Distribution of company esop and 401k

Submitted by William Harkrader on Tue, 2020-02-11 16:06

Hi,
I retired from my company at 59, I am now 63 and received a notice of distribution for my esop and my 401k . Both accounts comprise of my company stocks which are not publicly traded. The cost basis on esop is very low because I started in 1976 and the 401k started in 1996 so the cost basis is about 50% of total value . I am living off dividends and SS. I have option to roll over to an IRA as stock for both 401k and esop but have been told by financial company that because of cost basis on esop to roll into to my individual stock account and pay taxes for 2 reasons, 1.only chance to take adv. of low cost basis and 2. dividend’s will now be qualified
instead of ordinary. The 401k has a much higher cost basis so I should roll to IRA to defer taxes in 72 yrs old. I have read on many options and been through Ed Slotts dvds and retirement books that I have purchased. Still can not find. out which is best option for each acct. tax wise for me personally then my heirs.
I am sorry this was so long,
Please advise
Sincerely,

W.L.Harkrader



Submitted by Alan - IRA critic on Tue, 2020-02-11 20:26

  • If your cost basis for NUA purposes is 50% for the 401k shares, you should roll over those shares to your IRA unless you are required to sell them back to the plan. Find out the cost basis % for the ESOP shares as the lower that % is the better option NUA becomes.  Be sure you did not take a distribution from the 401k (other than 404k dividends) after retiring and before the year you do the lump sum distribution since that would disqualify your LSD for NUA purposes.
  • I think the notice of distribution means that you will have to sell the shares back to the plan, and that means you will be taxed on both the cost basis and the LT cap gain in the same year. Normally, that is not good, but if your other income is low enough, some of the cap gains could be taxed at 0. You would have to run the expected results through a tax program to determine this. This would be driven based on the total value of the ESOP shares that would be distributed.

 

Submitted by William Harkrader on Tue, 2020-02-11 21:37

Hi, thank  you for the response. On the 401k I think you are right to roll into an IRA because the cost basis is high. But just to clarify I can roll the shares of stock. what I do not understand is the esop which I can keep the stock as well . If I roll the shares into my personal acct, do I pay tax on the low single digit cost basis x how many shares or do I pay tax on the diff of the low cost basis and value of stock today. I believe if I roll it all to an IRA as stock I defer taxes until I am 72 and have to take minium disttributions. I also belive if I do this my heirs lose the stepup advantage and will have to pay on originalcost basis at their tax rate during distributions. Please advise and correct where needed. Thank you for your advice

Submitted by Alan - IRA critic on Tue, 2020-02-11 23:38

  • You will have to check with the plan administrator what your options are with respect to NUA. Because the shares are not publicly traded, you might have to sell them back to the company (one or both plans) instead of either rolling them over or moving them to a brokerage account. That does not mean you cannot use NUA, but if the shares must be sold back to the plan, you will be taxed on both the cost basis and NUA in the current year. On the other hand if you were allowed to distribute the shares without selling them back, you could sell the NUA shares when you wanted to. Could be years later or the shares could be inherited. If inherited, there is no cost basis step up on the NUA portion for your beneficiaries, but there is for the rest of the share value.
  • If you are allowed to distribute the NUA shares to your brokerage account instead of selling them back, you will only pay current taxes on the cost basis, and you said that the cost basis per share is very low for the ESOP shares. Low would be 10-20% of value and very low would be less than 10%. You would only be taxed on the NUA in the year the shares are actually sold. 
  • You are correct that there is no step up on any IRA holdings or on the NUA portion per share outside the IRA, so not quite as good for heirs to inherit NUA shares as other non IRA shares.
  • You will need to check with the plan to get a cost basis quote on all the shares and also find out about the requirements for distribution or sale back to the company. If the shares must be sold back, all you get is the cash, but will be taxed at the lower LT cap gain rate on the NUA portion.

