NUA Taxation
I want to verify I have my NUA facts and taxation correct on the following example, it’s hard to find local CPA’s who have good knowledge of the process and taxation!!!
Client age 56, married and will separate from his company March 1, 2021, 401K aggregate plan balance is 1 million. Employer publicly traded stock makes up 400k of 1 million balance. The employer stock has 2 lots; 1st lot has 50k basis with market value of 100k, the 2nd lot has basis of 200k with market value of 300k.
NUA planning idea is to move the 1st lot of employer stock (aggregate 100k) via NUA and sell all shares immediately. This will require him to claim the 50k as ordinary income and the 50k gain as L/T capital gain. This 100k plus some YTD wages will keep them within the 12% marginal bracket after standard deduction. My assumption is the 50k of gain wont be taxed under current tax rules unless the NUA capital gain must be taxed at L/T rates which I don’t believe is the case, can you verify my assumption?
The remainder of the 401k will be rolled over to an IRA leaving no 401k balance at year end. My understanding is he can rollover the other lot of employer stock and not hinder NUA on 1st lot? Also, I believe he could sell some of the 1st lot within the plan before requesting the NUA distribution to lower market value which in turns will lower basis for ordinary income to ensure we keep all wages within 12% marginal bracket for the tax free capital gain on any sold shares?
Should he not sell all the NUA shares after distribution this is where my tax ramification is cloudy? My understanding is the gain when stock arrives in Brokerage account is always taxed at L/T gain but any additional growth on market value would have a separate capital gain tax depending on the holding period. Example; NUA shares have been moved to a Brokerage account and on April 1, 2021 NUA basis is 50k with MV of 100k. He sells full position on July 1, 2021 with a MV of 120k. The 50k gain is taxed as L/T cap gain rates and the 20k of additional growth at S/T cap gain rates since not held for 1 year? If all sold after April 1, 2022 then all gain at L/T cap gain rates?
Any clarification or confirmation of the above example would be much appreciated!!!
Permalink Submitted by Alan - IRA critic on Thu, 2021-02-11 16:11
For your first question, the 0 bracket for LTCGs tops out at 80,800, just below the 81,050 of taxable income where the 12% bracket on ordinary income tops out. All the NUA for the shares sold in 2021 are included in taxable income, and stacked on top of the ordinary income. Therefore, the cap gains that fall under 80,800 are taxed at the 0 rate, and those that spill over that figure will be taxed at 15%. If half the gains fell under 80,800 of taxable income and half over, client would pay an average rate on the gains of 7.5%. So the tax on the gains depends on how much room is left in the 0% cap gain bracket. I think this is what you assumed.
You are correct that just a portion of the employer shares can be used for NUA, with the rest sold in the plan before the LSD or rolled to an IRA. It should be verified with the plan that the 1099R will be based on these lots separately, and that the usual average cost basis will not be applied to all the NUA shares. Similarly, you are correct that some Lot 1 shares could be sold in the plan to reduce the number of shares distributed for NUA purposes. That would reduce the Box 2a cost basis and the Box 6 NUA amounts and assist in keeping the cap gains on shares sold after the LSD within the 0% cap gain bracket.
You are also correct that any additional gains after distribution from the plan will be taxed at the ordinary income rate if sold in the first year after distribution. An effort should be made to have the receiving broker capture the cost basis per share and the NUA per share, so their 1099B will break out the LT and any ST gains properly. Should the shares drop in value after distribution, and then sold, this will simply result in a reduced amount of NUA and a lower LT gain. It will simplify things if any dividends are not reinvested in more shares.
If client has any other similar plans from this employer such as an ESOP, the entire value of such other plans must also be distributed by year end to have a qualified LSD.
Finally, note that client will not be subject to the 10% early distribution penalty on the cost basis of 50k because he separated from service at 55 or later. The 1099R for the NUA shares should be coded 2 in Box 7 and the lump sum distribution should be checked. If client has made any after tax contributions to the plan, most plans use that to reduce the taxable cost basis, but some provide greater flexibility.
Permalink Submitted by MIKE KRUCHTEN on Fri, 2021-02-12 22:24
Thanks for the detailed response. I have 2 follow up questions on the L/T Cap gain question in my example showing 50k in basis and 50k gain sold immediately.I assume the date the NUA securities post to the Brokerage account determines the valuation date for market value to determine if there are additional gains between client requesting and shares actually being available to sell. I have seen this process take 7-10 business days from date of request. 2nd question on the LT Cap gains. If a married couple both 65 have the NUA transaction as only reportable income (50k basis and 50k gain) I feel there would be no capital gain tax since the standard deduction of $25,100 for 2021 would come off the 100k bringing their taxable income below $80,800. Am I correct on my assumption? I realize what spills over the $80,800 would be taxed at 15%.
Permalink Submitted by Alan - IRA critic on Fri, 2021-02-12 23:31
The cost basis and NUA per share is determined by the share value upon distribution from the plan. Therefore, any gain or loss after the processing of the distribution will count as post distribution gain or loss, and the holding period for any additional gains also starts immediately. The broker should be advised what the cost basis and NUA amount should be per share as soon as it can be confirmed with the plan, so the broker will record it before any of the shares are sold. You are correct on the second question, the CG tax rate should be 0.