NUA and After Tax Contribution in 401k
A client has a large 401k account with low basis company stock that is eligible for NUA when he retires at age 60 this year.
Part of the stock was purchased with AFTER TAX funds. Other funds in the account are in mutual funds.
Are only the PRE TAX and COMPANY MATCHING STOCK eligible for NUA and must the AFTER TAX stock roll with the mutual funds to an IRA?
Permalink Submitted by Alan Spross on Wed, 2007-10-31 22:36
Both the shares considered purchased with pre tax funds AND those purchased with after tax funds are NUA eligible. This can be confusing because plan basis and tax basis are two different animals.
The company shares considered purchased by after tax contributions will have the same NUA, but a lower taxable cost basis for the year of distribution. The plan should be requested to provide a breakdown in an understandable format.
Permalink Submitted by [email protected] on Thu, 2007-11-01 09:36
Thank you for the reply.
So, for simplicity sake, if I have one share in pre tax with a plan basis (the pretax money I contributed) of 20$/share and one share of after tax with a basis of 50$/share.
If I remove these shares using NUA I would end up owing tax (ordinary income) only on the $20 basis potion of the one share but nothing on the 50$ basis after tax share. I now own two shares of long term gain stock outside of a qualified plan for which I only paid tax on the one item. When I sell, I have the appropriate capital gains tax tied to each individual share.
Is this basically how it all works?
Permalink Submitted by Alan Spross on Thu, 2007-11-01 21:53
Yes, the taxable amount on the 1099R should be $20.
The NUA will be an average per share basis for all shares elected to be distributed to the taxable account. For example, if the FMV of the shares at distribution is $80 per share, the plan average cost basis will be 50+20/2 or $35. The NUA per share will be $80-$35=$55. That $55 figure will apply to both (all) shares.
There may be some accounting differences between plans. Most plans use averaging over all company shares, but there are some that keep the cost basis separate for various periods or lots of shares. That can enable an employee to order the plan to sell the higher cost shares in the plan leaving fewer lower cost shares to distribute for NUA. You have fewer shares, but the taxable cost basis is less and the NUA greater per share.
Another option for plans that provide separate accounting is to transfer the higher cost shares to an IRA if employee wants to keep all shares, and use only the lower cost shares for NUA. Again, the employee has to get this all straight with the plan before ordering the LSD because the IRS will expect the 1040 to conform to the 1099R issued by the plan. And the 1099R will reflect the accounting conventions of each plan. Because of the obvious complexity and accounting gyrations, most plans just use average plan cost over all shares.
Permalink Submitted by BruceM on Fri, 2007-11-02 17:13
Alan
While we’re on the topic….
…do you know how share of privately held companies are valued when calculating the cost basis for the LSD? And does this method of valuation have to be the same method used when the NUA shares are later sold?
It seems that with private shares, the NUA system could be ‘gamed’ by using one discounting system to value the stock pre-LSD and then another more generous valuation methodology when selling the shares out of the taxable account.
BruceM
Permalink Submitted by Alan Spross on Fri, 2007-11-02 19:53
Sorry, Bruce, can’t really help you in this area, but if the cost basis of these shares could be “depressed”, it seems like that would also reduce the deduction to the employer for contributing these shares to the plan.