Submitted by William Harkrader on Wed, 2020-02-12 05:04

Thank you for youe advice.  to answer your questions, yes the stocks  from 401k and esop can be distributed as inkind as shares of stock. I was originally planning with broker to roll 401k as in kind as stock to IRA. My plans with the esop was to distribute as a lump sum in shares of stock im my personal stock acct that also as shares from my company that I purchased. These would be held as e certificates. My second choice would be a lump sun distribution to an IRA in kind as stock. The reason I was going to do this finanial advisor said that if I distribute to my personal stock acct as in kind that I would have to pay tax on difference of total value of stock now and my cost basis which is about 9% of total value. On the esop account the dollar value of the cost basis.is 9% of total value of shares. This was sent to me by company, almost looks like a 1099r but is just a printout. They did cost basis averaging because I worked from 1975 till 2015. I have read on numerous finanial sites I only would have to pay the tax on the cost basis which is about 9% of total value. I think that is what is considered NUA. Please advise whis is best and how I would be taxed. Thank you in advance for your time and advice 

Submitted by Alan - IRA critic on Wed, 2020-02-12 14:27

  • It sounds like your advisor stated that when the shares are distributed to your brokerage account in kind, you would be current taxed on the NUA. That is incorrect. You are only taxed on the 9% cost basis, which is the amount that will go in Box 2a of the 1099R. The other 91% is NUA (box 6) and only taxed when you actually sell the shares, whichever year you do that. If you never sell, your beneficiary inherits the NUA but does not get a basis adjustment on it.
  • Example – Stock value per share $100. Cost basis is $9 and NUA is $91. You do not sell for 5 years and then the stock is worth $130. Your taxable gain (Lower LTCG rate) will be $121. If the stock declines instead and you sell for $70 per share, then $30 of NUA evaported and your LTCG will be $61.
  • Note that if you ever made after tax (non Roth ) contributions to the plan, many plans will apply that to erase the taxable cost basis. That could erase the $9 of cost basis in Box 2a. Or your plan might allow you to apply the after tax amount to a Roth IRA rollover tax free. Check into this if you have an after tax balance, which should show on your plan statement.

Submitted by William Harkrader on Wed, 2020-02-12 18:07

Hi I appreciate all the advice , it has made things clearer fo me.Thank you

Submitted by William Harkrader on Wed, 2020-02-12 19:08

How do you know if the dividend from your esop consisting of company stock on your 1099div is considered distribution? If it is this means you can not take advantage of  NUA if you do in kind distribution into a aindividual account? 

Submitted by Alan - IRA critic on Wed, 2020-02-12 20:28

Are you sure the dividends you have been receiving are reported on a 1099 DIV and not on a 1099R coded U? All ESOP dividends are to be reported on a 1099R. If the 1099R is coded U, PLR 1999-47041 states that such dividends are not to be treated as intevening distributions that would disqualify the LSD for NUA purposes.

Submitted by William Harkrader on Wed, 2020-02-12 22:27

Hi , no it is a 1099-div and it list the divdends in the ordinary dividends box 1a,   My privately held stocks with my company that I have purchased pay the same dividends but the 1099div shows the amount in the ordinary  1a and qualified box 1 b . Reading the definition of 1b states in effect that box is for qualified dividends from a company stock and should be treated asa disbursment, but on the esop 1099 there is nothing in the box 1b

Submitted by William Harkrader on Thu, 2020-02-13 15:18

Hi , no it is a 1099-div and it list the divdends in the ordinary dividends box 1a,   My privately held stocks with my company that I have purchased pay the same dividends but the 1099div shows the amount in the ordinary  1a and qualified box 1 b . Reading the definition of 1b states in effect that box is for qualified dividends from a company stock and should be treated asa disbursment, but on the esop 1099 there is nothing in the box 1b

