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Union Pacific Employees: How to Use Options Collars to Manage Appreciated Stock Without Triggering Taxes

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'Union Pacific employees navigating concentrated stock positions should view strategies like collars as part of a broader wealth and tax planning discussion that requires careful coordination with qualified professionals.' – Paul Bergeron, a representative of The Retirement Group, a division of Wealth Enhancement.

'Union Pacific employees with significant stock holdings can benefit from understanding how thoughtful planning techniques provide both flexibility and time to make informed decisions about future diversification.' – Tyson Mavar, a representative of The Retirement Group, a division of Wealth Enhancement.

In this article, we will discuss:

How an options collar can help manage concentrated stock positions without triggering immediate taxes.
Key considerations for constructive sale treatment under Section 1259.
Practical examples and alternatives for Union Pacific employees holding appreciated stock.

By Tyson Mavar, advisor at Wealth Enhancement

The Difficulty of Keeping Valuable Stock

Many Union Pacific employees hold highly valued company stock, which may have been built up over years of employment or from investments that performed better than expected. Leaving these shares without a hedge exposes them to downside risk if the stock price falls, but selling would create a significant capital gains tax liability.

One method of limiting potential losses without selling outright is an options collar. Even if the stock is not sold, certain hedging techniques can be treated as taxable sales under Section 1259 of the Internal Revenue Code, which governs 'constructive sales.'

The Operation of an Options Collar

A collar strategy combines shares already owned with two option positions:

Put option: Purchasing a put option gives you the right to sell shares at a set strike price. For example, if you own stock at $100 and buy a $90 put, you can still sell at $90 even if the price falls further.
Covered call: Selling a call requires selling at a higher strike price. For instance, selling a $120 call limits gains above $120.

When paired, the call premium can offset the put’s cost. This creates a range where downside is limited and upside is capped. Additionally, with careful planning, the collar can often be cost-neutral.

The Use of Collars by Investors

Union Pacific stockholders and others might use collars in the following cases:

Concentrated positions: A large portion of wealth tied to one company.
Market uncertainty: When downside management is needed but selling isn’t desirable.
Estate and legacy planning: Preserving value while postponing capital gains.

The Problem of Constructive Sales

Section 1259 defines some hedges as constructive sales, including:

- Short sales of stock you already own.
- Contracts for future delivery of the stock.
- Deep in-the-money calls and puts that eliminate both risk and reward.

If the IRS views a collar as removing nearly all economic exposure, it can be treated as a constructive sale, triggering immediate recognition of capital gains.

Collar Design to Steer Clear of Constructive Sales

To reduce the risk of Section 1259 issues, Union Pacific employees can structure collars with careful attention:

- Keep strike prices wide enough to allow both risk and reward.
- Use out-of-the-money calls and puts rather than in-the-money options.
- Roll collars forward instead of holding outdated positions.
- Document investment intent with an advisor.

An Example

Suppose you hold $2 million in stock purchased years ago for $200,000. Selling outright could result in over $400,000 in federal taxes, depending on your state.

Instead, you might sell calls at 120% of the stock’s value and purchase puts at 80%. In this design:

- Losses are limited to 20%.
- Gains are capped above 120%.
- The position retains risk and reward, so it generally avoids being classified as a constructive sale.

This approach can provide time to manage sales across multiple tax years or to wait for a more favorable tax environment.

Considerations

Union Pacific employees considering collars should note:

Liquidity: Large-cap companies usually have strong options markets.
Rolling: Positions can be extended as expiration approaches.
Alternatives: Other hedging tools include donor-advised funds, charitable remainder trusts, gifting strategies, or exchange funds.
Advisory guidance: Given the complexity of constructive sale rules, consulting tax and legal professionals is critical.

The Bottom Line

Options collars can help Union Pacific employees preserve the value of appreciated stock while limiting downside and postponing taxable events. This strategy allows time for thoughtful diversification while maintaining both risk and opportunity. However, collars must be carefully designed to reduce the chance of triggering constructive sale treatment under the Internal Revenue Code.

Disclaimer: This material is for educational purposes only. Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes, and potential illiquidity. Investing involves risk, including possible loss of principal. Always consult your tax professional before making decisions, as tax laws are complex and subject to change.

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Sources:

1. United States Congress. 26 U.S. Code §1259 - Constructive Sales Treatment for Appreciated Financial Positions. Cornell Law School, Legal Information Institute, 5 Aug. 1997, amended 4 Oct. 2004. https://www.law.cornell.edu/uscode/text/26/1259.

2. Internal Revenue Service. Revenue Ruling 2003-7, 2003-1 C.B. 363. 2003. https://www.irs.gov/pub/irs-drop/rr-03-7.pdf.

3. Options Industry Council (OIC). Options Strategies Quick Guide. The Options Clearing Corporation, 2021. https://www.optionseducation.org/getattachment/007fe864-029a-490d-8dc1-3b58bd558f64/options-strategies-quick-guide.pdf?lang=en-US

4. Internal Revenue Service. 2024 Instructions for Form 5227, Split-Interest Trust Information Return. 26 Nov. 2024. https://www.irs.gov/pub/irs-pdf/i5227.pdf

What are the specific eligibility requirements for employees of Union Pacific Corporation to participate in the pension plan, and how might these requirements evolve as IRS regulations change? Understanding how Union Pacific Corporation aligns its eligibility criteria with broader IRS regulations can help employees assess their own eligibility for the pension plan, particularly in light of any new IRS guidelines issued for 2024.

