CEP Investment Strategies 3 — Questions and Answers
Question 1: A financial advisor suggests using a 'collar strategy' on concentrated employer stock. What does a collar involve?
- Buying call options and selling put options on the same stock
- Buying put options and selling call options to bracket the stock price (Correct answer)
- Selling all shares and reinvesting in an index fund
- Using margin to leverage gains on the concentrated position
Correct answer: Buying put options and selling call options to bracket the stock price
A collar limits both downside risk (via a purchased put) and upside gain (via a sold call), protecting the value of a concentrated position within a defined price range.
Question 2: Which of the following is a primary benefit of using an exchange fund to diversify a concentrated stock position?
- It triggers an immediate capital gain recognition on the contributed shares
- It allows the investor to diversify without triggering an immediate taxable event (Correct answer)
- It eliminates future dividend income on the contributed position
- It converts ordinary income to capital gains automatically
Correct answer: It allows the investor to diversify without triggering an immediate taxable event
An exchange fund allows an investor to contribute appreciated shares and receive a partnership interest in a diversified pool, deferring the capital gain that would otherwise arise from an outright sale.
Question 3: When must a Section 83(b) election be filed after receiving restricted property subject to a substantial risk of forfeiture?
- Within 30 days of the transfer (Correct answer)
- By the due date of the employee's tax return for that year
- Within 60 days of grant
- At any time before the property vests
Correct answer: Within 30 days of the transfer
An 83(b) election must be filed with the IRS within 30 days of the date of transfer of the restricted property; missing this deadline permanently forfeits the election.
Question 4: An employee exercises NQSOs and immediately sells the acquired shares. Which tax rates apply to the transaction?
- The spread is taxed as long-term capital gain; any additional gain is ordinary income
- The spread is taxed as ordinary income; any additional post-exercise gain is capital gain (Correct answer)
- The entire proceeds are taxed as ordinary income
- The spread is subject to only payroll taxes, not income tax
Correct answer: The spread is taxed as ordinary income; any additional post-exercise gain is capital gain
For NQSOs, the spread at exercise is ordinary compensation income (subject to payroll taxes), and any subsequent appreciation from exercise price to sale price is a short- or long-term capital gain.
Question 5: What is the purpose of a 'Rule 144' filing when a company affiliate sells restricted or control securities?
- To register the shares with the SEC for public resale
- To satisfy volume, holding period, and manner-of-sale conditions allowing affiliate sales without full registration (Correct answer)
- To notify the company's compensation committee of an insider sale
- To trigger the lock-up expiration for post-IPO shares
Correct answer: To satisfy volume, holding period, and manner-of-sale conditions allowing affiliate sales without full registration
Rule 144 provides a safe harbor for affiliates and holders of restricted securities to sell without registration, provided they comply with holding period, volume limits, current public information, and manner-of-sale requirements.
Question 6: Which of the following best describes 'dollar-cost averaging' as applied to equity compensation decisions?
- Selling all vested shares at once to capture the current market price
- Exercising or selling equity grants in scheduled increments to reduce timing risk (Correct answer)
- Diversifying equity awards across multiple brokers for SIPC coverage
- Electing different exercise methods for each vesting tranche
Correct answer: Exercising or selling equity grants in scheduled increments to reduce timing risk
Dollar-cost averaging in this context means systematically exercising or selling equity awards in regular installments to reduce the risk of choosing a single unfavorable price point.
Question 7: Under Section 409A, what is the consequence of a non-compliant deferred compensation arrangement?
- The deferred amount is forfeited to the employer
- The deferred amount becomes immediately taxable plus a 20% excise tax and interest penalty (Correct answer)
- The employee must return the compensation and renegotiate the deferral
- The arrangement is automatically corrected without tax consequences
Correct answer: The deferred amount becomes immediately taxable plus a 20% excise tax and interest penalty
Section 409A violations cause the deferred amount to be included in gross income immediately, subject to an additional 20% excise tax plus premium interest, making compliance critical.
CEP Investment Strategies 3
A financial advisor suggests using a 'collar strategy' on concentrated employer stock.
What does a collar involve?