Inherited Stock with NUA
A number of posts cover the typical case of capital gains on NUA stock but unfortunately losses after the date of distribution/inheritance can occur. The situation is as follows
Father passed away with large employer stock contribution in 401K. It was distributed to his children as lump sum distribution.
In simple numbers, his cost was $8/sh, FMV at time of distribution/inheritance was $38/share with NUA of $30/sh, with 5000 shares for each beneficiary.
Also the estate paid a notable estate tax, so roughly $150k for each beneficairy is attributable to the stock and the stock becomes a 691 (a) item, IRD. The understanding is that as the stock is sold a deduction, per 691 (c) is allowed. It turns out to be 18% deduction for each dollar of IRD. The IRD is of course created when the stock is sold. Details of the 18% are not explained here.
Question 1) How exactly is the deduction to be taken, Schedule A ? or as I beleive, as reduction of the captial gain on schedule D somehow. [It doesn’t seem likely the IRS would allow an income deduction against a capital gain given the different tax rates]
Unfortunately the stock has tanked since the inheritance and is now $16/sh which makes things really messy.
I see the following three components but have no idea how to report things when part of the stock is sold. Assume 2500 shares are sold.
1) LTCG on NUA $30/sh ($38 -$8)
2) LT capital loss between NUA and actual sale price ($38 -$16)
3) some sort of 691 (c) credit
Question 2) How exactly is this reported on schedule D? Is it one line item, two or three and how much detail needs to be spelled out in the return? And what do you see the total capital gain to be reported as?
Question 3) Is the IRD based upon the NUA (2500 x $30 = $75k) or is it based upon the actual sale price (2500 x ($16-$8) = $20k)?
Question 4) If the IRD is based on the actual sale price, and not the NUA how can the estate tax deduction ever be recouped? (With the stock at a significant loss, the full IRD may never materialize)
On top of the stock taking a huge hit, I’m worried that the 691(c) deduction may also be wiped out.
Any help would be greatly appreciated as no one ever seems to addess the devaluation of NUA assests.
Permalink Submitted by mk foss on Wed, 2011-02-09 20:14
Although NUA is an IRD item, it’s generally not still held at death so some of the questions are items I’ve not previously come across.
1. When NUA stock is sold, the plan cost basis of the shares is offset against the sales price. The fact that there is less appreciation when the stock is sold is not a problem. You merely report the proceeds $16 per share and the basis $8 per share to determine the gain. You would indicate that the shares are inherited but no other details need be furnished. This is the answer to your question #2.
2. The IRD deduction is claimed on Schedule A on the bottom of the form – it is not subject to the 2% limitation and is not an “add-back” for AMT purposes, as a general rule. There may be some precedent for claiming the deduction on Schedule D. When an installment obligation is inherited, the IRD attributable to the unreported gain is claimed on Schedule D. This is your first question.
3. NUA is based on the lower of the value when the stock is distributed or the sales proceeds. That’s why the NUA is only $8 per share in the first item above.
4. You calculate the IRD deduction with a “within and without” calculation by removing the IRD item from the estate tax calculation. The IRD as of the date of death was greater than the income to be reported – so I agree that the entire estate tax attributable to the IRD may not be deductible.
Most states do not allow an IRD deduction so you should watch for that in return preparation.
Permalink Submitted by Alan Spross on Thu, 2011-02-10 00:07
Mary Kay,
Pub 559, in interpreting the cap gain provisions in 691(c) indicates that for cap gain IRD assets the deduction (eg. NUA share sale) is applied by reducing the gain. This will eliminate the prospect that the IRD deduction becomes worth more on CG assets than ordinary assets, but there is no specific advice on reporting. Perhaps Sch A does not apply in this situation and the sale and deduction are wrapped up on Sch D instead. The gain cannot be reduced below 0. Or perhaps Sch A Misc should be reported as a memo total and referred over to Sch D.
The other issue appears to be the rate at which the IRD deduction is applied as shares are sold, ie all up front or on a ratable basis calculated as a % of each sale. Can’t really tell what the 18% actually relates to here.
What to you think?
Permalink Submitted by Gary Christensen on Thu, 2011-02-10 01:42
Alan,
You’ve hit the crux of the dilema in your second paragraph. First more background. The 18% represents the deduction that is allowed (by going though all the estate with and without calculations) on the income that is generated from the NUA when the stocks are sold, up to $150K in ‘realized’ NUA. I’m pretty sure this calulation was all done correctly.
Becasue the stock price can change, the capital gain could be more than the NUA, or in this case, much less. If all was sold at once with capital gains of $150K, there would be an 18% ($27k) 691 (c) deduction [b][size=120][color=#0000BF]somehow[/color][/size][/b] taken so as to “reduce the capital gain”. How, I don’t know. I’d love to see $27K schedule A (income) deduction but I’m fairly confident that isn’t right. If the gains were more than $150K, the 691 (c) dedduction caps out at $27K. What if the gain was $0 (sold at $8/sh, or even)? Then, is the 691 (c) deduction $0 gone forever. Hardly seems right. If the stock was sold for $8+($27K/5000)=$13.4/sh, presumably the capital gain wouldn’t drop below $0 (after the 691 (c) deduction was claimed) and the 691 (c) deduction would at least have some value.
It all gets really messy if only part of the shares are sold, and boils down to whether the deduction should be pro-rated agaisnt the percentage of the stock as it is sold or against the income from selling the stock. This is the $27K question.
I would have liked to see the stock appreciate to the point where one share was worth $150,008 becasue then you would (presumably) sell one share (generating $150k capital gain) and take the entire $27K 691 (c) deduction at that time.
Permalink Submitted by Gary Christensen on Thu, 2011-02-10 01:54
Again, thanks to everyone, that may have insight into this. I’ve asked local people and just get blank stares when I talk about IRD deductions against capital gains. I know it’s not common so any help is greatly appreciated.
Permalink Submitted by Bruce Steiner on Thu, 2011-02-10 03:55
This is answered by the language of Section 691(c)(1), which limits the deduction to “an amount which bears the same ratio to the estate tax attributable to the net value for estate tax purposes of all the items described in subsection (a)(1) [the IRD items] as the value for estate tax purposes of the items of gross income or portions thereof in respect of which such peson included the amount in gross income (or the amount included in gross income, whichever is lower) bears to the value for estate tax purposes of all the items described in subsection (a)(1).”
Note the parenthetical “or the amount included in gross income, whichever is lower”.
Treas. Reg. § 1.691(c)-1(d) Example 1 is consistent with the statute.