Prepaid Variable Forward Contract Analysis: How It Works, Who It Fits, and the Catch

How it works, in plain English

You own appreciated public stock. A bank pays you a lump sum of cash today, a large share of the stock's current value, discounted for time and for the price band. In return you agree to deliver shares (or the cash equivalent) on a future settlement date. The number of shares you deliver varies with the stock price at settlement, between a floor price and a cap price:

• Below the floor: you deliver all the pledged shares. The bank takes the downside, so you are protected below the floor.
• Between floor and cap: you deliver shares worth roughly the floor amount, so fewer shares as the price rises.
• Above the cap: you deliver fewer shares still, keeping only part of the upside.

You pledge the maximum number of shares as collateral, but you keep the legal right to settle in cash or other shares. The structure turns a concentrated position into cash now, locks in a floor, and pushes the taxable sale to settlement.

Who it fits, and who it does not

Fits: an owner who sold a company for acquirer stock, a founder or executive with a large low-basis position, or a family holding a legacy stock position worth several million dollars or more, where the stock is liquid and borrowable and the holder wants cash and downside protection without selling today.

Does not fit:

• Real estate, farmland or private company interests. Banks write these contracts on liquid, listed stock.
• Small positions, where dealer pricing eats the benefit.
• Insiders who cannot hedge under company policy or securities rules (trading windows, Rule 144, Section 16 reporting).
• Anyone who expects to need the shares or to extend the contract later.

Worked example

Assumptions (labeled, from the Big Sale Tax engine): married filing jointly, 2026 federal tables (Rev. Proc. 2025-32), public stock worth $10,000,000 with a $1,000,000 basis, so $9,000,000 of long-term gain if sold today, no other income.

What the forward buys you is time and a floor, not a smaller gain. At settlement the amount realized is generally the cash you received upfront (plus any cash or value exchanged at settlement), measured against your basis in the shares delivered. If tax law and your income are the same in the settlement year, the bill is similar; the benefit is the use of the cash in the meantime and protection below the floor. The upfront payment and the band depend on the bank's pricing, so we do not invent them here.

IRS stance and audit risk

• Rev. Rul. 2003-7. In Rev. Rul. 2003-7 the IRS held there is neither a current sale under IRC 1001 nor a constructive sale under IRC 1259 when the shareholder receives fixed cash, agrees to deliver a number of shares that varies significantly with the price, pledges the maximum shares, keeps an unrestricted right to settle with cash or other shares, and is not economically compelled to deliver the pledged shares.
• Share lending is the trap. When the bank can also borrow the pledged shares, the IRS treats the deal as a current sale: see TAM 200604033 and Chief Counsel memorandum AM 2007-004. The Tax Court agreed in Anschutz Co. v. Commissioner, 135 T.C. 78 (2010), affirmed by the Tenth Circuit in 2011.
• Extensions can trigger tax. In Estate of McKelvey v. Commissioner (2d Cir. 2018), extending the settlement dates was treated as a new contract, producing gain on the old contracts and a constructive sale where the share count had become substantially fixed.
• Straddle rules. The stock and the forward are offsetting positions under IRC 1092. Losses can be deferred, a short holding period can be suspended, and interest and carrying costs are capitalized under IRC 263(g). Dividends on hedged stock may lose qualified dividend treatment.

A properly drafted forward is a recognized, mainstream technique, not a listed transaction. Audit exposure comes from departing from the 2003-7 facts.

Costs and fees

The cost is embedded in pricing: the discount between the upfront cash and today's value reflects the time value of money, the floor, the cap and the bank's spread and expected dividends. Expect legal fees for the contract, pledge and securities filings, and, for insiders, company approvals. Because the bank keeps upside above the cap, part of the cost is the growth you give up.

How it compares with a Section 453 installment sale

A Section 453 installment sale is not available for publicly traded stock: IRC 453(k)(2) excludes sales of stock or securities traded on an established market. So the forward is the deferral tool for listed shares, and the installment sale is the tool for the rest of a deal, such as real estate, private company stock or business assets sold for a note.

The two often appear in the same transaction. A seller paid partly in acquirer stock and partly in seller financing can use a forward on the stock and an installment note on the rest. For the note portion, the seller manages buyer credit risk with a down payment, a first-position lien or UCC lien, a personal guarantee from the buyer's owners and firm note terms. See also zero-cost collars and exchange funds.

How Hans helps

Hans does not sell derivatives or broker these contracts. The $5,000 Big Sale Tax Analysis models settlement-year tax under your facts alongside a cash sale, an installment sale for the non-stock part of the deal, and the other paths, so you and your banker are negotiating from real after-tax numbers. Start with the estimator.

Frequently asked questions