NUA
A Target 401K participant has just transferred from mutual funds to Target stock therefore her basis is zero. Can she take those shares in certificate form, transfer those shares to a non-qualified account and change tax treatment from ordinary income to LT cap gains?
Permalink Submitted by Alan Spross on Wed, 2007-09-19 17:57
No. Even if she was eligible for a lump sum distribution, cost basis for NUA purposes is different from traditional tax cost basis.
Since she just exchanged into the Target stock her cost basis for NUA is the full cost per share on the date of purchase. There has been no time to generate substantial gains in the shares, and it is that gain that would potentially be taxed at the LT cap gain rates. Therefore, NUA is more viable for those who have been acquiring employer shares over many years, with the exception of the dot com bubble where some of those stocks doubled and tripled overnight. Typically, for NUA to be compelling the cost basis should be less than 40% of current FMV and preferably under 30%.
In a lump sum distribution of employer shares, the cost basis is taxable in that year, and it is determined by what the plan paid for the stock. If the employee acquires some of these shares with after tax contributions in the plan, then the taxable cost basis is further reduced, but the NUA remains the same.
In any event, this participant may have the potential for NUA over a period of years if the Target stock in the plan does very well, ideally tripling. She may also have other Target shares from the employer match and those shares may have a lower cost basis than the recent purchase, so her actual average cost per share may be less than what was paid for the recent purchase. Companies usually account for the employer shares using an average cost basis for all shares, although some companies may be able to recognize different costs per various lots. In that case, the employee might want to distribute only the lowest basis shares for NUA. Despite the potential tax advantage, diversification is more important, and no employee should overload on employer stock or any other single issue, because the tax break is not worth the additional risk if the stock tanks.
Finally, we don’t know what the LT rate will be after 2010, but any change in the rate will probably be to the upside.