The Advisor Institute: Coach's Corner
The concentration conversation

Practical messages intended to help you elevate the success of your practice.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By David GordonDirector, Eaton Vance Advisor Institute

      Employees of public companies can find themselves in the happy predicament of having a large amount of employer stock to which they can be very attached. However, this attachment can complicate conversations about reducing the risk of concentrated stock.

      While diversification is a hallmark of modern portfolio theory (MPT), many people who hold concentrated positions have a difficult time moving away from the stock that has been so good to them. How can we help clients appropriately diversify?

      Tax code to the rescue

      Some conversation approaches are dead ends. If you have ever challenged a client's rosy expectations regarding their employer's stock performance, you've probably seen that dead end yourself. Consider changing the subject away from your client's attachment to the stock and in the direction of the tax code. The tax code treats some shares of employer stock more favorably than others — either by taxing the eventual sale at a lower rate, deferring the taxable event or both.

      Before offering an example, it is important to note that I am not a tax advisor or legal advisor. In most cases, neither are you. However, by learning how and when various exposures to employer stock are taxed, you can enlist Uncle Sam's help with the concentration conversation. You can help clients see how and why the tax code makes some shares of employer stock worth keeping for the long term and others worth selling immediately.

      Sell now or later?

      Here is a simple but common example. Many employees keep the shares they get from the vesting of restricted stock units (RSUs), but immediately sell the shares they accumulate from participation in Section 423 Employee Stock Purchase Plans (ESPPs). The tax treatment of both stock sources suggests, however, that the opposite approach makes more sense.

      When RSUs vest and become employer stock, they vest at full market value on the vesting date and are immediately taxable at ordinary income tax rates. The employee receives no discount on the stock and pays the same tax as he or she would on cash compensation. In most cases, therefore, these shares are good candidates for immediate diversification.

      ESPP shares, on the other hand, are often purchased at a discount with after-tax dollars. For Section 423 ESPPs, the next taxable event does not occur until the disposition (sale, gift or transfer) of those shares. If certain conditions are met, most or all of the price appreciation could be eligible for long-term capital gains treatment.

      Bottom line: Understanding the tax code can help improve your diversification conversations.