# Cash in Stocks & Defer Taxes with Variable Prepaid Forward Contracts

## The Variable Prepaid Forward Contract: An Overview

A variable prepaid forward contract is used by stockholders to cash in some or all of their shares and defer the taxes owed on the capital gains. Company founders and executives are typical users of such contracts and get immediate access to cash by transacting them. They usually have a large number of shares in their company and seek cash while deferring taxes. Variable prepaid forward contracts can attract scrutiny from both the IRS and financial journalists because of the tax-deferral benefit they offer.

### Key Takeaways

*   Tax Deferral Strategy: A variable prepaid forward contract enables shareholders to obtain cash by selling shares while delaying the payment of capital gains taxes.
*   Investor Protection: This contract sets predefined floor and ceiling prices, safeguarding investors against significant losses if stock prices fluctuate before the transaction is finalized.
*   Controversial Practice: While beneficial for stockholders, the use of variable prepaid forward contracts often attracts scrutiny from both the IRS and financial journalists due to its tax deferral nature.
*   Applicability and Benefits: The strategy is particularly useful for corporate executives and founders with concentrated stock positions, offering a way to diversify without immediate tax liabilities.
*   Complex Structure: As part of a sophisticated financial strategy, these contracts involve a collar strategy combining both put and call options, alongside monetizing the transaction through a form of loan.

## How Variable Prepaid Forward Contracts Work

A typical user of a variable prepaid forward contract might be a founder or top executive of a corporation who has accumulated a large amount of company stock. That person might want to [diversify their concentrated investments](https://www.investopedia.com/articles/stocks/11/diversify-stock-position.asp), lock in profits in the stock, or at the very least raise a large amount of cash.

This contract lets a person sell stock to a brokerage, receiving 75% to 90% of its value right away, though the sale isn't final yet. Until it is finalized, the taxes on the capital gains are not due. Once finalized, the stockholder turns over shares or cash, with an agreed price range to guard against major loss.

This practice is useful when executives can't sell stock options immediately due to restrictions. Also, a large stock transaction by a company insider at any time makes investors nervous. A variable prepaid forward contract helps bypass these issues.

The contract's floor and ceiling prices protect investors from large losses if a stock's value spikes before finalizing the transaction.

Needless to say, this practice is controversial and some think it should not be allowed.

Technically, a prepaid variable forward contract is a [collar strategy](https://www.investopedia.com/terms/c/collar.asp), which is a bundled long put option and [short call option](https://www.investopedia.com/terms/s/short-call.asp) on a security. However, it has a third element: the monetization of the transaction in the form of a loan against the underlying security. While once fairly sophisticated, these types of strategies have become more commonplace thanks to advancements in financial engineering.

These contracts often attract attention from the IRS and financial journalists. In 2011, _The New York Times_ ran a front-page feature highlighting how Ronald Lauder, the Estée Lauder cosmetics heir, was "artfully sheltering" his compensation through a prepaid variable forward contract. With executive pay at many multiples of the average employees' compensation levels, these types of strategies are popular targets for scrutiny.

## The Bottom Line

Variable prepaid forward contracts allow large shareholders, such as company executives or founders, to raise cash while deferring capital gains taxes on the sale of large holdings of stock. The contract involves an agreement with a brokerage firm to sell stock at a predefined future date, providing immediate liquidity without finalizing the transaction. While the strategy is beneficial for managing large stock positions and preventing large market movements or disruption, it requires careful consideration due to its complexities and the potential to attract the attention of the IRS over regulatory issues. Be sure to consult with a financial or legal advisor when considering a variable prepaid forward contract.

> **Article Sources**
>
> 1.  The New York Times. "[A Family's Assets, Artfully Sheltered](https://www.nytimes.com/2011/11/27/business/estee-lauder-heirs-tax-strategies-typify-advantages-for-wealthy.html)." Accessed Feb. 11, 2021.