Separately Managed Account
Sep 17, 2026|ByPatrick Geddes
A wave of high-profile IPOs in 2026 may endow many employees with wealth windfalls. Guidance from their investment managers and tax advisors will be essential, especially given the following issues:
- The complicated tax rules for different types of equity compensation.
- Restrictions on reducing risk through sales and hedging at different phases of the IPO.
- The variety and complexity of portfolio tools available to help maximize after-tax wealth.
Since many employees may feel overwhelmed by the decisions they need to make before and during an IPO, we’ll begin with an overview of the main types of equity compensation they may hold. Advice on those choices may represent the first challenge employees need help solving. Then we’ll turn to some of the various portfolio strategies that may further help manage their risk and tax consequences.
Step 1: Making Good Decisions on Equity Compensation
The first step in IPO planning is understanding for which decisions around equity compensation the employee controls the timing of the tax recognition event, for which they have no control, and how each affects tax liability. The table below summarizes timing and tax implications for four of the most common ways in which employees may end up with exposure to their companies’ stock, emphasizing especially when they generate ordinary income and capital gain.
*ISOs generally qualify for long-term gain treatment if two conditions are met: 1) the stock is sold at least two years after grant, and 2) after exercise the underlying stock is held for longer than a year before sale. ISOs can also trigger problems with Alternative Minimum Tax (AMT), as the exercise, while not a taxable event for conventional tax, is taxable under AMT.
†ESPPs can have different tax treatment based on whether qualified or nonqualified.
Since tax rules can vary across various situations, the descriptions above should be construed only as general guidance since so many exceptions may apply. Consult a tax expert before making any decisions.
Advisors helping employees consider the best decisions for their specific situations will need to incorporate issues like the employees’ long-term financial goals, need for diversification, and tax situation. While it’s always wise advice to “consult your tax advisor,” it’s especially true in the case of complicated equity compensation, and it provides a terrific opportunity for wealth and tax advisors to demonstrate how much value they can add by framing the choices. This is not a situation where a do-it-yourself approach will normally suffice given the complexity and need for good tax expertise and planning software. For example, both investment advisors and an employee’s tax advisor may need to analyze a range of possible tax and stock price outcomes across multiple years and varying scenarios, e.g., exercise half the ISOs in 2026 and the remaining ones in 2027, assuming stock price is either flat or rises. This may help advisors demonstrate certain implications of different decisions under the employee’s control, like when to sell stock already held or exercise either type of option, ISO or NSO.
ISOs can present particularly challenging tax implications with respect to the Alternative Minimum Tax (AMT). Advisors can work with clients and their tax advisors to hopefully mitigate the likelihood of painful AMT surprises by planning in advance and understanding how a client’s individual circumstances may affect the likelihood of triggering AMT. For example, in years with high ordinary income from RSUs, AMT may potentially be less likely.
In addition to being clear on the risk implications and reminding clients to consider the potential tax consequences of their choices, advisors may need to come up with ways to paint a simpler picture for employees who may not be familiar with all the terms and conditions affecting their situation and may not even know what they have. The best wealth and tax advisors will be able to switch easily between 1) assessing the nuances of arcane tax issues and 2) explaining choices in plain English for employees who might feel overwhelmed or confused by a lot of unfamiliar tax or investment jargon.
Step 2: What Portfolio Strategies Can Help Experts Manage Risk and After-tax Wealth from an IPO?
After equity compensation decisions are made, advisors can provide even further value by implementing portfolio solutions to help employees manage IPO-related risk, liquidity, and tax consequences. Some of these can potentially be implemented even in advance of an IPO. The table below shows a variety of strategies, in order of the phases around an IPO.
For illustrative purposes only. Lock-up restrictions may apply. These strategies may not be available to all investors. Limitations on managing restricted stock may also apply. Executives and other individuals may be subject to blackout periods during which they are prohibited from buying or selling company shares, including unrestricted, fully vested shares. For more information on these strategies refer to the glossary table below.
The effectiveness of each of these strategies will depend on an employee’s specific tax and financial planning, i.e., no tool in the toolbox can fix all problems. For example, employees facing capital gains could utilize a direct indexing or long/short strategy in a Separately Managed Account (SMA) that, in addition to its pre-tax goals, may generate capital losses that can be used at some point to tax-efficiently diversify any unrestricted, concentrated stock position. However, as discussed in Step 1, only certain types of income from employee compensation will be capital gain.
