What about estate planning? – Upon a person’s death, their assets generally receive a step up in basis. This means that upon inheriting an asset, the cost basis for the asset is equal to the value at the date of death. If you hold a single, large, highly appreciated asset, it may make sense to hold the position as opposed to selling it and diversifying.
For example, let’s assume that you have an asset worth $1,000,000 that you paid $50,000 for many years ago. If you sell the asset now, you will pay $142,500 in capital gains tax (assuming a flat 15% rate). If you die holding the asset and your beneficiaries sell it the next day (assuming the price stays the same), your beneficiaries’ basis will be $1,000,000, and they will not have to report any capital gains – a tax savings of $142,500.
Psychological Barriers
While the decision to sell and diversify may make sense on paper, taking the action to do so may be difficult for some.
For example, some may have worked for a company since its infancy or for many years and feel a strong sense of loyalty. They may feel that selling the shares is a disloyal act toward their employer.
Others may have inherited a position from a spouse and/or another family member. In an effort not to offend their loved one’s memory, they may elect to retain the stock because “this is what he or she would want me to do.”
Other psychological barriers include having a “feeling” that the stock price will go up because it always has in the past. Another barrier may be picking an artificial stock price at which you will sell if the stock price reaches that price or waiting for the stock price to reach a value that it once was previously, locking in on a high point that may or may not be attainable.
In fact, these psychological barriers are so common that extensive research is being completed in the field of behavioral finance. This research relates to how our emotions impact our decision making, specifically as it pertains to finances and investments.
Legal Barriers
For senior executives or members of a board of directors, constraints may be in place that impact their ability to liquidate their shares as freely as other shareholders can.
While beyond the scope of this discussion, it’s important to know that certain key employees are subject to rules regarding notification and reporting of transactions; no trading on material, non-public information; no short-swing profits; and limitations on trading of the founder’s stock.
Non Qualified and Incentive Stock Option Planning
In the end, the decision to retain or sell some or all of one’s incentive stock options should take into consideration personal financial well being and individual goals and objectives.
However, this should be coupled with attention to other technical and behavioral considerations, such as taxes and/or personal barriers to liquidation.
Once all of this has been considered, it should be much easier to create a path to retain, sell, or transfer shares in a manner that attempts to optimize the outcomes for the shareholder.
The following article was republished with permission from Daniel Zacjac.