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

• Author: Rubin, Aaron
• Position: Taxationadvice

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.

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