Thursday March 28, 2024

4.6.6 Net Unrealized Appreciation

Net Unrealized Appreciation

Employee Stock Plan Distribution:  Some qualified retirement plans are permitted to hold employer's stock.

Diversify Tax Free:  An excellent means for tax-free diversification that preserves maximum liquidity is a zero capital gains tax sale and unitrust.

Employee Stock Plan Distribution


Some qualified retirement plans are permitted to hold employer's stock. When an employee retires from a corporation, he or she may receive a distribution of shares of company stock. For a lump sum distribution of company stock, the "net unrealized appreciation" (NUA) is not taxed. Only the cost basis in the stock is included in the employee's ordinary income. In addition, the stock is immediately treated as a long term capital gain asset. If the employee were to sell the stock, there would be long term capital gain on the NUA sale. Sec. 402(e)(4).

Since the employee has received a large distribution of company stock and he or she may have acquired other company stock through options or purchases over the years, there frequently is a pressing need for diversification. However, the employee would prefer to diversify without payment of tax.

Diversify Tax Free


An excellent means for tax-free diversification that preserves maximum liquidity is a zero capital gains tax sale and unitrust. A portion of the NUA stock is transferred into a charitable remainder unitrust. The capital gain is bypassed on that portion. In addition there is a charitable income tax deduction. This deduction may offset part or all of the long-term capital gain on the sale of the NUA stock. Reg. 1.402(a)-1(b)(1)(i). PLR 199919039.

Example 4.6.6A Jones NUA Tax-Free Sale

John Jones retired this year from a major corporation. He received a lump sum distribution of his 401(k), which was invested entirely in the stock of the major corporation. His lump sum distribution was $600,000 in stock with a cost basis of $150,000. The $150,000 is ordinary income, but $450,000 represents net unrealized appreciation (NUA).

John would like to diversify by selling $400,000 of the stock. He transfers $200,000 of stock into a 6% unitrust for the benefit of himself and his spouse Kris for their lifetimes. John and Kris sell the $200,000 inside the unitrust tax free. In addition, there is an income tax deduction of approximately $68,000. The tax savings in their high income bracket will save enough to offset the tax payable on the sale of an additional $200,000 of stock. Thus, John and Kris are able to diversify $400,000 of stock with zero tax. $200,000 is in the unitrust and $200,000 is cash. Both amounts are reinvested in diversified securities portfolios.

Case Studies on Net Unrealized Appreciation

A 401(k) Rollover to a CRT:   Jackie Judson, age 60, has worked for the same company for over 30 years. Back when she began as an employee with this company, a 401(k) plan was established to provide for her retirement. The 401(k) is invested exclusively in the company stock, which has appreciated substantially over the years. In fact, based upon the number of shares in her 401(k) and the current fair market value of the company stock, the plan is currently valued at $1,000,000. Jackie is considering retiring and is quite concerned that the plan is invested entirely in one stock. She has read many times in financial planning publications that there are three key ingredients to investments - diversify, diversify and diversify. Also, she is interested in making a current gift of $50,000 to one of her favorite charities and a planned gift, possibly through a charitable remainder unitrust.

Private Letter Rulings

PLR 200038050 ESOP Stock to Unitrust:   Taxpayer A was an executive and retired in 1999 at age 55. He proposed taking a lump sum distribution from his retirement plan. Part of the distribution would be rolled over into an IRA and part would be received and then transferred to a charitable remainder unitrust.

PLR 200434022 Filing Wrong IRA Rollover Form Triggers Taxable Income:   During his time at Big Corp, Edward Employee participated in Big Corp's retirement plan. The retirement plan was a combination Employee Stock Option Plan (ESOP) and Sec. 401(k) plan. A portion of Edward's ESOP was invested in Big Corp stock. The rest of Edward's ESOP and his 401(k) plan consisted of a diversified portfolio of mutual funds.


      Quiz-Basic



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