Tax Planning for People with Concentrated Positions

Sometimes when you’re accumulating wealth, your portfolio could become tied to one or more specific assets. When that happens, you’ll have what’s known as a concentrated position. In this post, we’ll explain more about what a concentrated position is, the impact it can have on your finances, and the best ways to manage your taxes when you’re trying to reduce your position.

What is a Concentrated Position?

Most financial experts agree that a concentrated position is any asset that constitutes more than 10 percent of your overall portfolio. An example of this would be a holding of stocks where 10 percent or more of them is a single stock such as GE (General Electric). If the stock were to experience a sudden or major loss, then this would have a significant impact on the overall value of the portfolio.

Though most discussions about concentrated positions are generally about stocks, they can also include other types of assets like real estate or a family business. Real estate, specifically commercial property that the owner intends to use for generating revenue, is free to fluctuate in property value. Likewise, if you own a stake in a family business, this also could have profound implications on your net worth if the business were to go bankrupt.

Therefore, rather than associate a percentage, it might be more appropriate to think of a concentrated position as any asset that can harm the investor’s overall financial situation.

What Are the Risks of Having a Concentrated Position?

There are many reasons why it’s not a good idea to have concentrated positions in your portfolio.

First, there is the obvious lack of diversification. When Wall Street darling Enron collapsed in 2001, it was a shock not only to the financial world but more specifically to those who people who had accepted company stock as part of their retirement plans. Anytime your financial future hinges on the performance of one single company, it puts you in an incredibly vulnerable situation.

Secondly, having a concentrated position may cause you to miss other positive financial opportunities. For example, if the majority of your portfolio is in a real estate holding and the stock market experiences a bull run, then you would have foregone all of the appreciation that would have come with this growth in the economy.

Finally, there is the notion of irrationality. You might hang on to a failing family business because your father or grandfather started it. But this sentiment would mean you’re making financial decisions based on emotion rather than facts. Anytime it comes to your investments, always let the numbers speak for themselves.

How to Manage Taxes for Concentrated Positions?

If you’ve got concentrated positions you’d like to reduce, there are several strategies you can use to keep your taxes to a minimum.

Strategic Selling of Stocks

Before you start unloading any particular stock holdings, you may not want to do this all at once. Doing so may bump you into the highest capital gains marginal tax bracket (currently 20%). To stay within the 15% or even 0% tax brackets, it would be better to work with your advisor and sell your positions over a long and calculated period. 

Net Unrealized Appreciation (NUA)

If your concentrated position is in an employer company stock, then making withdrawals in retirement would be considered as ordinary income. In this specific situation, the IRS will allow you to make an election of employer stock to be taxed as net unrealized appreciation and receive the more favorable capital gains tax rate.

Exchange Funds

If your concentrated position is a stock, rather than sell it and pay taxes on the capital gains, another alternative could be to use what’s called Exchange Funds (or Swap Funds). These are private placement limited partnerships or LLCs where groups of investors are allowed to exchange individual stocks for shares in pooled funds that contain several stocks (similar to a mutual fund).

Grantor Retained Annuity Trust (GRAT)

If you have any wishes to pass on your wealth to future generations, then you could establish a GRAT and contribute your concentrated position to it. By doing so, you’ll not only retain the right to the original value of the assets but also earn a specified rate of return. Then, after the trust expires, your beneficiaries will receive the assets tax-free.

Donate to Charitable Remainder Trust (CRT)

Again, if you’d like to use your concentrated position as an estate-planning opportunity, then another solution may be to form what’s known as a Charitable Remainder Trust (CRT). This is where you move the asset into an irrevocable trust that will eventually be given to the charity of your choice upon the expiration of the trust. Not only does the donor receive an immediate income tax charitable deduction when the CRT is funded, but they will also enjoy an income stream from the appreciation of the assets.

Related: Estate Planning Tips for Protecting Your Assets

Everyone’s situation is different. If you would like to work with a financial advisor to help you determine which solutions may be most appropriate for your situation, we invite you to connect with us by sending an email or filling out our contact form.