7.10 Distribution of Employer Stock or Other Securities
If you are entitled to a distribution from a qualified plan that includes employer stock (or other employer securities), you may be able to take advantage of a special exclusion rule. If you withdraw the stock from the plan as part of a lump-sum distribution and invest the stock in a taxable brokerage account instead of rolling it over to a traditional IRA, tax on the “net unrealized appreciation,” or NUA, may be deferred until you sell the stock. To defer tax on the full NUA, the employer stock must be received in a lump-sum distribution, as discussed below. If the distribution is not a lump sum, a less favorable NUA exclusion is available, but only if you made after-tax contributions to buy the shares; see below.
Lump-sum distribution.
If you receive appreciated stock or securities as part of a lump-sum distribution, net unrealized appreciation (increase in value since purchase of securities) is not subject to tax at the time of distribution unless you elect to treat it as taxable.
Planning Reminder
For purposes of the NUA exclusion, a lump-sum distribution is the payment within a single year of the plan participant’s entire balance from all of the employer’s qualified plans of the same kind (all of the employer’s profit-sharing plans, or all pension or stock bonus plans). The distribution must be paid to: (1) a participant after reaching age 59½, (2) an employee-participant who separates from service (by retiring, resigning, changing employers, or being fired), (3) a self-employed participant who becomes totally and permanently disabled, or (4) a beneficiary of a deceased plan participant. If there is any plan balance at the end of the year, there is no lump sum and the NUA exclusion is not available.
Assuming you do not waive the NUA exclusion, you are taxed (at ordinary income rates) only on the original cost of the stock when contributed to the plan. Tax on the appreciation is delayed until the shares are later sold by you at a price exceeding cost basis and the gain attributable to the NUA will be taxed at long-term capital gain rates (5.3).
The NUA in employer’s securities is shown in Box 6 of the Form 1099-R received from the payer. It is not included in the taxable amount in Box 2a.
If, when distributed, the shares are valued at below the cost contribution to the plan, the fair market value of the shares is subject to tax. If you contributed to the purchase of the shares and their value is less than your contribution, you do not realize a loss deduction on the distribution. You realize a loss only when the stock is sold for less than your cost or becomes worthless (5.32) at a later date. If a plan distributes worthless stock, you may deduct your contributions to the stock as a miscellaneous itemized deduction subject to the 2% of adjusted gross income floor.
Election to waive tax-free treatment.
You may elect to include the NUA in employer stock or securities as income. You might consider making this election when the NUA is not substantial or you want to accelerate income to the current year by taking into account the entire lump-sum distribution. If you were born before January 2, 1936, and are claiming averaging or capital gain treatment on Form 4972 (7.4), follow the form instructions for adding the unrealized appreciation to the taxable distribution. If you are not filing Form 4972, the election to include the unrealized appreciation as ordinary income is made by reporting it on Line 16b (taxable pensions and annuities) of Form 1040 or Line 12b of Form 1040A.
Distribution not a lump sum.
If you receive appreciated employer securities in a distribution that does not meet the lump-sum tests above, you report as ordinary income the amount of the employer’s contribution to the purchase of the shares and the appreciation allocated to the employer’s cost contribution. You do not report the amount of appreciation allocated to your own after-tax contribution to the purchase. In other words, tax is deferred only on the NUA attributable to your after-tax employee contributions. Net unrealized appreciation is shown in Box 6 of Form 1099-R. Cost contributions must be supplied by the company distributing the stock.