NUA - Employer Securities in a BEAR Market

[Guest Richard Plant]

A retiring client, age 65, needs cash and wishes to distribute the employer securities (in-kind) from his 401(k), pay income taxes on the basis, and immediately sell the distributed shares at capital gains rates versus taking a fully income taxable distribution from the plan.

His average cost basis is $30 per share with a market value of $100 per share on the day he requests the distribution. A few days later the In-Kind distribution is made when the value of the stock has suddenly dropped to $25 per share ($5 per share less than his basis).

Would the In-Kind distribution still be taxed on his basis of $30 per share (despite the $25 per share market value)?

If the client is taxed at $30 per share, could he claim a loss if he immediately sold the distributed shares at $25 per share? Would it be a long-term or short-term capital loss?

Or would the In-Kind distribution be taxed at the market value of $25 per share?

If the client did not really need the cash, I would imagine that he could get the recently distributed In-Kind share certificates into an IRA within 60 days, pretend the whole thing never happened, and pray for the market value to rise.

STRATEGY FOR CLIENTS PLANNING WITH NUA IN A BEAR MARKET:

Assume another executive, an active participant in the same 401(k) plan that is not scheduled to retire for several years has a average cost basis of let’s say $50 per share for the employer securities in his 401(k). The total combined current market value of his 401(k) is $1.2 million (600k in employer securities and 600k in mutual funds). He is very happy with the long-term outlook and the current fundamentals of the employer stock despite its recent fall from a $100 per share market value to a $25 per share market value.

Do you see any tax disadvantages to having such a plan participant sell his existing employer securities with a current basis of $50 per basis only to re-purchase it a day later with a new basis of $25 per share? I am not much for short-term trading (especially with 1.2 mil) so perhaps the client would consider placing two transactions in one day as follows:

This client would simply instruct his plan to:

1) Sell his existing 600K in employer securities and purchase 600k in mutual funds.

2) Then he would immediately place another trade instructing his plan to sell his existing 600k in mutual funds and purchase 600K in employer securities.

He has now dropped his basis from $50 per share to a basis of $25 per share and still holds the same amount of employer securities and funds! If the stock continues to decrease in value and he maintains the same level of confidence in the stock, he will repeat this transaction in an effort to obtain an even lower basis in the employer securities.

If someone is planning on using an In-Kind distribution as part of his or her overall long-term tax strategy, doesn’t it make sense to obtain the lowest possible cost basis? Excluding portfolio diversification, what are some of the disadvantages to this approach?

[Guest Harry O]

The date the participant requested the distribution is irrelevant. The stock is considered "distributed" on the date the trustee delivers the certificates to the transfer agent or directs the transfer agent to reissue shares in the participant's name. See Rev. Rul. 81-158.

In your example, the client pays tax on $30 per share but can claim a loss when he sells the shares.