Madison, Wis.
- We have looked at several types of equity compensation in our last
few columns. Generally, the hope is always the same: if the company
succeeds, the equity compensation holders will get to share in that
success. Sounds easy, right?


Not so fast. If you hold stock options and have not thought about
how they might affect you until the moment of the company's IPO or sale
(or, worse, AFTER the IPO or sale), you will have lost a golden
opportunity to plan.



For this column, I've asked a business associate of mine to take us
through some basic guidelines to prepare for that day. Chris Burque is
a Wealth Management Advisor in the Madison office of Merrill Lynch,
specializing in preparing equity compensation holders for IPOs. I've
asked him to give us all some guidance in how to prepare.


In pre-IPO planning, you should consider three major areas:
providing for your family or heirs, minimizing estate taxes, and
minimizing income taxes.



Providing for family



To provide for your family, heirs or beneficiaries, start
transferring your wealth - even your future wealth - today. By
transferring options before the IPO or merger increases the value,
you'll minimize gift taxes and maximize the wealth passed on to those
you want to be comfortable. There are many ways to accomplish this
transfer without giving up control or spoiling the recipients of your
gifts. Some of the most common and accepted methods are family limited
partnerships and grantor retained annuity trusts.


Family limited partnerships (FLPs) act as a comingled investment
vehicle for your family. With an FLP, you can transfer wealth to the
next generation while retaining control over the asset. In addition,
valuation discounts may reduce transfer taxes, and you may be able to
divide illiquid assets (such as real estate) into units for gifting.
However, you should work with an experienced advisor to ensure that
your FLP is properly designed to meet Internal Revenue Service tests, and an FLP may have additional accounting and administrative costs.



Where significant appreciation is expected, grantor retained
annuity trusts allow you to transfer future growth to a beneficiary
with little or no tax, while the trust pays back to the grantor
(creator of the trust) an annuity stream. This annuity can be in cash
or in the stock that was gifted to the trust. If the trust pays the
annuity with the contributed securities, it may be possible for the
grantor to avoid income tax consequences.


With the right planning in place, you may be able to take advantage of these planning techniques with your stock option rights.



Minimize taxes



We all know too well that life is fleeting, and so does the IRS.
Estate taxes are onerous, and you have the choice to direct your
fortune to those you love and to philanthropic projects that you
admire. At this stage, you can set up trusts to be used after the
explosion of growth, such as family foundations, charitable remainder
trusts, charitable lead trusts, and life insurance trusts.



You might also be able to use valuation discounts to leverage these
transfers. Valuation discounts can be thought of in the following ways:
a large block discount reflecting the market impact of selling a large
block of stock; minority and non-controlling interests in closely held
corporations or partnerships; and restrictions on disposition. After
the IPO or merger, using valuation discounts will be much more
difficult.



Minimize income taxes



With success often comes increased income. This income comes not
only in the form of a paycheck, but also from a variety of compensation
awards, such as employee stock options and restricted stock grants. The
Internal Revenue Code states that if you receive restricted stock as
compensation, you will not be subject to federal income tax until the
restriction lapses.


In most cases, the value of the stock rises when any restriction on
transfer ceases. If you receive restricted stock and it is subject to a
substantial risk of forfeiture, then under IRC Section 83(b) you can
elect to be taxed on the value of the restricted stock at the time you
receive the stock, rather than on the higher unrestricted value,
potentially saving you significant tax dollars.


However, under IRS guidelines, you have only 30 days upon receipt
of the restricted stock to make this election. As we have discussed in
earlier columns, the opportunity to plan is gone after a limited amount
of time, so working with your advisors earlier is always better.



Related stories



• Sverre Roang and Chris Burque: Your stock options are a success! Now what?



• Sverre Roang: Executive compensation: Besides stock options, what else is there?



• Sverre Roang: ISOs: What's my option worth and when do I get it?



• Sverre Roang: What's so incentivizing about the incentive stock option?



• Sverre Roang: Even with backdating backlash, classic stock option still in vogue