NUA problem with company issuing ESOP
Two weeks ago, we helped a client with his rollover 401(k) with appreciated ESOP. The company that processed the rollover sent the pretax rollover portion to our firm as instructed. We told the company to issue the ESOP in-kind (amounting to $40k with a cost basis around $5k) as a taxable distribution to take advantage of the NUA tax and place the stock in a newly created after-tax account. At the time, the company issued the stock in-kind but did not withhold taxes and issued the stock to be placed into an IRA instead of the after-tax account. After receiving the stock, we called the company to have them correct the problem. After multiple attempts, they refused to reclassify the stock and correct the problem by recoding the stock and having the taxes taken before they transfer the stock to our company. As we understand it, this is the only time we can take advantage of the NUA tax break.
Questions:
1) Is there another way to take advantage of the NUA tax break having already received the stock without taxes withheld?
2) Is there another way to minimize the tax consequence of the appreciated stock if the NUA is no longer available?
Thank you for your help.
Permalink Submitted by Alan Spross on Mon, 2008-01-28 21:41
The only good news is that since this is only January, you have plenty of time to get this corrected. Success probably depends on how clear your original instructions were to distribute the shares in kind to a taxable account in order to utilize NUA. If the instructions were clear, the plan should be well aware of the cost of litigation should you need to pursue that path. It sounds like they actually issued the entire LSD as a direct rollover intended for an IRA.
Note that getting the shares into a taxable account is only half the battle. You will also need a compliant 1099R next January showing the amount of NUA. The 20% withholding does not apply to the NUA amount, only the cost basis.
You are correct that the LSD must all be done within a single year in order to have a qualified LSD for NUA purposes. There is no work around and the IRS is very firm in requiring that the LSD be reported and executed correctly, particularly the LSD requirements. With a cost basis of around 12%, the NUA benefit is compelling. I do not believe that the IRS considers the shares part of an IRA if an IRA custodian has not taken possession, so you should be OK if you can get the plan to reverse the incorrect portion of this transaction.
Should there be something unclear in the transfer/distribution papers provided to the plan, your leverage could be pretty well eliminated. If the client carries any weight with the former employer, you might also consider intervention from the employer HR Dept with the plan administrator. You would think with share appreciation of this extent, the plan would be aware of and able to handle NUA requests. One other area of concern in a declining market is what these shares will be worth by the time client is able to sell them in the taxable account. Market value loss will be in the form of reduced NUA.