Submitted by Alan - IRA critic on Thu, 2020-02-13 16:29

The plan is not reporting the ESOP dividends correctly. They should be reported on a 1099R with Code U since 2009. At least they plan is not indicating that any of the ESOP dividends are qualified dividends, but the PLR referenced earlier applies to Code U, and reporting on a 1099 DIV eliminates Code U. The other question is that you have been getting non ESOP employer stock dividends that are not 404k dividends and thus can be reported on a 1099 DIV. In short, you have been receiving dividends from two sources. I assume that an intervening distribution applies to any of the plans that must be part of the LSD and a 401k and ESOP are considered as “like plans”. It is possible that ANY distribution reported on a 1099 DIV would not be treated as an intervening distribution (disqualifying the LSD). Therefore, to cut to the chase, I would call the plan administrator of the ESOP (since you are only interested in the ESOP shares for NUA) and ask if the 1099R issued for the ESOP shares distribution will show NUA in Box 6. Without a complying 1099R, you are not likely to be able to utilize NUA anyway, and the plan must decide whether they consider these dividends (from either plan) as intervening distributions. 

Submitted by William Harkrader on Thu, 2020-02-13 20:41

Thank you, I did call my company as you suggested, and thet told me that they do not issue a 1099r until distribution takes place. They said on the 1099r that box1   has gross distribution , box 2a list the taxable amt which they think.  is my cost basis, box 6 states net unrealized appreciation from employers securities and then a $ figure, and finally box 7 has a code 7. She told me that this is all that is on it in the example 1099r she has. Thank you for your advice

Submitted by William Harkrader on Thu, 2020-02-13 20:42

Thank you, I did call my company as you suggested, and thet told me that they do not issue a 1099r until distribution takes place. They said on the 1099r that box1   has gross distribution , box 2a list the taxable amt which they think.  is my cost basis, box 6 states net unrealized appreciation from employers securities and then a $ figure, and finally box 7 has a code 7. She told me that this is all that is on it in the example 1099r she has. Thank you for your advice

Submitted by William Harkrader on Fri, 2020-02-14 15:16

Thank you, I did call my company as you suggested, and thet told me that they do not issue a 1099r until distribution takes place. They said on the 1099r that box1   has gross distribution , box 2a list the taxable amt which they think.  is my cost basis, box 6 states net unrealized appreciation from employers securities and then a $ figure, and finally box 7 has a code 7. She told me that this is all that is on it in the example 1099r she has. also is there a time limit on executing nua, I retired 4 yrs ago but did not take any distributionsThank you for your advice

Submitted by William Harkrader on Sat, 2020-02-15 02:51

  Thank you, I did call my company as you suggested, and thet told me that they do not issue a 1099r until distribution takes place. They said on the 1099r that box1   has gross distribution , box 2a list the taxable amt which they think.  is my cost basis, box 6 states net unrealized appreciation from employers securities and then a $ figure, and finally box 7 has a code 7. She told me that this is all that is on it in the example 1099r she has. Thank you for your advice 

 

Submitted by William Harkrader on Mon, 2020-02-17 18:53

If I take my distribution from esop in kind as shares of company stocks I understand I have to pay income taxes on cost basis, and LT on shares sold in the future, my question is my current income consist of dividends from company stock and ss, some dividends are qualified and some are not. Will the cost basis from nua be taxed on tatal income as a whole or will qualified divs be taxed at 15 and non quualified 20 or 25%. I am trying to figure the percent of the 2020 taxes if I do this, thank you for your advice   

Submitted by Alan - IRA critic on Mon, 2020-02-17 20:10

  • The cost basis is taxed at your ordinary marginal rate, as just another addition to your taxable income. Qualified dividends are taxed at a lower rate, but they are stacked on top of other income, so it is possible that adding the cost basis of the ESOP shares to your income will increase your total income enough to cause the rate on the qualified dividends to go from 0 to 15, or from 15 to 20 or even higher. But of course, your cost basis for the ESOP shares is only 9% of current value.

Submitted by William Harkrader on Mon, 2020-02-17 21:19

Thank you, so with the amt of tax I will be looking at for next year is it a smarter move to do  in kind as stocks to an IRA given the new secure act and no longer availability of stretch IRA..I realize I will lose the cost basis if I do. Or is just pay me now or pay me later, also concerned for the best move for heirs.  

