Employer Stock/401k withdrawal

[Tobey]

I have a client, age 61, (born 1945) who will be separating from his company this year. As part of the separation agreement he will receive a 12 month salary severence package, all to be received this year. This will place them (MFJ) well into the 25% tax bracket, with somewhat over $100k taxable income.

Client has a 401k, that among other investments has 2,000 shares of employer stock, current market value Of $60.00/share. He has an average basis of $8.00 in these shares.

The client's investment councellor/financial consultant has told me that he intends to withdraw these shares, and cash them in, and would like to know the best way to do this from a tax point of view. Clearly, he would like to have them taxed as LT Cap gains.

Is the following treatment correct?

If entire 401k is closed out, taking the employer stock in kind, TP has a lump sum distribution , with an NUA of (60-8)*2000 = $104,000 which should be reported in box 6 of his 1099.
He can then sell the shares, with LTCG tax treatment up to the amount of the NUA even if held in his name for less than 1 year.

TP cannot rollover any part of his 401k, else losing the Lump Sum and NUA treatment.
Without NUA treatment, gain from sale of stock would be treated as short term if held less than 1 year.

Remaining taxable portion of 401k payout will get hit at 28% rate or even 33% if TI exceeds $182,800. (I don't know the value of the rest of his 401k)

I think this is correct. My problem is that on page 20 of pub 575 the paragraph on NUA included in income, reference is made to an NUA worksheet for form 4972. This form, income averaging, is not available to my client because of his age. Do I just use the worksheet to calculate the CG on the NUA, and enter the sale directly on Schedule D?
So I am confused

Can anyone confirm the above approach, or set me straight if I have erred?

[veritas]

If the company stock is in the 401K his basis is zero and it will be ordinairy icome if they distribute the stock or the cash.

[Tobey]

I think at one time employees could make after tax contributions to the 401k. Thus a basis is possible. Any one remember this?

What about the lump sum/ cap gain part of my question? Much more significant I think.

[Matt Sova]

Was it after tax?

If the contributions were after tax contributions, then yes, he has basis in those amounts. I think that the income withdrawn is still subject to ordinary tax rates. Also, I do not believe that he can roll over those amounts. Perhaps he should take this money out in 2007 to avoid higher tax rates in 2006.

If he chooses to take some of the money out page 13-20 of TTB has a worksheet on how to calculate what the taxable portion is.

Matt

[Bill Tubbs]

401(k) or annuity?

First, I would suggest double-checking whether you're dealing with a 401(k) or a pension/annuity. The rest of this msg is predicated on a 401(k).

page 20 of pub 575 the paragraph on NUA included in income, reference is made to an NUA worksheet for form 4972.

Page 20 of Pub 575 is within the "Taxation of Nonperiodic Payments" which begins back on page 13: "This section of the publication explains how any nonperiodic distribution you receive under a PENSION or ANNUITY plan are taxed." (emphasis added) Further, on page 18 under "Lump-Sum Distributions":
"This section on lump-sum distributions only applies if the plan participant was born before January 2, 1936."
Your client was born after 1936, so the Lump-Sum Distributions from pg 18 - 24 does not apply to your client.

My position would be:
1) if any contributions were after-tax contributions, then he would have some basis
2) income subject to ordinary tax rates (no cap gains)
3) should be able to roll over to IRA
4) with the high income this year with the severance package, not withdraw anything from IRA til next year when in a lower bracket

Added 6/20/06 10:52pm CT:
After further research, I still don't see Pub 575 addressing NUA for 401(k) since 575 is Pensions and Annuities, which a 401(k) is neither. But, after reading several sections of code and a couple IRS Notices, do now conclude that NUA is indeed valid for 401(k). http://www.fpanet.org/journal/articl...p0204-art7.cfm says in part:
"For individuals who want to diversify a portion of their company stock holdings, the NUA strategy can be used on a partial or full distribution of employer stock. An individual can roll over some of the company stock to an IRA and use the NUA treatment on the balance."

Bill

[Bees Knees]

I didn't realize you guys were already answering this question. I gave my answer at http://www.thetaxbook.com/forums/showthread.php?t=2527

The issue Tobey is asking about is covered in TTB, page 13-22, 2nd column under Author's Comment.

Basis here refers to the amount that is subject to ordinary tax rates, which then becomes the basis in the stock that is distributed. The taxpayer now has a basis in stock that is held outside of any retirement plan, with the unrealized appreciation subject to LTCG rates when the stock is eventually sold.

[Tobey]

401k/NUA

Thank you for your responses. I apologize for the confusing double posting of my original question. BK and TTB authors comment page 13-22 both support my thought to receive the stock out of the plan in kind, and take the capital gains on the NUA portion. Can any of you others that offered opinions cite any chapter and verse that supports your positions? I really want to be sure that I offer up the right advice here.

I spoke with the financial planner about rolling over the distribution, cashing out in a later year with presumably lowertax bracket, and/or holding onto the company stock. None of these are options that he is willing to consider. There is a need for a large sum of money concurrent with TP separation, and the FP will not consider holding onto the stock for any reason.

