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Tax Break For Company Stock

Do you have highly appreciated stock in a 401(k)?

Return to Index Printable Version

Let's suppose you are retiring or leaving a company and inside your 401(k) is company stock. It may be to your advantage to implement the NUA Tax Break.

NUA stands for "Net Unrealized Appreciation." It relates to company stock within a retirement plan which has appreciated. The "break" gives an employee the opportunity to withdraw the company stock from the plan with less taxes owed on company stock.

This can be significant ... if there is significant appreciation. Here's a hypothetical example for illustrative purposes: John Smith is 45-years-old and is changing jobs. His 401(k) has a market value of $100,000. His retirement account is composed of $40,000 in company stock and $60,000 in a variety of mutual funds and a fixed account.

When John called the 401(k) administrator, he found out the cost basis of his company stock is $10,000. Now he has a unique opportunity.

John can withdraw his shares of company stock. He will get a stock certificate. The rest of the 401(k) could be rolled over to a Traditional IRA. For the $60,000, the IRA rollover would continue the tax deferral.

Through the NUA Tax Break, when John receives the stock outside of the plan, he will pay taxes based on the stock's cost basis. If his combined federal and state income taxes are 30%, John will be taxed $3,000 on this withdrawal. In addition, because he is younger than 59½, he will also have a 10% penalty for a premature distribution. So he has to plan on an additional $1,000 in taxes (10% of $10,000).

This unique tax break means John is able to receive $40,000 of company stock and pay only $4,000 in taxes (for our hypothetical example). Once completed, John has the company stock outside of the retirement plan. A later sale of the stock (at least 12 months and one day after the withdrawal), could result in taxes being paid at the current capital gains rates (15% federal tax in John's tax bracket) instead of ordinary income tax rates.

The NUA Tax Break only applies to company stock. It is only available when there is a full distribution of the retirement plan.

The opportunity can be dismantled by active trading of the company stock. Back to our example, suppose John chooses to capture the gain of his company stock while it is within the 401(k). So he sells his shares and moves $40,000 into a money market fund. Then he reads about the NUA Tax Break and moves it back to company stock. That transaction changed his cost basis from $10,000 to $40,000. The reentry into company stock created a new cost basis and eliminated the tax advantage of the NUA Tax Break.

For highly appreciated company stock, the NUA Tax Break can offer significant tax savings. It is a complicated topic and should be discussed with your financial advisor and tax advisor. At Woolman Financial Group, we're ready to help with this topic.

** Financial advisors do not provide specific tax or legal advice. You should consult your specific tax or legal professional regarding your specific situation.

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