When a qualified retirement plan account holds employer stock, a retirement plan participant could potentially save thousands of dollars with proper planning. As clients face triggering life events such as separation from service and retirement, questions regarding the next steps for treatment of retirement accounts will be at the forefront of their minds. At retirement, it is common for an individual to make a tax-free rollover of a 401(k) into an individual retirement account (IRA). This can allow for more flexibility and the ability to further diversify investment holdings. However, an individual can miss a tax planning opportunity if the 401(k) was composed of employer stock.
A previous article in The Tax Adviser discusses the favorable tax rules that apply when a lump-sum distribution is composed in whole or in part of the employer corporation’s securities (Ellentuck, “Planning for Distributions of Employer Securities,” 38 The Tax Adviser 419 (July 2007)). The net unrealized appreciation (NUA) on the employer stock is not taxed upon distribution. NUA is the excess of the stock’s fair market value (FMV) over the cost basis of the securities.
In this situation, ordinary income tax is due at the time of distribution on the original cost of the company stock inside the 401(k) plan. Tax is deferred on the NUA until the stock is sold, and the NUA is taxed at capital gains rates. In comparison, if the stock is rolled directly into an IRA, the NUA loses its long-term capital gain character and is taxed at ordinary income tax rates when distributed from the IRA. Bear in mind that any appreciation beyond the NUA is taxed as a capital gain based on the holding period starting from the date the stock was received as a distribution from the qualified plan under Regs. Sec. 1.402(a)-1(b)(1)(i) and Notice 98-24.
If the account consists of both employer securities and outside investments, a taxpayer can take a lump-sum distribution of the employer stock and contribute the nonemployer stock or other remaining amounts to an IRA within 60 days of the distribution to qualify as a tax-free rollover.
Read the full article on the AICPA Tax Adviser site here.
Meet the Author
Senior Tax Manager
Elizabeth Hutchison, CPA, CDFA
In 2010, Elizabeth joined the firm’s Portland team with three years of experience in public accounting at a Big Four and local accounting firm. Going beyond compliance, Elizabeth’s role at the firm is both problem solver and strategic tax planner. Her expertise allows her to help her clients navigate the complex nature of tax laws.…
- High-net worth individuals and business owners
- Strategic tax planning and compliance
- Divorce support
- Certified Public Accountant
- Certified Divorce Financial Analyst (CDFA)