Lifepoint Financial Design – LifePoint Financial Services – Mike Metzger Financial Planning

Your company values you and wants to keep you as an employee, so they give you the option to buy employer stock or give you employer stock at a discount.  Pretty sweet deal! But over a longer period of time, this gift of the “golden handcuffs” can cause you a lot of tax pain.

When it comes time to take the gift that was given to you at retirement or 59 ½, all withdraws from tax qualified retirement plans (i.e. 401(k), IRA, profit sharing, money purchase, and Employee Stock Purchase Plans (ESOP)) are taxed at federal and state income tax brackets. For those in high income tax brackets, this could be upwards of 40%. The top federal income tax alone is 37%!

As an alternative to ordinary income tax, another method is to take a distribution of all of the company stock from the employer plan to a taxable brokerage account. The IRS will allow you to pay long-term capital gains tax and not the ordinary income tax rates. This could potentially provide you with huge tax savings, as the long-term capital gains tax rate is currently 0%, 15% or 20% dependent on your taxable income.

What is Net Unrealized Appreciation (NUA)?

Net unrealized appreciation is the difference between the cost basis and the market value when the stock is distributed from the plan.

Net Unrealized Appreciation Example

Let’s say Charlie received Berkshire Hathaway stock from his employer with a cost basis of $20,000. At retirement, his Berkshire Hathaway stock is distributed with a market value $200,000. The difference, $180,000, is not taxable until Charlie sells the stock, but the cost basis of $20,000 is taxable now at distribution as ordinary income (because the company gave him that amount). If the Berkshire Hathaway stock is sold 6 months after distribution for $250,000, then $180,000 is taxed at long-term capital gains rates, and $50,000 is taxed at short-term capital gains rates.

Qualifying For the NUA Tax Break:

  • Your distribution from the plan must be a “lump sum distribution.”  

  • The stock must be distributed to you in-kind (certificate form). It can’t be sold before the distribution.  

  • · Once distributed, the stock must be deposited into a taxable account. You can’t use the NUA strategy if you roll the stock into an IRA.

In addition, if you don’t sell the company stock during your lifetime, your beneficiaries can use the NUA tax break when they sell the shares 

Distribution Considerations:

While the tax savings using the NUA strategy are compelling, it may not be appropriate for everyone. Consider the following:

  •  The NUA strategy generates an immediate tax bill on the cost basis of the stock. If you can’t pay the tax out of pocket, you may need to sell some of the stock to pay the tax.

  • If the stock distribution is sizeable, it may cause you to move into a higher tax bracket. You may want to take only part of the distribution in stock.

  • When you eventually sell the stock, a sizeable capital gain (the NUA) may trigger the Alternative Minimum Tax. You may want to plan on selling the stock over a period of years.

  • If you are under age 59½, a 10% early withdrawal penalty generally applies to the cost basis of the stock distributed to you.

  • Employer stock is a wonderful benefit that your company may offer, but navigating the taxation and distribution of that stock can be complicated. You want to make sure you don’t turn that gift into a curse.

At Lifepoint Financial Design, we have sophisticated software that can do a cost-benefit analysis to determine if taking a distribution of employer stock is the right choice for your unique situation. Net Unrealized Appreciation can be a complicated landscape and I’m here to create a plan so that you can focus on what you enjoy most.

For more advanced planning techniques, download the 6 Advanced Planning Strategies For High Income Earners PDF


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.  Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

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