Pre-55 NUA and LSD
My wife is contemplating a NUA distribution this year and we’d like some help thinking it through. Situation: Company went public 10/06, qualified retirement plan. She terminated service as a regular employee at age 48 in 12/06. No intervening distributions. Self employment income in 2008 and 2009. The plan has two components: the company stock and a special dividend that was allocated into participants’ individual accounts in the plan and subsequently invested by us in different funds offered by the plan. According to Vanguard, the plan sponsor, there is a 17K basis in the company stock, market value 184K. The dividend was originally 75K, market value now 83K.
If we do an LSD before the end of this year, is it correct that stock cost basis + market value of dividend amount would be added to total income for this year? And that the 10% penalty on the stock cost basis is just added on top of tax owed on total income? I also have a question about the exemption of the 10% penalty on the dividend, which I’ll get to in a moment.
If the above is correct, then with an LSD in 2009, we expect our marginal tax rate to be 28%, whereas we expect our marginal tax rate to be 15% in 2010. We understand that the NUA is figured as of LS distribution date, and then cap gains rate applies to gain/loss after that. The big question is: if the stock is sold in 2010, is the LTCG tax on the NUA figured based on our marginal tax rate of 2009 when the plan was distributed or 2010 when the stock is sold? This is critical, as it’s the difference between a 0% and a 15% LCTG rate.
As far as the dividend, the IRS determined that it was a “dividend” under federal tax laws, but did not permit an election to receive the special dividend in cash, and the company was not permitted to receive a tax deduction for any amount of the special dividend paid to the plan. According to plan rules, the dividend is not allowed to be rolled over, and is ordinary income upon distribution. That being the case, can anyone comment on whether this dividend falls under the 72(t)(2)(A)(vi) exemption of the 10% penalty or not?
Thanks to any and all of you in advance for your help.
Permalink Submitted by Alan Spross on Tue, 2009-08-11 21:14
The NUA LSD appears fairly routine with an excellent cost basis of less than 10% of current FMV. The ordinary income tax on the cost basis would be due and the early withdrawal penalty would apply unless your wife meets some special penalty exception under Sec 72t. This is as you expected.
However, the LSD tax bill is heavily affected by the special dividend provisions since those funds must also be distributed if the LSD is to qualify for NUA treatment. Typically the proceeds from the dividend would be directly rolled to an IRA and avoid taxes and withholding. But I do not understand the “no rollover” statement regarding the dividend proceeds which are now in Vanguard funds in the plan. Why are they saying these funds or the cash proceeds thereof cannot be rolled over?
Permalink Submitted by Andrew Schwartz on Tue, 2009-08-11 22:24
Thanks for the reply Alan. The plan language as it was laid out in 2006 stated: “A distribution of dividends paid on SAIC stock is not eligible for rollover”. Calling Vanguard today, a plan person said that they see no plan language restricitng the cash portion of the plan from being rolled over. Which would be great. Still, there were enough convoluted conversations between the company and the IRS on this matter as they went public, that I am not reassured that the first line of customer service from Vanguard knows the bottom line fully. More digging on my part is needed.
I take it that you feel that a stock sale in 2010 would apply the NUA to the cap gains rate associated with the marginal tax rate from 2010 even if the distribution occurred in 2009?
Permalink Submitted by Alan Spross on Tue, 2009-08-11 23:07
Yes, I neglected to address that question. The tax rate that applies to the sale of NUA stock is that of the year of sale. There is no guarantee that the top LTCG rate will remain at 15%. It could also conceivably rise to different top rates in the higher brackets in the future. Any additional gain above the FMV at the share distribution date will be taxed at ST rates until the first year passes in the taxable account, and then the additional gains would also be LT. NUA gains are IRD and therefore do not get a basis adjustment at death, whereas any additional gains DO get the basis adjustment.