Eligibility Requirements for Pension Plan Participation: Eligibility to participate in the Union Pacific Corporation pension plan is governed by specific criteria set forth in the plan documents. As of January 1, 2018, the plan was closed to new participants, meaning individuals hired on or after this date are not eligible. For existing employees, eligibility to accrue benefits continued provided they were active participants as of December 31, 2017, and remained in covered employment. Changes in IRS regulations could potentially alter these eligibility criteria by requiring adjustments to maintain compliance with legal standards, potentially affecting who can accrue benefits in the future.

How does Union Pacific Corporation calculate an employee's final average compensation for pension benefits? Given the potential for changes in compensation structures, it is essential for employees at Union Pacific Corporation to comprehend how their average compensation is determined and how this figure might impact their retirement planning.

Calculation of Final Average Compensation: The pension plan calculates an employee's final average compensation based on the average monthly compensation over the 36-consecutive month period out of the last 120 months of active participation that yields the highest average. This includes base pay, overtime, and certain incentive and bonus payments. Understanding this calculation is crucial for employees to appreciate how raises, bonuses, and other compensation changes might impact their pension benefits.

What forms of payment options are available to employees of Union Pacific Corporation when they choose to retire, and how do these options influence the total benefit received? Employees need detailed information on the different payment structures to make informed decisions that suit their financial needs in retirement.

Payment Options Available at Retirement: Union Pacific offers various payment options for pension benefits upon retirement. Employees can choose a lifetime annuity or opt for joint and survivor annuities, providing continued benefits to a designated beneficiary. Other options include certain annuities that guarantee payments for a set period, regardless of the employee's lifespan. These choices allow employees to tailor retirement benefits to their financial needs and family circumstances.

In what ways does Union Pacific Corporation integrate Social Security and Railroad Retirement benefits into the pension plan, and how does this integration affect the overall retirement income for employees? Employees should explore the implications of these benefits on their pensions to develop a comprehensive retirement income strategy.

Integration of Social Security and Railroad Retirement Benefits: The pension benefits are coordinated with Social Security or Railroad Retirement benefits through an offset formula in the pension plan. This integration reduces the pension benefit by a portion of the government retirement benefits projected at the time of retirement, reflecting that some of the funding for these benefits comes from Union Pacific. Employees need to understand how this interaction affects their total retirement income to plan effectively.

What strategies can employees of Union Pacific Corporation employ to maximize their pension benefits prior to retirement while adhering to IRS limits? Employees must be informed of practical steps they can take to enhance their benefits within the framework established by IRS guidelines.

Maximizing Pension Benefits: To maximize pension benefits under the IRS limits, Union Pacific employees can ensure they maximize their earnings during the final average compensation period, continue employment as long as possible to increase credited service, and make strategic decisions about retirement age and benefit commencement. Understanding the interplay of these factors with IRS contribution and benefit limits is essential for optimizing pension payouts.

How does the vesting schedule work within Union Pacific Corporation's pension plan, and what implications does this have for employees who leave the company before full vesting? An understanding of the vesting schedule is crucial for employees at Union Pacific Corporation to grasp the long-term benefits they might forfeit by leaving before they are fully vested.

Vesting Schedule: The vesting schedule is crucial as it determines an employee's entitlement to pension benefits upon leaving the company before retirement age. Union Pacific's plan requires employees to complete five years of vesting service to qualify for a vested benefit, which is payable as early as age 55. Employees considering leaving Union Pacific should be aware of how their vesting status might affect their pension entitlements.

What responsibilities do employees have to keep Union Pacific Corporation informed about their earnings records, particularly when claims for benefits arise, and what might happen if these records are not accurately reported? Employees should be aware of their duties to maintain their benefits and the potential consequences of noncompliance within the pension plan.

Responsibilities for Reporting Earnings: Employees are responsible for ensuring that Union Pacific has accurate records of their earnings to calculate pension benefits accurately. Failure to report or correct discrepancies in earnings records can lead to miscalculations in pension benefits, affecting retirement income. It's vital for employees to regularly review their earnings records and report any inaccuracies.

How does Union Pacific Corporation ensure compliance with ERISA regulations as they relate to employee retirement benefits, and what rights do employees have under these regulations? Employees of Union Pacific Corporation should familiarize themselves with their rights under ERISA to ensure they are adequately protected when claiming pension benefits.

Compliance with ERISA Regulations: Union Pacific ensures compliance with the Employee Retirement Income Security Act (ERISA) regulations, which protect employees' rights to their pension benefits. Employees have specific rights under these regulations, including the right to receive information about their pension plan, appeal denials of benefits, and sue for benefits or breaches of fiduciary duty. Awareness of these rights is important for employees to safeguard their benefits.

What happens to the pension benefits of employees of Union Pacific Corporation in the event of a company merger or acquisition, and how can employees prepare for these changes? Understanding the potential impacts of organizational changes on their pension benefits can enable employees to safeguard their retirement plans.

Impact of Company Mergers or Acquisitions: In the event of a merger or acquisition, employees' pension benefits could be affected. Union Pacific's pension plan provisions include terms for handling benefits under such circumstances. Employees should be proactive in understanding how these corporate changes might impact their pension benefits and seek clarity on their rights and options.

How can employees of Union Pacific Corporation contact the Benefits Group to inquire further about the pension plan and related questions? Clear guidance on contacting the Benefits Group will assist employees in accessing the information necessary to navigate their retirement options effectively.

Contacting the Benefits Group: Employees with questions or who need assistance regarding their pension plan can contact Union Pacific's Benefits Group. Having the contact information handy ensures that employees can promptly address concerns or seek guidance about their retirement benefits, aiding in effective retirement planning.