NUA

Submitted by Spencer Frank on Thu, 2016-10-13 14:35

I have a client who has $3.2 million in company stock in his 401k. We are considering taking advantage of Net Unrealized Appreciation. The cost basis on the statement shows about $1 million. He did not contribute $1 million during his 17 years of employment starting in 1975, he thinks he contributed close to $100k. My guess is dividend reinvestment raised his cost basis to $1million. Does the IRS look at what money he actually contributed plus the match to his 401k or what he and the company contributed plus reinvestment of dividends? Are company dividends considered a contribution or appreciation inside a 401k? I cannot find this addressed anywhere in the IRS Publication.

Thanks for any guidance!

ps- He did contribute almost $100k after tax to his company sponsored retirement plan and only $950 pre tax.



Submitted by Alan - IRA critic on Thu, 2016-10-13 20:05

  • The IRS just looks at Box 2a of the 1099R to determine the taxable cost basis, barring an audit of the employer’s records or tax reporting. 2a would include the cost of the shares when contributed to his account regardless of the source of funds. That means in addition to his salary deferrals, company matching contributions, dividend reinvestments, any ESOP shares or other bonus shares and forfeitures would all be reported in 2a. However, shares purchased with after tax contributions would usually NOT be included in 2a. The NUA amount is limited to actual appreciation of the shares after crediting to the client’s account. Cost basis over 30% is typically questionable for applying NUA unless employee will sell the shares right away due to spending needs. That would also provide fast diversification out of the shares.
  • Note that NUA need not involve all the shares. He could elect any portion he wants to be distributed to a brokerage account for NUA purposes and roll the rest to an IRA. While rare, some plans provide accounting in various lots of shares with certain lots having different cost basis. If so, and he wanted to use only some of the shares for NUA he could ask to have the lowest cost basis shares distributed. It is worth asking about, but most plans simply use average cost for all the shares.
  • Where his scenario really gets complex is when he would want to use Notice 2014-54 in order to roll his 100k of after tax money into a Roth IRA. In that case, the after tax contributions could not also be used to lower the box 2a amount for the company shares.
  • I assume he is over 59.5 and therefore would not owe a 10% penalty on the cost basis.

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