The Huge Tax Break for Laidoff Company Executives
Company executives who have been laid off with large amounts of appreciated employer stock in their retirement plan are eligible for a huge tax break known as the Net Unrealized Appreciation (NUA) benefit. Basically, the law provides that when there is a “triggering event”, the employee may do an IRA rollover and that when the employer stock is distributed from the plan, the cost basis only is taxed at ordinary rates and the appreciation is taxed at capital gain rates only when the stock is sold. The higher the appreciation and the lower the cost basis, the more advantageous this tax break is. The following items outline the technical requirements to become eligible for this tax break.
1) Unlike a normal IRA rollover, the employer stock does not go into the IRA rollover account. It does go into the taxable brokerage account. If this opportunity is missed, the NUA tax break is lost and the appreciation will be taxed at ordinary income rates when the value is withdrawn from the IRA rollover account.
2) The other assets in the employer retirement plan do go into a regular IRA rollover account.
3) The distribution from the employer retirement plan must be a lumpsum at one date in one calendar year, completely wiping out the balance in the employer retirement plan, pursuant to a “triggering event” which is usually the termination of employment.
4) Under IRS Notice 98-24, the appreciated stock, which is now in the brokerage account, can be sold the day after the distribution and the amount of appreciation measured to the date of distribution will be taxed at capital gain rates because the holding period is assumed to be long term.
5) Any appreciation while in the brokerage account over the amount of appreciation measured on the distribution date will be treated as either long-term or short-term based on the length of time held in the brokerage account.
6) The nonemployer assets which are in the IRA rollover account may be sold with no tax consequences, since they are in a IRA rollover account. In all respects, the IRA rollover account is treated for tax and other purposes the same as any other IRA rollover account.
7) For estate tax purposes, the NUA stock and the IRA rollover is includible in the estate. However, the cost basis to be used when the NUA stock is sold is determined separately for the two portions of NUA stock. The appreciation that existed on the date of distribution is not “stepped up”. The cost basis is the same as it was on the date of distribution. The appreciation that occurred since the date of distribution is stepped up to the market value on the date of death.
8) If the employee is under the age of 55 on the date of distribution, a 10% premature penalty applies, but it applies only to the cost basis of the NUA stock. Obviously, the lower the basis, the more advantageous the distribution is.
9) If the employee has reached his or her Required Beginning Date (RBD), the NUA stock in the brokerage account is not subject to RBD rules. The IRA RMD rules do not apply to NUA stock in the brokerage account. Such stock can be held forever.
10) There is no 20% income tax withholding on a NUA distribution Five Mistakes That Shouldn’t Happen
There will be some repetition under this heading, but it is worthwhile to reminder readers that if rules are not followed exactly, this great tax break will be lost.
1) Failure to ask about NUA Company Stock. When the distribution from a company plan is rolled into an IRA, including any NUA stock, because the employee and any advisors involved acted quickly, this mistake cannot be corrected. The NUA tax break is lost forever.
2) Not going all the way. Every dollar in the company retirement plan must be withdrawn in one calendar year in one lumpsum distribution. There is no halfway course of action. If there is any dollars left in the plan, the NUA tax break is lost. There can be problems when mutual funds make year-end dividend and capital gain distributions. This has to worked out so that there is no balance in the company retirement plan at 12/31.
3) Taking RMDs and other distributions in the year of a triggering event. Certain distributions taken in the year a lumpsum distribution is taken, pursuant to a triggering event, such as termination of employment, will cause the loss of the NUA tax break. For example, let’s say John Doe reaches age 70 ½ in 2007 and must take his RMD in 2008. If John Doe does take his RMD from the company plan and then attempts to take a lump sum distribution to qualify for the NUA tax break in 2008, it will fail the lumpsum test and John will not be entitled to the NUA tax break.
4) Panic and selling the company stock. Troubles in the economy, in the stock market, and in theemployer’s business in particular can cause employees to sell the stock prematurely. While investment policy should take precedent over tax policy, if the company stock is sold, the NUA tax break will be significantly reduced, if not eliminated completely.
5) The beneficiaries are not told about the NUA tax break. When an employee dies while funds are still in the company retirement plan, if there is company stock in the plan, the beneficiaries may not know about the NUA tax break. Beneficiaries do qualify for the NUA tax break, but unfortunately, they are not told about it. Both the surviving spouse and nonspouse beneficiaries qualify for the NUA tax break.
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