I suppose that there is some account value, where the28%(or 33%) tax rate on the ordinary income portion of the distribution, when averaged in with the LTCG rate on the NUA portion might prove to be a heavier tax burden then rolling over the whole account, cashing the stock in within the account, and waiting to take out the balance in a later tax year, at a lower rate. I guess I need to find out the total account value and play out both scenarios to really be sure.

[Unregistered]

Tobey
I think you are on target. It's clear that SOME of the other posters have no clue what NUA is nor how to handle it.

[Unregistered]

Nua

The difference in value between the average cost basis of shares and the current market value of the shares held in a tax-deferred account.


The NUA is important if you are distributing highly appreciated company stock from your tax-deferred employee-sponsored retirement plan, such as a 401(k). Upon the distribution the NUA is not subject to ordinary income tax. For this reason it may be better to transfer the company stock to a regular brokerage account instead of rolling the stock over to a tax-deferred IRA: that is, if rolled over to an IRA, the company stock's NUA would eventually be taxed at your ordinary income tax rate (when you take distribute the stocks).

[Bill Tubbs]

Unregistered...

Tobey
I think you are on target. It's clear that SOME of the other posters have no clue what NUA is nor how to handle it.

It also appears that some people who hide behind the "Unregistered" tag are unwilling to educate the less-informed. Yes, NUA's were new to me tonight.

Bill

[OldJack]

Tobey
I think you are on target. It's clear that SOME of the other posters have no clue what NUA is nor how to handle it.

So what the hell-0 does NUA stand for? Not used appreciation? Really... we should not allow abbreviated terms on this board.

BTW, IMHO those that do should all be banished from the forum.

[Bees Knees]

So what the hell-0 does NUA stand for? Not used appreciation? Really... we should not allow abbreviated terms on this board.

NUA stands for Net Unrealized Appreciation. Pub 575 pages 14 and 20 uses the abbreviation and explains what it is.

[OldJack]

The difference in value between the average cost basis of shares and the current market value of the shares held in a tax-deferred account.

Note that the "Net Unrealized Appreciation" (if calculated correct), that is subject to capital gains when the stock is sold, is only that amount calculated on the "employees contribution" amount. Not the full unrealized appreciation that the stock may have at the time it is received by the distributee. And yes, the employee's contribution NUA will get capital gains treatment. I have had this in a couple of cases in the past and its usually not that big of an amount or tax savings.

[Tobey]

401k/NUA resolution

Follow up/ Thank you all (FU/TYA)

So it turns out that the taxpayer's 401k account total value (ATV) is around $700,000, and the employer stock value (ESV) is around $200,000. When I told the Financial Planner (FP) that he would have to withdraw the entire account balance (EAB) in order to get the capital gains treatment (CGT) he was looking for, his response was "well, we aren't going to do that!" (WWAGTDT) Problem solved. Thanks.

Clearly, this topic is one that many tax preparers are not familiar with, and that goes for newbies as well as more experienced ones. The question certainly sent me back to source material, and my main reason for posting was to get some corroboration and make sure that my understanding was correct. If it served to introduce or review this topic to others, then I say its a good thing, even though not commonly encountered.

Old Jack: You shouldn't be afraid of abbreviations. Abbreviations are our friends. (AAOF) But yes, they should be clearly defined first, if they are not commonly used (NCU). Back in my neophyte HRB days (need a definition?) we used RTFS rather frequently (Read the Form, Stupid) and indeed the answers to many problems were found right there, both in the "read" part, as well as in the "stupid" part.

As a relative newcomer to this forum, I would like to add that offering up opinions without adequate certainty, support, and/or research of the topic does a disservice to other participants. No one here lauds their credentials, education, or experience over anyone else. But I for one would like to know that "senior member" refers to more than a person's age, and advice offered has some factual basis to it. I always like reading BK's postings because they include reference to some resource or source material.

BTW OJ: Do you have a source reference on your previous posting regarding "employees contribution" amount? I didn't pick up on that in pub 575. I'd like to see where I missed it. Really. No joke. I'm not just BYB (Busting Your Cojones).

Thanks again to everyone that weighed in.

[Bill Tubbs]

Tobey,

>>Senior Member<<

I believe it is simply a measure of how much time that one has been a member and/or postings that have been made.

>>When I told the Financial Planner (FP) that he would have to withdraw
>>the entire account balance (EAB) in order to get the capital gains treatment
>>(CGT) he was looking for, his response was "well, we aren't going to do that!"
>>(WWAGTDT) Problem solved.<<

From what I've read on NUA in the past couple days, that is not my understanding. Granted all of what I've read on this point has been from CPA's, brokerage houses, etc. asserting a position, without any independent information from the IRS or tax code. Here is one quote from http://www.eatonvance.com/alexandria/2492.pdf
"However, you do not have to distribute the entire amount of the stock position, but only the amount you wish. If you choose to roll over all or a portion of the company stock position into an IRA Rollover account, you cannot select NUA tax treatment for the company stock in the Rollover account."

Good luck with this, and thanks for teaching me something.
Bill