For Tax Year 2003, client retired from large major food store chain in Florida and took a lum-sum distribution which was part of an ESOP program. Client received 1099R with amounts in box 1, 2a and 6 plus 1099B with the same amount reported as box 1 of 1099R. Instructions from the company says box 2a is your cost basis and taxed as ordinary income and that the shares when sold are taxed as capital gains. IRS is telling client that effectively they didn't receive the shares and it is all taxed as ordinary income and have sent a bill for an additional $3000+ tax. Has anyone else seen or heard of this?
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We had a lengthy discussion on that a while back here:
Maybe something from that thread will help. -
A 1099B would indicate that the shares distributed with unrealized appreciation (box 6) were immediately sold for the taxpayer after the distribution to the taxpayer and now the gain or loss must be recognized. Gain on the sale upto the unrealized appreciation would be long-term and any gain above that would be short or long depend upon how long the shares were held. In your case it appears the shares were sold in the same year.
Another way of looking at it is the total income in box 1 is the total to be taxed, but since stock was distributed only box 2a was taxable until the shares were sold. Now that the shares have been sold per 1099B, gain has to be reported and taxed on the sale.
If the client receiving the lump sum was born before Jan 2, 1936, he might qualify for an averaging of the proceeds on form 4972 thereby resuling in a lower tax.Comment
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Capital Gains Box
Your client must have worked for this employer a LONG time. If he was born before the magic date in 1936, there are alternate methods of computing his tax other than claiming the taxable distribution as ordinary income.
On Form 4972, the income is not calculated in either AGI or taxable income, but rather a separate tax is computed. To make a long story short, the effect of the tax is calculated over 10 years, but the base is first multiplied by ten, and after the tax assessed, the tax is then divided by 10.
The older plans were not tax-deferred. Tax-deferred plans, as well as IRAs, did not appear until the mid-70s. The nature of some of these older plans gave rise to a portion of the proceeds qualifying for capital gain treatment. If the distribution was sufficiently large, the above-described 10-year averaging would ultimately result in such a large tax that it would no longer be attractive (because of multiplying the base by 10). In cases of these very large distributions, a taxable distribution would result in a lower tax if a portion of the proceeds qualified for capital gain treatment. That is why there continues to be a box dedicated to capital gains portion of the distribution.
This is a long-winded answer which states the situation in general terms. There are detailed instructions for form 4972.
Also, the accompanying 1099-B most likely means that the plan was in company stock and the stock was sold (either by the company or at the employees direction concurrent with the distribution). This is treated as a separate transaction from the retirement distribution on schedule D. The basis should be the taxable amount of the distribution in stock. If it was sold concurrently with the distribution, it stands to reason that there should be a very miniscule gain or loss.Comment
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Relevant Answer
Apologies to ecb -- looks like I got carried away with the capital gains box instead of reading your question carefully. I'm going to leave the above post for anyone interested in the ancient history of why the capital gains box exists.
ecb - don't know all the details, but my gut tells me the IRS is correct. The preparer has most likely claimed the unrealized appreciation as capital gains. However, this appreciation occurred while the stocks were still in the plan -- not in the hands of the taxpayer. Often this appreciation is a measure of increase beyond contributions by the employee.
What has probably happened: The ESOP distributed shares of company stock to a plan trustee at fair market value. The FMV (less any employee contributions) at that point determined the taxability of the distribution at ordinary income rates. Also, since the shares at FMV were taxed upon distribution, the FMV became the taxpayer's basis in the stock as it existed.
Shortly thereafter (probably in a matter of days), the plan trustee sold the shares at a value slightly different than the FMV which existed upon distribution. The time lapse between these two events is normally very short, sometimes only a day or two, and it is normal for the market to be only slightly different over this short time period.
The taxpayer has two separate transactions to report: 1)a distribution of the ESOP at ordinary income rates (unless he was born before 1936) which can result in large amounts of reportable income, and 2)the sale of distributed stock which results in very small capital gains or losses.Comment
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