The Variable Prepaid Forward Contract: An Overview
Let me walk you through what a variable prepaid forward contract is—it's a tool stockholders use to pull cash from some or all of their shares while putting off the capital gains taxes. You get the money upfront, but the sale isn't locked in right away.
You'll see this approach most often with investors holding a big chunk of shares in one company who need cash but want to delay those taxes.
Understanding the Variable Prepaid Forward Contract
Picture this: you're a founder or high-level executive with a ton of company stock built up. You might want to spread out your investments, secure some gains, or just get a large sum of cash. That's where this contract comes in.
With it, you sell the stock to a brokerage and get paid 75% to 90% of its current value immediately, but the deal stays open. Taxes on gains don't hit until it's finalized, when you hand over the shares or equivalent cash within a preset price range to guard against big drops.
It's especially handy in specific situations. Say you're an executive with stock options you can't sell yet due to rules, or a big insider sale would spook the market—this contract sidesteps those issues cleanly.
Plus, that floor and ceiling on the final price shields you from massive losses if the stock skyrockets before closing.
I have to note, though, this whole thing is controversial; some argue it shouldn't even be allowed.
Key Takeaways
- This strategy lets a large shareholder cash out while delaying capital gains taxes.
- The sale isn't finalized, which benefits holders of stock options with future exercise dates.
- It's controversial and often draws IRS scrutiny.
Technical Details and Scrutiny
At its core, a prepaid variable forward contract is like a collar strategy—a combo of a long put and short call on the security—but it adds monetization via a loan against the asset. These used to be pretty advanced, but financial engineering has made them more accessible.
Of course, they catch the eye of the IRS and reporters. Back in 2011, The New York Times spotlighted Ronald Lauder using one to shelter his Estée Lauder compensation, and with exec pay so high compared to average workers, these tactics get a lot of heat.
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