. 

The market value of the donated securities on the date they are donated represents the value of your contribution and is the value you would use in itemizing the donation as part of your itemized deductions.  For shares held for over a year the full market value is deductible. For shares held less than one year, your deduction is limited to the amount of your cost basis in the shares.

Beyond the value of the donation, this method eliminates any tax on gains that would arise if the security was sold outright.  Under the new tax rules, this benefit remains even if the value of the donation cannot be itemized due to the increased standard deduction levels and the SALT limitations.



6. Bunching Charitable Donations and Using a Donor-Advised Fund

There were no changes in the ability to deduct charitable contributions arising from the new tax law. There were a couple of changes that might make it more difficult for some to itemize deductions.

  • The standard deduction was increased to $12,000 for single filers and to $24,000 for those who are married and filing jointly. Those over 65 get to add an additional $1300 to the standard deduction as well.  These are almost double the rate for 2017. What this means is that the amount of itemized deductions needed for itemizing to make financial sense is higher than in past years. Many more taxpayers will be using the standard deduction in 2018 than in past years.
  • Tax reform also capped the SALT (state and local taxes) deduction at $10,000. The biggest components of the SALT deduction are typically property taxes and state income taxes. This will cause many in higher income brackets to lose the ability to itemize $5,000 - $10,000 or more in expenses that they had itemized in prior years. Along with the increased standard deduction levels this makes the hurdle to be able to itemize deductions that much higher.

While many would likely donate to the charities they support with or without the deduction, it makes sense to donate in the most tax-efficient manner possible.  Here are a couple of suggestions for year-end donations: 

You might consider bunching deductions into a single tax year if you find that you might be short of the threshold where itemizing deductions makes sense. For example, if you might consider donating $10,000 to an organization over a several year period, consider donating all or a larger portion of that amount this year or perhaps in 2019 to get your total itemized deductions over the $12,000 or $24,000 levels based on your filing status.

One tool that can help in bunching charitable contributions, and charitable giving in general, is a Donor-Advised Fund (DAF). A DAF is a pooled fund where you can choose a pooled investment like a mutual fund. Gifts can be made in the form of cash or securities. Donors direct the donations to accredited charitable and non-profit organizations which are called grants.

A donation to the DAF can be made in one year, with the grants doled out over a period of time.  The tax deduction is realized for the year you donate the DAF.

DAFs offer a lot of tax planning flexibility for our clients. They offer a great vehicle for bunching deductions into a single year for those who need or want to do this. The money donated is invested and grants can be made to the organization(s) of your choice over several years. The market value of your donation at the time of the gift is the amount that is used to determine the value of your charitable contribution.



7. College 529 Contributions & Gifting

You'll want to complete any gifts to college accounts by year-end.  The annual gift tax exclusion amount is $15,000 for 2018.  Each parent can contribute up to $15,000 annually to a child's 529 without affecting their lifetime estate and gift tax exemptions.  You can even utilize a five-year election and make a lump sum contribution worth five year's contributions, or $75,000 ($150,000 for a couple).  Though no federal tax deduction is available for making the contributions, some states offer tax breaks or incentives.  And the investments can grow federal tax-free with no tax on the distributions if they are used for qualified college expenses.

The annual gift tax exclusion amount not only applies to 529 college savings accounts, but any gifts made to family or friends.  Keep in mind that you don't have to gift cash but can gift low-cost-basis securities.  This is a great option for those with young adult children in a much lower tax bracket as the children can sell the securities and pay lower or even no capital gains tax. 



Year-end tax planning is always complicated and will be again this year as well with changes arising from the recent tax reform legislation.  But by putting some thought into year-end planning and taking advantage of available strategies can go a long way to reducing your tax bite and positioning you financially for the next year. 


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We regularly help our clients plan around complex issues like options and restricted stock units. We also integrate year-end strategies and tax planning for all our clients in our financial planning recommendations.  Give us a call to discuss your unique situation to see how we can help you.

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About the Author David M. Smith

David is a Senior Financial Advisor and the firm’s Co-Chief Investment Officer. He has more than 20 years’ experience in the financial services industry and holds the highly respected Certified Investment Management Analyst™ and Certified Financial Planner™ designations; he is a Co-Managing Member of the firm.
Disclaimer and Disclosures: Past performance is no guarantee of future results. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Our opinions are subject to change without notice as market and economic conditions shift.