NUA strategy with No Appreciation?? Good idea?
Does it still make sense to distribute stock from a client’s 401k using the NUA strategy when there is currently little or no appreciation?
Obviously the client would pay ordinary income taxes on the cost basis at the time of the distribution but any future appreciation would be taxed at long term capital gains instead of ordinary income taxes (which currently could be a big difference for high net worth clients. Is this reason enough to still move forward on the strategy? Am I missing something? Let me know ASAP. Thanks a million!
Permalink Submitted by Alan Spross on Tue, 2010-01-12 17:27
It could be a good idea, but in quite limited situations identified by analysis. Some factor to consider:
1) Marginal tax rate in LSD year would have to be relatively low since the entire FMV of the shares will be taxable at ordinary income rates.
2) Shares sold within one year that have gains are subject to ST gain rates; if client passes, any gains will get step up (pending estate tax legislation), unlike NUA or other IRD assets.
3) Dividend payments will be taxable with the future of qualified dividend tax rates clouded. High dividend payers may generate lower LTCG over time.
4) Future LT cap gain tax rates may rise particularly for higher incomes, but the ordinary income rates will also likely rise. The spread between these two rates could expand or contract somewhat.
5) Possibly more viable when a very large amount of employer stock exists; this allows for various portions to be rolled over to an IRA vrs taxable account, ie hedging your bet. If plan uses other than average cost basis, use the lowest cost basis shares for NUA. Distribution of large amounts will almost certainly inflate the marginal tax rate.
6) Distributions to a taxable account can never be converted to a Roth IRA
7) There is time to reconsider the initial decision by rolling shares to an IRA within 60 days of distribution from the plan.
8) As in large NUA situations, diversification is a potential problem with large amounts held in a single issue. This is probably the largest single factor, since the quick sale of most of the shares has resulted in nothing more than a reduction in tax deferred retirement assets. Sale at a loss is limited to net cap losses of only 3,000 per year.
9) Possible AMT implications?
Permalink Submitted by Stephen Rhodes on Wed, 2010-01-13 04:14
Thanks for the prompt and detailed reply. One other question, if the stock is distributed and the FMV is currently less than the cost basis, does the client pay ordinary income tax on the cost basis or the FMV?
Permalink Submitted by Alan Spross on Wed, 2010-01-13 04:38
Since there is no such thing as negative NUA, it seems logical that the FMV upon distribution would determine the ordinary tax if less than the plan cost. In addition it is possible to have after tax contributions allocated to some of these shares which would further reduce the taxable amount.
Any loss generating a misc itemized deduction for the LSD would only be possible if the entire LSD were received in cash and worthless securities with no IRA rollover. Just depreciated shares could not be used to generate a misc deduction.