Net Unrealized Appreciation (NUA)

[HowdyDoodle1]

I am considering whether to take a distribution of company stock in my 401K and transfer to a brokerage account then report net unrealized appreciation.  I was trying to model this in Turbotax assuming I will receive a 1099R.  For example purposes, I entered the Gross Distribution ($100,000) in Box 1.  Entered taxable amount (basis) in Box 2 for $40,000.  Entered $60,000 in Box 6 for NUA.

TurboTax should only be taxing me for the taxable amount of $40,000.  Instead it is taxing me for the Gross Distribution of $100,000.  

I would appreciate if someone could advise me as to the proper way to fill out the form.  As I do not have an actual 1099-R form in hand, it's guesswork for me at this point.  Thank you.

[Mike9241]

When you take an in-kind distribution of employer securities from your retirement plan as part of a lump-sum distribution, you generally pay tax on the cost basis (the trust’s cost basis for the security) of the securities at ordinary income rates in the year of the distribution. A 10% penalty may apply before age 59½.

The employer securities are then held in a nonqualified brokerage account and any gains, either while the securities were in plan or after the securities were distributed from the plan, are not taxed until you sell them.

When you sell the securities, you will pay taxes at the long-term capital gains rate on any NUA and the applicable short or long-term capital gains rate on any additional appreciation since distribution. The applicable capital gains rate on any additional appreciation depends on the holding period after the distribution from the retirement plan.

A lump-sum distribution is the distribution or payment within a single tax year of a plan participant's entire balance from all of the employer's qualified plans of one kind (for example, pension, profit-sharing, or stock bonus plans). Additionally, a lump-sum distribution is a distribution that's paid:

• Because of the plan participant's death,
• After the participant reaches age 59½,
• Because the participant, if an employee, separates from service, or
• After the participant, if a self-employed individual, becomes totally and permanently disabled.

your scenario does not appear to be a lump sum distribution.

There are additional requirements that must be met as part of the NUA rules. Within one year, you must distribute the entirety of the vested balance held in the plan, including all assets from all of the accounts sponsored by the same employer. Certain qualifying events must also be met. You must have either separated from the company, reached the minimum retirement age for distribution, suffered an injury resulting in total disability, or you must have died.

therefore, as you describe the situation the whole $100K is taxed as ordinary income because it does not meet the NUA rules

on the other hand, if you meet the NUA rules the $40K is taxed as ordinary income and if you sell immediately in the brokerage a/c you get a 1099-B showing proceeds of $60K. With tax basis of zero you now have your $60K LTCG

Assuming when i enter $100 for gross distribution, $40 as taxable, and $60 as NUA only $40 shows up as taxable but I'm using a different version of  Turbotax so why you get $100K as taxable is unknown if that's what you filled in. 

[HowdyDoodle1]

Thank you for taking the time to reply- it is much appreciated.  It appears I should find a tax accountant to determine if I qualify to take the NUA treatment.  I am retired from my former company and have a significant amount of company stock in my 401K.  My thought was to have the stock distributed to me then placed into a nonqualified brokerage account for favorable capital gains treatment down the road.  The rest of my 401K would be rolled over from the 401K to an IRA.  This would deplete my 401K balance. However, if I don't meet the qualifications for NUA treatment, I certainly don't want to proceed.  Thanks again for your answer.

[Mike9241]

you have given me more info. orginally, I thought you were taking a partial distribution and thus did not satisfy the NUA rules 

however, if you are retired meet the NUA criteria and have employer stock in your 401(k), under the NUA rules, you can consider rolling only the stock into a brokerage account. The rest can go into an IRA tax deferred.

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additionally, the NUA rule cannot be used if they roll the stock over to an IRA and then liquidate it.
and you are taxed as on the cost basis of the stock distributed in kind in the year in which it is taken.

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here's more info i copied from another website

As a result, the best practice for NUA distributions is to really scrutinize the cost basis of the employer stock inside the qualified plan, and if necessary cherry pick only the lowest-basis shares for the NUA distribution to ensure the most favorable tax consequences. Fortunately, the NUA rules do allow such flexibility – to take some shares in-kind, and roll over the rest – but that still means it’s necessary to actually do the analysis to determine whether or how many of the NUA-eligible shares should actually be distributed to take advantage of the strategy (or not)!

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thus, consulting a tax pro is advisable. 

[dmertz]

It's generally up to the plan administrator to determine if the distribution qualifies for NUA treatment.  If so, the Form 1099-R will be prepared as you indicated (along with code 1, 2 or 7 in box 7 and the IRA/SEP/SIMPLE box unmarked).  Entering such a Form 1099-R (making sure to indicate that you did not move the money to another retirement account but instead "did something else with it") does cause TurboTax to include in taxable income only the amount from box 2a, not the entire gross amount.

[HowdyDoodle1]

Thank you!!  You just solved the issue I was having - my error - I was checking the IRA/SEP/SIMPLE box which was causing the entire distribution to be taxed.  Unchecking the box made the calculation work perfectly.   I have asked the plan administrator for the basis of the stock and will proceed from there to determine if this is the best alternative for me.  Many thanks for your assistance - it  is  greatly appreciated. 

[andreeank2]

Treatment of Net Unrealized Appreciation when moving the stocks to a brokerage account and securities are consequently sold*

https://www.irs.gov/taxtopics/tc412#:~:text=Net%20Unrealized%20Appreciation,-If%20the%20lump%2Dsum

*under the assumption the taxpayer elected not to include the NUA in the income in the year the securities were distributed.

• NUA is a special tax treatment that relates to distributions of appreciated employer securities from an eligible employer-based retirement plan as a part of a qualifying lump-sum distribution.

• The taxation of the securities is based on the cost basis of the securities and the amount that they have appreciated while in the plan.

• The cost basis of the securities that are distributed in-kind will be taxed at ordinary income tax rates when you take a qualifying lump-sum distribution that includes appreciated employer securities. It will be taxed in the year you take the distribution from the plan. A 10% premature distribution penalty may apply.

• Taxation of the appreciation, the NUA, following a lump-sum distribution is deferred until the employer securities are sold or disposed of.

• When securities are sold, any NUA is taxed at the long-term capital gains rate. Any additional gain is taxed based on the holding period of the securities after they are distributed.

• You can elect not to use the NUA tax strategy.

• NUA is not available and is irrevocably forfeited if the employer securities are rolled into an IRA.

TurboTax does not have a native interview for the securities sold under NUA. The customer will receive a 1099-B with cost basis $0.

If the stock was hold for more than 1 year in the brokerage account the entire amount can be entered as per 1099-B, box "cost basis is incorrect or missing on my 1099-B" checked, and cost basis = cost basis of the stock in 401K (box 2 of the 1099-R)

For stock hold for less than 1 year, sale has to be broken in two pieces in order to tax the NUA as long term capital gain:

One part for the long term capital gain of NUA:

• The type should be long-term did not receive 1099-B, cost basis = 0, proceeds = NUA. The result will be a long term capital gain for the amount of the NUA.

Second part for the consecutive appreciation of securities, long-term or short-term capital gain/loss, depending on the holding period of the securities in the hands of the distribute.

• For the Net gain/loss realized in the sale – complete first part of the interview based on the information form 1099-B (cost basis = 0)

• The box "cost basis is incorrect or missing on my 1099-B" checked

• Cost basis = NUA

The result will be capital gain/loss equal to the difference between the net unrealized appreciation at the time of distribution and the market value at the time of selling the stock.