Submitted by Alan - IRA critic on Mon, 2020-02-17 23:02

  • If you are concerned about taxes on the cost basis, another option is to roll over half the ESOP shares to an IRA and distribute half to taxable. That reduces your taxable cost basis to 50% and the NUA to 50% and reduces the temptation to hold on to too many shares of a single holding. Generally, your largest holding should not be more than 10% of your total savings, so if all the ESOP shares exceed that, you should sell the excess sooner than later. Shares you roll over to an IRA can be sold with no current taxes due, but shares distributed to taxable will be taxed on 90% (plus any later gains) of the proceeds, so there might be some hesitation to sell right away and incur cap gains, even though the rate is lower on cap gains.
  • As for heirs, if in lower brackets they could sell any inherited NUA shares and pay 0 taxes up to the top of their 12% bracket (under current law). 
  • Yes, doing the LSD means paying on the cost basis now in order to lower the rate on cashing out the rest at the lower LT rate vs. ordinary income from increased RMDs if rolled over to an IRA instead. The lower rate also applies to any additional gains after the LSD for shares held over one year after the LSD. 9% cost basis is very attractive for NUA, whereas 30% or higher is not.

Submitted by William Harkrader on Tue, 2020-02-18 00:58

If I understand correctly any shares rolled to Ira taxes are defered but any that are sold after are tax at 100%of sale because there is no longer a cost basis and taxed at regular income tax rate?. If I take advantage of nua weather totally or 50% I pay tax on cost basis that year of distribution. Then if I sell shares later I will pay taxes at LT of 15% or 20% on diff of cost basis per share and total value of sale per share . example :cost basis of $10 per share and sale at  $100 per share will be taxed on $90 per share?  Any shares I sell in future would be based on the cost basis at time of distribution? ?Then I do not have to worry about RMD? and my heirs get stepup when I die?                             

Submitted by Alan - IRA critic on Tue, 2020-02-18 01:32

  • If you roll the shares to an IRA, they are treated like any other IRA holding after that. Selling the shares in the IRA is not a taxable event. You are only taxed when an IRA distribution is made, so eventually with RMDs or other IRA distributions, amounts distributed that came from these shares will be taxed at the full ordinary income tax rate, but that would be spread out over the rest of your life plus 10 years for most beneficiaries. The only exception is when you have IRA basis from having made non deductible contributions.
  • NUA example – yes, you would report 90% of the amount received as a long term cap gain taxed at the lower rate. If the shares gain, additional gains are also taxed at the lower LT rate as long as you wait 1 year to sell. Otherwise, additional gains sold in the first year will be taxed at the higher ordinary rate. If the shares drop in value, then the NUA is just erased for the lost value. There are no RMDs for these shares so you can hold them as long as you wish.
  • If inherited, the NUA portion does NOT get a step up. The cost basis plus additional gains after distribution do get the step up. Example: Heirs sell shares worth $150 assuming no change after they inherited – there is no step up for $90 of the proceeds. Their cost basis is $60 and they owe cap gains for 90.

Submitted by William Harkrader on Tue, 2020-02-18 22:00

It is all very confusing but seems because of low cost basis and Lt on future sale of stocks taking advantage of nua is a better choice. Although they are close but if I understand correctl if the stocks were in IRA any distribution would be taxed on 100 % of value at full income tax rate vs  in my individual acct  future sales taxed at basically 90% of value at LT . Just have to pay tax on cost basis now.

Submitted by Alan - IRA critic on Tue, 2020-02-18 22:26

Yes, that is correct.

Submitted by William Harkrader on Thu, 2020-02-20 00:43

Thank you, I have decsions to make

Submitted by William Harkrader on Thu, 2020-02-20 17:58

In ref to above conversations. I retired from company in 2015 at 58yo, I have not taken any distributions from 401 k or esop other than dividends paid directly to me from the stock. I just did inkind distribution of 401k to ira due to high cost basis, now I am ready to do inkind dist on my esop to my personal acct. My question is because I retired from company in 2015 do I still qualify for nua tax advantage ,?  Will the dividends once in my individual acct be ordinary or qualified?

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