Employees who own company stock or other securities in their retirement plans should review their options before taking any distributions or doing rollovers.
There’s a substantial tax break available to many of these workers. The tax break is known as net unrealized appreciation, or NUA.
It’s very valuable when you know the tricks and follow the rules.
If you sell the employer stock while it is in your 401(k) or other retirement account such as an ESOP, you do not get the tax break.
The proceeds from that sale eventually will be distributed to you (from either the 401(k) or an IRA rollover) and be taxed as ordinary income.
When you retire or otherwise leave the employer and the account still owns the employer stock, however, you have a choice.
You can treat the stock the same as other assets, keeping it in the 401(k), or ESOP, or rolling it over to an IRA.
As distributions of the stock or its sale proceeds are made, they are taxed as ordinary income.
The other option is to take advantage of the Net Unrealized Appreciation (NUA) tax strategy.
Step one of the NUA strategy is to roll over the non-employer stock assets to a traditional IRA.
(There’s no tax on the rollover.)
Step two of the NUA strategy is to distribute the stock to a taxable brokerage account.
The shares must be distributed in kind and directly to a taxable account.
They can’t first be rolled over to an IRA or other type of retirement account and later transferred to a taxable account if you want the NUA treatment.
In the year of the distribution, only the original value, or cost basis, of the shares is included in your gross income and taxed as ordinary income.
No other taxes are due at that time, no matter how much the shares appreciated since the retirement account acquired them.
As you sell the employer shares from the taxable account, long-term capital gains taxes are due on the appreciation that occurred since you first acquired them in the retirement plan.
Long-term gain treatment is allowed regardless of how long the shares were owned either inside or outside of the 401(k).
To receive the tax-favored treatment, you have to take a lump sum distribution from the 401(k) plan.
This means that all the assets, without exception, must be distributed from the account in the same calendar year.
You also cannot have taken any previous withdrawals from the retirement plan, even required minimum distributions.
The lump sum distribution must occur after a triggering event.
These triggering events are as follows: attaining age 59½, leaving the employer, or death.
Note that the lump sum distribution and triggering event don’t have to occur in the same year.
The treatment of the employer stock under this procedure is the same whether you purchased the shares through your employer retirement plan or received them as a contribution from the employer.
The NUA tax break is available even if the company’s stock is not publicly traded.
Many private companies regularly determine a value for their stock, which can be used to determine your basis in the stock.
When the stock is distributed to you, the employer should tell you its basis.
But some private companies have ownership restrictions that prevent the use of the NUA, because the stock can’t leave the employer retirement plan.
The NUA treatment also is available to heirs who inherit an employer retirement account and take a lump sum distribution after the employee’s death.
And it is available to divorced spouses if they received part of the retirement account under a qualified domestic relations order.
You don’t have to use the NUA treatment for all the stock in the account.
Some can be rolled over to an IRA.
If someone took advantage of the NUA treatment by transferring the shares to a brokerage account and held the shares until death, the heirs do not increase the tax basis of the shares.
The heirs will owe capital gains on the appreciation when they sell the shares just as the employee would have.
For most people, NUA treatment is the best way to handle employer stock held in a retirement account.