Concentrated Low-Basis Stock and Charitable Intent
Client, age 62, has $6 million net worth, including $2.5 million of employer stock with a $300,000 basis. The stock is 42% of her liquid portfolio and has doubled in four years. She needs $120,000/year pre-tax from the portfolio, has $500,000 of charitable intent, and is in the 35% federal bracket plus 5% state. She is risk-averse but hates taxes. Her adviser proposes four ideas: (1) an exchange fund with a seven-year lockup, (2) a zero-cost collar with a $5 call away and $10 put floor, (3) a charitable remainder unitrust paying 5%, and (4) a completion portfolio using direct indexing and tax-loss harvesting. She asks which will let her “diversify without paying tax and still get income.”
1. Compare the four strategies on diversification, tax deferral, income, control, and liquidity.
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Exchange fund: immediate diversification with other low-basis holders, tax deferred until redemption, seven-year lockup, high fees, no income, and carryover basis. Collar: reduces downside and caps upside, but does not diversify, produces no income, and may trigger constructive sale if too tight; liquidity depends on margin. Charitable remainder unitrust: irrevocable, provides a charitable deduction, pays a 5% income stream, can sell the stock tax-free inside the trust, and diversifies, but the client gives up the remainder and control. Completion portfolio: buys non-correlated assets, harvests losses to offset gains, and diversifies gradually; it is liquid but does not remove single-stock risk immediately. Direct indexing adds complexity and tracking error.
2. What strategy or combination would you recommend, and in what sequence?
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Recommend a staged plan. First, retain enough cash or stock for 12 to 24 months of spending. Second, fund a charitable remainder unitrust with $500,000 to $1 million to satisfy charitable intent, create income, and sell stock inside the trust. Third, use an exchange fund for $500,000 to $750,000 if she can accept the seven-year lockup. Fourth, sell $500,000 to $750,000 outright and reinvest in a diversified completion portfolio, using direct indexing to harvest losses. Avoid the collar as the primary diversification tool. Sequence matters: harvest losses first, then sell, then fund the exchange fund or trust. Reduce the single-stock position below 10% to 15% over time and model the tax and cash flow.
3. What are the key risks in the collar and the CRUT, and what suitability checks are needed?
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Collar risks include constructive sale under Section 1259 if the put and call are too tight, loss of upside, counterparty and margin risk, no income, and straddle rules. CRUT risks include irrevocability, loss of remainder to charity, annual valuation, a 5% payout that may not meet her income need, trustee fees, self-dealing rules, and charitable deduction limits. Suitability checks include charitable intent, liquidity needs, risk tolerance, age, tax bracket, estate plan, and alternative minimum tax. Confirm the CRUT meets the 5% to 50% payout and 10% remainder requirements. For the exchange fund, confirm accredited-investor status and lockup tolerance. Document the analysis and the client’s informed consent.