Turning from tax planning to risk planning, it may not be possible to sell securities or hedge them directly prior to an IPO or during the lock-up period that typically follows. During these restricted terms, a risk-conscious investor may be allowed to enter into a basis hedge or a cross hedge, which rely on securities that are correlated with the IPO stock. Once the lock-up period has passed, direct hedging with a covered call, collar, or exchange fund replication may be possible, as well as monetization through capital efficient borrowing, for which stock can be used as collateral. Each of these transactions has complex tax consequences, and clients should consult their individual tax advisors regarding considerations that may apply to them. For more information on strategies that can help manage risk and after-tax wealth, visit BlackRock’s Tax Center.
Glossary
- Cross-hedging: An investor hedges a concentrated portfolio with a highly correlated proxy when a direct hedge is not available.
- Covered call: An investor sells call options against shares, generating income from the premium received.
- Outright donation: An investor donates some or all of the concentrated portfolio to a charitable entity.
- Collar: An investor purchases an out-of-the-money put option while writing an out-of-the-money call option on the shares. Such a strategy protects against large losses but also limits large gains.
- CRUT (charitable remainder unitrust): A donor transfers a concentrated portfolio to an irrevocable trust. Annuity payments are made to the donor or other noncharitable beneficiaries. The trust is generally tax-exempt, but the annuitant may be subject to income tax on trust distributions. Assets remaining in the trust at the end of the specified trust term pass to one or more charities.
- Exchange fund: Multiple investors contribute stock to a pooled investment vehicle in exchange for a stake in the fund. A stock may be rejected, and a seven-year lockup on accepted stocks may be applied.
- Exchange fund replication: This is an option-based strategy that attempts to synthetically produce many of the benefits of an exchange fund without some of the downsides.
- Hedge-Borrow-Harvest-Exit: An investor hedges a concentrated position by collaring a stock, borrows with a box spread loan, harvests losses in a long/short portfolio, and exits the position.
- Long/short TLH: An investor extends a concentrated portfolio by acquiring additional securities, using borrowed funds, while simultaneously establishing short positions by selling borrowed securities. Larger extensions can lead to increased capacity for loss harvesting, which may speed up diversification.
Variable prepaid forward: In exchange for pledging stock for a fixed term, an investor receives a sizable cash prepayment equal to a large portion of the stock’s value. Taxes are generally deferred until the prepaid variable forward contract matures.
FAQs
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Equity compensation is generally taxed either at ordinary income rates or as capital gain/loss, depending on the type of award and the timing of key events such as vesting, exercise, and sale. Restricted stock units typically generate ordinary income at vesting, though appreciation after vesting may constitute capital gains. Stock options may generate ordinary income or capital gains, depending on type and meeting certain conditions.
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Ordinary income is taxed at marginal income tax rates and is commonly triggered by events such as RSU vesting or exercise of nonqualified options. Capital gains may apply to appreciation after shares are owned or from qualified options. This distinction is central to estimating after-tax outcomes from IPO related equity compensation.
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Lockup periods generally restrict the ability to sell shares but typically do not directly defer taxation. Employees may owe taxes on vesting or option exercise even if their IPO shares cannot yet be sold. This timing mismatch, amongst other things, underscores the importance of planning well in advance of an IPO.
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Exercising incentive stock options may trigger application of the alternative minimum tax, even if no shares are sold. While sale of the underlying shares may ultimately qualify for favorable long term capital gains treatment, clients should keep in mind the variability of tax consequences and the possibility of a tax liability without immediate corresponding liquidity.
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RSUs are typically taxed at ordinary income rates at vesting regardless of whether shares can be sold, and vesting can sometimes be limited to both an employee’s length of employment and a liquidity event like a sale or IPO. Lockup restrictions often limit liquidity but generally do not delay taxation at vesting. This may create cash flow challenges if taxes are due before employees have the ability to sell shares to generate proceeds. Some IPO structures do allow for payment of taxes at the time of the IPO to mitigate such cash flow problems.
Patrick Geddes
Senior Advisor and Co-Founder of Aperio, BlackRock
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BlackRock provides this material for informational purposes only and for the sole use of the recipient. The information contained herein was carefully compiled from both internal and external data, but we do not guarantee its accuracy. The information is provided with the understanding that we are not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in these areas. The strategies and/or investments referenced may not be suitable for all investors, because the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. None of the examples should be considered advice tailored to the needs of any specific investor or a recommendation to buy or sell any securities.
