NUA Basis Allocation after N2014-54

Submitted by James Blankenship on Thu, 2014-10-02 19:01

Just read the excellent overview of IRS Notice 2014-54’s impact on allocation of after-tax money during rollovers. My question is: will this Notice affect the way that NUA *basis* allocation can occur?

Example: Taxpayer has a 401(k) account with $1MM in it, all from after-tax contributions. Of the total, he has $500,000 in employer stock, with purchase basis of $200,000. The remaining $500,000 is in mutual funds. Of course the taxpayer can transfer his mutual funds worth $500,000 to his IRA. Can he also transfer $200,000 worth of his employer stock to the IRA, allocating the basis to these stocks, and then distribute the remaining $300,000 to his taxable brokerage account so that there is an effective basis of zero, and therefore also zero tax on the distribution? Then when he sells the stock in the brokerage account, naturally the first $300,000 has long-term cap gains treatment and if there is growth of the funds the holding period (for determining LTCG vs. STCG) starts on the date of the distribution.

The reason I wonder about the possibility is from IRC Sec 402(c)(2) where it is stated that the transfer to an IRA as part of a lump-sum distribution with multiple destinations is treated “as consisting first of the portion of such distribution that is includible in gross income”. Since the amount from his distribution that is “includible in gross income” is his mutual funds plus the cost basis of his employer stock, should this basis allocation be allowed?

Any comments on this? Appreciate your insights –

jb



Submitted by mk foss on Fri, 2014-10-03 00:02

The regulations regarding the determination of cost basis for NUA purposes indicate that you use average cost basis to determine the NUA. You can’t split the shares by allocating basis to some shares and no basis to others. Also Notice 2009-75 indicates that more than the basis amount is taxed when NUA shares are converted to Roth.

Submitted by Alan - IRA critic on Fri, 2014-10-03 02:45

  • The plan provisions may contain specific priorities in applying after tax contributions within the plan. The document could apply after tax amounts first to the employer shares, to the other assets, or pro rata. In any of the prior situations, Notice 2014-54 would not change the amount of after tax applying to the employer shares vs the rest of the plan. However, since the plan must allow the employee to specify the destination account for after tax contributions, then the employee could choose to request the direct rollover of the mutual funds or other assets be done with pre tax amounts, thus leaving more after tax amounts for the NUA shares.
  • Note that after tax contributions in the plan often referred to as basis is quite different from the “cost basis” description used in describing the purchase price of the employer stock in the plan, which is the SAME whether the shares are purchased with after tax amounts or pre tax amounts. For these purposes, there has been an uresolved issue since 1985 when the IRS in PLR 8538062 allowed the employee to roll employer shares that had been distributed to him to an IRA equal in value to the cost basis for the NUA. The remaining shares were then 100% NUA because the PLR allowed the total cost basis and NUA to float over all employer shares. Therefore, there was no current tax due in the LSD year for the employer shares because the NUA cost basis was gone, and 100% of the shares remaining were NUA. This PLR may not hold up today, as the IRS at various times denied current applicability of that PLR but never issued Regs to my knowledge. This entire issue boils down to whether the NUA cost basis is locked to the shares on a PER SHARE basis, or floats over all the shares as an aggregate number like after tax contributions do. Several taxpayers have reported in accord with the 1985 PLR, but it is not clear whether the IRS agreed or simply overlooked the math that had been applied. Or whether the IRS was looking at Sec 402(c)(2) which states that a rollover done by the employee is considered to be applied to pre tax amounts first and considered the NUA cost basis as a pre tax amount. It is far from clear that this section even applies to NUA cost basis, as it does to after tax amounts.
  • You will note that in your example (despite not providing the total after tax amount in the plan) you focused on eliminating the current tax on the employee shares (Box 2a) of the 1099R by rolling over already distributed employer shares. This is not necessary if you have after tax contribution amounts remaining equal to the NUA cost basis. By not rolling employer shares to an IRA you would still have all 500k of employer shares, with the same amount of NUA per share, but the taxes on the NUA cost basis will be eliminated due to after tax contributions. Conversely, if you rolled over 200k of employer shares to an IRA, the outcome is the same (no current tax but the cost basis in the taxable account and the NUA per share is the same) but you have fewer shares. Note that this is preferable to having all 300k as NUA because that is more NUA to be taxed when you sell.
  • It would be interesting to look at an example, but the example you posted would be more realistic if you used something like 100k in after tax contribution. To have a plan with no pre tax amounts is nearly impossible as it would require no pre tax elective deferrals, no matching and no investment gains.

Submitted by James Blankenship on Fri, 2014-10-03 12:35

Criminy! No matter how carefully you review something, there can still be problems with it.I intended for my example to be all pre-tax money, not after-tax. If you look at it that way the example should make more sense – if it was all after-tax money he wouldn’t likely rollover/transfer those funds to an IRA. Roth IRA possibly, but likely not a traditional IRA.Thank you both for your insights – and if the correction I’ve mentioned above has any bearing on your opinions, I’d be very interested in hearing them.Thanks.

Submitted by Alan - IRA critic on Fri, 2014-10-03 19:34

It is a much simpler scenario with no after tax contributions in the plan. The only cost basis here is what the plan paid for employer shares when purchased for the taxpayer’s 401k or ESOP. Therefore we are back to the 1985 PLR, which is what your question depends on, but the current position of the IRS on this is not clear. Under the proposed situation, taxpayer would take a distribution of all 500k of employer shares and then roll 200k of the shares to an IRA within 60 days, and take the position that Sec 402(c)(2) that states the taxable portion is rolled over first can apply to NUA cost basis, and that cost basis can be aggregated instead of each share being composed of 40% cost basis and 60% NUA. Since Notice 2014-54 only deals with after tax contributions, the Notice does not affect the scenario you posted. There is a long and detailed thread on this same question here:   https://irahelp.com/forum-post/17504-nua-lsd-401k

Submitted by James Blankenship on Fri, 2014-10-03 20:48

Thanks again for your valuable insights. jb

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