Investing involves risk, including possible loss of principal. Asset allocation and diversification may not protect against market risk, loss of principal or volatility of returns. There is no guarantee that any investment strategy discussed herein will work under all market conditions. Many factors affect performance, including changes in market conditions and interest rates, as well as other economic, political, or financial developments.
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Mentioned products may include investments that are less tax-efficient than others and may have complex tax consequences when aggregated with other positions across an investor’s entire portfolio, in particular because of the wash sale rules, constructive sale rules, and straddle rules, among others. Prospective investors are urged to consider the impacts of any of these strategies with their investment and tax advisors.
Wash sale restrictions prevent investors from realizing a loss on a sale and buying a “substantially identical” security 30 days before and after the sale of the security. While “substantially identical” remains undefined, some tax practitioners suggest that investors ought to consider the degree to which the funds’ holdings may overlap and the degree of difference in prospective returns. The information and examples provided are not intended to be a complete analysis of every material fact respecting tax strategy and are presented for educational and illustrative purposes only. Tax consequences will vary by individual taxpayer, and individuals must carefully evaluate their tax position before engaging in any tax strategy. BlackRock does not provide tax advice. We urge you to consult with your client and a tax professional regarding the potential consequences of this rule.
Any tax information provided herein is for illustrative purposes only and does not constitute the provision of tax advice by BlackRock. Due to the complexity of tax law, not every single taxpayer will face the situations described herein exactly as calculated or stated, i.e., the examples and calculations are intended to be representative of some, but not all, taxpayers. Since each investor’s situation may be different in terms of income tax, estate tax, and asset allocation, there may be situations in which the calculations would not apply. Please discuss any individual situation with tax and investment advisors first before proceeding. For those clients using tax advantaged indexing, taxpayers paying lower tax rates than those assumed, or without taxable income, would earn smaller tax benefits from tax-advantaged indexing (or even none at all) compared to those described.
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Concentration and Lock-Up Risk:
A concentrated IPO stock position subjects the investor to company-specific risk. Lock-up or blackout periods, as well as other issuer-imposed, contractual, or regulatory restrictions, may restrict the ability to sell or directly hedge shares for an extended period, during which the stock price may decline significantly.
Clients are solely responsible for identifying and complying with any applicable lock-up agreements, insider trading policies, or other limitations on the transfer, disposition, or hedging of their securities. BlackRock does not monitor or verify the applicability of such restrictions and may rely on client representations in this regard. In addition, Aperio and SRA may have operational, legal, or compliance limitations that restrict their ability to accept, hold, transact in, or implement hedging strategies involving securities subject to such restrictions.
Clients with holdings of restricted stock may be limited in their ability to select, or may be ineligible for, certain strategies described in these materials. Clients should review the restrictions applicable to their stock positions to determine whether any limitations apply to the SMA investment strategies.
Short Sales
In a short sale, a portfolio sells securities it does not own. To accomplish this, the portfolio borrows the securities at a fee from the custodian (the lender). The position is “closed” by “returning” the security (buying a replacement security on the lender’s behalf). This “return” obligation to replace the borrowed securities does not typically have a specified “maturity” date and the lender generally may require replacement of the securities whenever it chooses. A short sale theoretically involves the risk of unlimited loss: The price at which a portfolio must buy “replacement” securities could increase without limit. A portfolio may experience losses on short positions that are not offset by gains on long positions.
Possibility of Margin Calls or Liquidations
Borrowings are usually from securities brokers and dealers and are typically secured by a portfolio’s securities and other assets. Under certain circumstances, such a broker or dealer may demand an increase in the collateral that secures a portfolio’s obligations, and if a portfolio is unable to provide additional collateral, the broker or dealer could close either long and/or short positions held in a portfolio’s account to satisfy a portfolio’s obligations. Closing positions in that manner could have extremely adverse consequences, including initiating closing transactions at disadvantageous times and prices and the acceleration of tax consequences.
Additional Costs Associated with Short Selling and Trading on Margin
Trading on margin and engaging in short sales in your advisory account may result in additional costs, including margin interest, stock borrow fees, and other regulatory or service charges that can significantly increase your overall expenses.
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